(Picture from Monday, August 30, while filming the live event at the studio with CFO Teo Ottola, VP Investor Relations Kiira Fröberg, and virtually EVP BA Service Fabio Fiorino)
On Monday, August 30, we organized a virtual event for investors and analysts on our Service Business Area featuring EVP BA Service Fabio Fiorino who gave an update on the business area’s recent development.
The event raised strong interest already well before the actual event date and registrations kept coming in until the last minutes. During the event, we had a large virtual audience of investors, analysts, employees as well as others interested in the business. We received good questions already during Fabio’s presentation and as part of the Q&A section and decided to extend the event past the initially scheduled one hour to cover as many questions as possible.
We also wanted to summarize the Q&A part of the event in this blog post as well as include a few additional questions that we did not have time to cover during the event.
You can find the recording of the event and the presentation material here.
Q1: You mentioned service addressable market is over eur10bn, how keen are you to serve cranes by other OEMs? What is the penetration you have on your own installed base? Is servicing your own cranes more profitable than servicing other OEM cranes?
(Konecranes IR comment: penetration of the installed base was well covered in the presentation)
We are very keen on servicing cranes made by other OEMs. We serve customers, and our customers have cranes of all makes. We want to service the customers’ entire fleet. On profitability, our proprietary parts have a higher margin compared to parts bought from third parties due to the value added from our own operations. However, there are also a lot of equivalent parts that we can manufacture or then acquire as commercially available parts. Another piece is the digital services which are mainly brand agnostic and with the same profitability, for example, the CheckApp is for any make. Servicing other makes of cranes also provides future opportunity for Konecranes equipment. At some point the hoist will need to be replaced, by either a new crane or then as a modernization or retrofit, and we can perhaps replace it with our own product.
Q2: Why has the growth rate in the agreement base slowed down recently and how could the growth momentum be sustained in the early quarter of 2020 H1 during peak COVID? What would you expect the growth rate to be in 2021 and 2022?
Our agreement base is now well above 2019 levels. Many businesses have faced a lot of volatility during the COVID-19 pandemic, whereas our agreement base has not seen it. We have gone through the entire pandemic cycle, although it’s not over yet, with a very solid agreement base which shows the resilience of the base. Instead of looking at a short period’s agreement base value development, one should have a longer perspective. For the future, we do not comment on specific targets, but the agreement base growth is key to achieving growth in Service.
Q3: Taking into account the differences between Konecranes and Demag branded equipment, is there major difference in asset coverage potential? What are the targets for the two brands? Is the business potential per asset very different?
Overall, the Demag installed base is lighter i.e. it includes more light lifting equipment, such as chain hoists and light cranes systems, compared to the Konecranes installed base. In general, the target and potential for the coverage should be the same for both brands. We also look at the asset coverage by customer as customers are buying multiple brands. We are not limited as to coverage by brand nor have we set a hard target for coverage. There is still more room to expand coverage especially for the Demag brand as the coverage is lower there. The MHE-Demag acquisition also helps us with the Demag brand coverage in the Southeast Asia Pacific region.
Q4: How has the pricing developed over the past years? Differences in pricing of legacy Konecranes services vs Demag branded?
The Demag Service business has been quickly integrated throughout the world after the MHPS acquisition. Pricing was thus aligned between the brands/organizations as we are one service organization servicing both Konecranes and Demag as well as other brands. We are a service company for all makes. We have applied the best practices from both legacy organizations also in terms of pricing.
Q5: Business Area Industrial Service growth has been relying quite a bit last years on increasing spare parts prices every year. How much spare parts prices can still increase? As individual parts prices are getting already above a new equipment.
That’s a broad statement – we have thousands of spare parts, and each category has its own dynamics. Across the world, the inflationary pressures are certainly there. Costs of commodities have grown, transportation costs have grown and there are impacts on supply chains and overall, impacts from operating in the COVID-19 environment. A lot of our price increases are to combat inflation. Spare parts tend to be relatively expensive in all industries. We want to make sure our offering is competitive and that our equipment is competitive regarding the total cost of ownership. One cannot look at the cost of a single part, but rather the whole.
Q6: Could you talk a little about the demand fluctuations of your various service sub-segments (parts, modernisations, maintenance etc.) throughout the pandemic, and where are we now vs pre-pandemic levels? What are you expecting in terms of pent-up / postponed demand?
It really varies, the pandemic had and continues to have different impacts around the world. Site access restrictions impacted the execution of the agreement base – the inspections, preventive maintenance, predictive maintenance and our overall ability to get on site. There were essential industries that were easier to serve and other industries that were completely shut down, there were also different approaches from customers. Basic maintenance fluctuates more according to capacity utilization rates, if the equipment is not being used it is not wearing. This has come back largely but there are regional differences. Then there is the capex picture where the larger modernizations are, and we are seeing some of that pent-up demand coming back. It is a mixed bag and there is variation.
Q7: At the time of the MHPS transaction in 2016-2017, investors were told that the Demag's installed base was 15-20% penetrated by their service business, whereas the comparable number for Konecranes was in the mid-30s %. Whilst the trend you highlight on slide 12 is clearly positive, I note that the penetration numbers themselves are non-comparable. Can you explain the difference between these penetration numbers and those communicated to investors in 2016-17?
(Konecranes IR comment: in the 2017 CMD, the presented number for Konecranes installed base penetration was 50%)
At the time of the MHPS acquisition, the definition of an asset differed between Konecranes and Demag. Now as the MHPS integration has been completed, the definitions have also been aligned. As a result, the penetration figure for the Demag installed base presented in the 2017 CMD has changed.
For example, a light crane system can have multiple hoists. Demag used to define each of the hoists in a system as a separate asset, whereas Konecranes defined the whole system as a single asset with multiple hoists. In addition, a hoist may be sold to replace an existing hoist on an existing asset – essentially not changing the asset count. In short, we were working with pieces of equipment delivered – not active assets in service. Now the same Konecranes methodology is applied also to the Demag installed base. With the Konecranes asset definition, the Demag base has a lower number of assets which translates into a higher penetration rate. The numbers presented now for 2017 and 2020 are comparable.
Q8: What is the level of cost inflation (salaries, material used in parts etc.) you are seeing in service business unit, and is pricing a challenge? Are the margin levels seen in past year sustainable, when your business moves into growth phase, taking into account underlying inflation, and potential labour shortages?
We don’t comment on individual price increase percentages, and the price increases depend on the product. We have been dynamic and have made price increases to combat inflation. We also have internal actions to manage cost inflation, for example procurement excellence. In addition, we continue to drive efficiencies. For example digitalization has driven organizational efficiencies, reduction of brick-and-mortar and allowed us to operate in a more efficient manner, and we have also learned that we do not need to travel as much. We are bringing in new products and digital services with good margins. There are a lot of moving pieces with plusses and minuses, but our goal is to continue the profitability expansion.
Q9: How would you compare Asian competitors' technical performance and capability against Konecranes. Seems that Konecranes BA Service just keeps struggling every year especially in China and India due to too high premium pricing position by Konecranes - resulting to that market is seeking and having preference on local service providers instead of Konecranes.
Asia is a diverse and vast region, so there is no single answer to the question. We have a premium approach, and our goal is not to chase the low-cost operators but to work with customers who are interested in safety and productivity, and who see the value in our offering and services. We believe this is a better way in the long run. These markets continue to develop, and we believe the markets will also mature in their approach to maintenance and what is required. We are also looking at ways we can segment our offering to different customer groups, but we are not chasing the lower end as we do not believe the value is there.
Q10: In the past, total services revenues were 5x to even 6x agreement base value. In H1 21 annualised services revenues were 4x. Is the ratio structurally falling or would you expect return to previous 5-6x?
We are in a good place with our business dynamics. The pandemic impacted the business with access restrictions: we may be doing inspections and maintenance, but if the equipment is not used as much, we are not doing the repairs. In addition, also capex decisions may be held off. We would expect the ratios to go back to a more normal level beyond 2020. Furthermore, we are bundling more and more products to our service agreements, creating recurring revenue, which means that they are covering some things that were sold separately earlier.
Q11: It is so easy for you to service other OEMs equipment, are there any barriers to entry for other OEMs to do the same with your own equipment? Can this turn to be very deflationary/price competitive for everyone?
The technology in lifting equipment is not too different – we are talking controls, motors, gearbox, drum, rope, hook. We can service other types quite easily. The key is obtaining proprietary componentry and where to source those if the equipment has them. The knowledge to inspect and knowledge to replace etc. is very much out there. Local service competitors also do maintenance on other makes as well. We believe what makes us uniquely positioned is our network and size, our systematic approach, our ability to source and to provide equivalent parts, and our ability to provide retrofits and replacement technology. It is not only about servicing the equipment, it is about providing the entire package and comprehensive approach. As mentioned earlier, other services such as the digital offering and consultation type services are brand agnostic. Most of our competitors at the end-user level are local or regional. We have the offering, the capability and the reach which makes our offering attractive.
Q12: What are KPIs/Incentives for Service sales employees? Would you say that you have emphasized margin improvement over growth post the Demag acquisition? Any change coming in priorities and incentives? Can the margin go above 20% or will you go purely for growth if you reach 20% margin?
We have emphasized profitability over growth in our incentives, and there is a weight on profitability over revenue growth. We have not yet decided on next year’s targets. On the 20% and beyond, we have not set that target specifically. Our target is to continue the profitability expansion. Profitability growth and sales growth are linked and go hand in hand, as much of the profitability growth comes through leverage. The infrastructure costs should not grow at the speed of the top line.
Q13: Could you reiterate and specify what you mean with "high single digit growth". In 2009-19 services sales CAGR was 4.8% including acquisitions such as MHPS. High single digit sounds unrealistic. How could you reach the targeted growth?
High single digit is quite self-evident, and it is a range of course. This revenue growth includes any other bolt-on acquisitions we would do in the future as well. Our focus has been on profitability expansion and building the ecosystem, building the products, and getting the integrations done. We have been building ourselves for the future while at the same time profitability has expanded. We are now positioning ourselves for the next phase. There is plenty of opportunity with new products, geographically, larger accounts, and tailoring offering also to smaller accounts.
Q14: Are you currently leveraging your Industrial Service best practice into your Port Solutions business? Have you started to transfer some of the competence you have into the port business yet? If so, what impact has it yielded on profits or growth thus far?
We certainly share best practices within the two businesses and try to learn from each other. We try to leverage some of the systems and practices, infrastructure for spare parts delivery, and supply chain and procurement actions. We have not commented the specifics or how these impact port service’s growth or profitability. The structure of the port services business is slightly different in terms of how much is agreement based and how much is spare parts, retrofits, and other type of services. There are also different businesses as well such as lift trucks which is largely distributor based.
UNANSWERED QUESTIONS DURING THE EVENT
You showed coverage percentages for Konecranes and Demag branded cranes. What could the coverage percentage amount for non-Konecranes or non-Demag branded cranes?
We have estimated the industrial crane maintenance market to be over EUR 10 billion and BA Service’s net sales in 2020 were around EUR 1.2 billion. Out of the industrial crane service market, a large share continues to be held by crane owners’ in-house teams. Konecranes is the market leader in industrial crane maintenance with a unique global branch network. Konecranes provides crane maintenance services to own Konecranes and Demag branded equipment as well third party manufactured cranes. We continue to target growth from both our own installed base and third-party cranes. Out of our agreement base, third party equipment represented approximately 55%.
How much are overall digital services revenues and are these new offerings profitable?
Digital services are an integral part of our service offering and are not a specific separate individual part of the offering. They are incorporated in our overall comprehensive and systematic service approach to the improve safety, productivity, and sustainability of our customers’ operations. Our digital capabilities allow us to provide crane maintenance efficiently and with a digitally-enabled customer experience. Our digital ecosystem covers the entire service business and is enabling growth and profitability. The ecosystem includes for example apps and digital tools for crane owners and operators, digital tools for our inspectors and technicians, TruConnect remote monitoring, analytics and digital platforms for internal operations, as well as utilization of the data to improve our operational efficiency further and deliver on customer promises. The digital services to our customers are truly brand agnostic providing additional value to any crane make. Our goal is to continue profitability expansion and these digital services and the entire digital ecosystem have a large role to play.
How are you working to expand into the Chinese market?
Please see the answer to Question 9.
We have solid and long-standing position in the Chinese service and equipment market supported by dedicated professionals, an extensive service network and a local supply chain.
How high can service coverage realistically grow?
Please see the answer to Question 3.
Do you have any meaningful synergies with Port Solution services?
Please see the answer to Question 14.
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