AIQ: The Tech Edition

Levelling up

How COVID-19 is accelerating a digital revolution in construction and manufacturing

The coronavirus pandemic has spurred companies to upgrade their digital capabilities, boosting productivity and creating investment opportunities in previously overlooked niches.

In his new book, Post Corona: From Crisis to Opportunity, the author Scott Galloway rejects the widespread view that the COVID-19 pandemic has fundamentally transformed the world. Instead, he argues the crisis “has been an accelerant of trends that were already well underway”.1

Take companies’ investment in digital processes. Many firms had gradually implemented digital upgrades in recent years, but the pandemic has given these projects a new urgency. Over the last 12 months, companies have stepped up investments in technology to ensure they can communicate remotely with customers and keep their businesses running under lockdowns.

Predictably, Big Tech companies have been among the main beneficiaries amid turbocharged demand for online services. On an earnings call in April 2020, Microsoft CEO Satya Nadella cited surging usage of its collaboration platform, Teams. “We’ve seen two years’ worth of digital transformation in two months – from remote teamwork and learning, to sales and customer service, to critical cloud infrastructure and security,” he said.2

Other tech sectors have seen even faster growth. According to one study, e-commerce penetration in the US more than doubled in the first quarter of 2020, as consumers who had previously been slow to shop online, such as the over-65s, logged in en masse – equivalent to ten years’ worth of growth in just three months (see Figure 1).3 Similar trends are being observed in other global markets.

Figure 1: Growth in US e-commerce penetration during pandemic (per cent)
Growth in US e-commerce penetration during pandemic
Source: Bank of America; Forrester Analytics; ShawSpring Research; US Department of Commerice; McKinsey analysis

“In retail, the pandemic has starkly illustrated the divide between companies that have good digital offerings and those that don’t,” says Trevor Green, UK equities portfolio manager at Aviva Investors. “While sales at Asos and Amazon have surged, Primark couldn’t sell anything as it has no online presence. Most firms are trying to avoid that fate – they are ramping up projects to invest in their websites and improve the user experience.”

Companies in other sectors, too, have sought to accelerate investment in digital solutions, including those that have traditionally lagged in this regard. One simple way of tracking progress on digital implementation is to compare sectoral investment in IT as a percentage of overall revenue. A global 2017 study from Deloitte showed finance, professional services and education were the leaders in IT spending; manufacturing and construction were at the bottom of the list (see Figure 2).4

Figure 2: Global IT spending across sectors as a percentage of revenue
Source: Deloitte 2016-2017 Global CIO Survey

This is partly a reflection of the technology required – it is much harder to digitise a construction site or assembly line than a trading floor or classroom. But the pandemic, coupled with the advent of 5G technology, is creating a revolution in these niches, as companies find ways to link the physical and digital worlds with new design tools and connected machinery.

“The pandemic has accelerated a digital wave that is rolling through all avenues of human activity,” says Alistair Way, head of equities at Aviva Investors. “It’s starting with the most easily digitalised workplaces and rolling onwards. But the earlier you are in this process, the more years of growth you have ahead of you. That’s where the most attractive investment opportunities are – in the sectors where the runway for growth is longest.”

Construction goes digital

Picture a construction site. Cranes swivel overhead and bulldozers leave trails across the grit. This most physical and tangible of environments is being rapidly transformed by the immaterial worlds of data and virtual design.

Construction firms have long been hampered by low productivity. According to one recent study, the industry, which accounts for 13 per cent of global GDP, has posted an annual productivity growth rate of just one per cent over the past two decades (see Figure 3).5 Even well-run firms regularly deliver projects late and over budget. And an estimated 20 per cent of the global construction workforce is set to retire over the next three years – a significant problem in an industry that has traditionally struggled to attract recruits.6

Figure 3: Labour productivity in construction and manufacturing
Labour productivity in construction and manufacturing
Source: McKinsey Global Institute

The pandemic has, in some cases, shut down construction sites and cast uncertainty over schedules, presenting further challenges. But the crisis has also acted as a spur to investment in digital tools that promise to improve productivity by cutting waste and boosting efficiency.

The digital element of the construction process used to end with the computer-aided design (CAD) tools used in the architect’s office. Now, companies are using building information modelling (BIM) software to simulate and cost the entire project, employing collaborative interfaces that bring together multiple sources of data and track progress in real time.

Digital methods are powering the construction process

Digital methods are also powering the construction process. Leading firms will now fly survey drones over a site before the build starts, gathering high-resolution, three-dimensional images to generate geospatial maps. This data is plugged into smart bulldozers equipped with machine-control technology; as the vehicles move, they collect information that is fed back to office-based teams so progress can be monitored remotely.

While not every construction firm is ready to connect its sites in this way, the end-to-end digital approach is set to become more widespread in the wake of the crisis. Two-thirds of industry respondents to a recent survey thought COVID-19 would accelerate adoption of digital methods in construction.7 Global spending on BIM will more than double between 2020 and 2024, from $6 billion to $13 billion, according to Berenberg estimates.

“Putting these digital methods in place requires investment, but in most cases the outlay is quickly recouped thanks to the savings in terms of cost efficiencies and waste reduction, especially when companies can more closely connect the initial digital modelling through BIM to the practical execution of the plan in the field,” says Way. “The commercial pressures of the COVID-19 crisis have made companies wake up and recognise the advantages these digital solutions can bring.”

The savings in both cost and material waste can be substantial. A commercial concrete contractor recently announced the results of its first project using 3D-modelling software, which vastly improved accuracy and eliminated waste almost entirely.8 Similarly, an infrastructure contractor found machine-control technology sped up road excavation by 44 per cent and improved accuracy by 75 per cent.9

As more companies take up digital methods, the industry as a whole could become cleaner and more efficient – an important consideration given building and construction account for 40 per cent of the world’s carbon emissions, making it one of the principal contributors to the climate crisis, according to the United Nations Environment Programme.

90 per cent of experts believe new regulations will have a major impact on construction operations

Over the coming years, new buildings standards and green regulation are likely to compel further improvements in sustainability and efficiency. Around 90 per cent of industry experts believe such regulations will have a major impact on construction operations over the next decade (and 20 per cent think new regulation will arrive even sooner, within the next 12 months).10

Companies such as Trimble, Autodesk and Graphisoft provide BIM software, machine-control technology and other digital solutions. But value should accrue to companies across the supply chain, which stands to become leaner, cleaner and more productive. Construction firms using BIM see an average return on investment of 20-25 per cent, according to McGraw Hill Construction, a consultancy (see Figure 4).

Figure 4: Contractors’ return on investment using BIM tools (per cent)
Source: McGraw Hill Construction

Digitally connected sites offer further advantages after projects are completed; BIM-powered buildings typically come with “digital twins”, or virtual facsimiles that serve as a reference point for refurbishments and upgrades. This could prove useful for asset owners in the post-COVID era, as they seek to renovate and adapt their buildings. Office blocks look set to become more open, collaborative spaces to complement increased home working, according to research from Aviva Investors’ real assets team.11

Meanwhile, manufacturers of components such as elevators, air-conditioning units and door locks can take advantage of improved connectivity to monitor performance and offer maintenance before problems arise, minimising disruptions for a building’s owners and tenants. For their part, such manufacturers are able to retain lucrative service contracts.

“Elevator manufacturers such as Kone and Schindler can continue to monitor their lifts after installation and gauge when they need preventative maintenance,” says Giles Parkinson, global equities fund manager at Aviva Investors. “Some elevator manufacturers have also begun to provide supplementary services, such as data-driven, people-flow management tools that can reduce waiting times and ease crowding in office buildings. Tenants are often willing to pay higher rents for offices equipped with these digitised lifts.”

Industrial manufacturing and the internet of things

Digitalisation is also yielding positive results in another area: advanced manufacturing. Experts have talked for years about the possibilities of the fourth industrial revolution, big data and the internet of things (IoT). But it is only now that companies are beginning to fully appreciate the value of these tools, as 5G improves connection speeds and the coronavirus pandemic forces companies to devise new ways of working.

COVID-19 has been a massive accelerant in the industrial manufacturing world

Giles Parkinson

Global equities portfolio manager

“The industrial manufacturing world has long been aware it needed to upgrade its operations by enhancing connectivity, but COVID-19 has been a massive accelerant,” says Parkinson. “When the pandemic first hit, companies put the brakes on new investment. But many firms soon realised they weren’t equipped to manage or maintain their factories remotely and there has been a push forward on digitising.”

Market intelligence firm IDC has identified rising investment across the industry in two categories: product engineering software, or digital tools and services that help companies design and manage industrial products, such as CAD, computer aided manufacturing (CAM) and product lifecycle management (PLM) systems; and operational technology, which helps with manufacturing and related services. It expects industrial companies to spend $21 billion on these areas by 2024, up sharply from $14 billion in 2020.

But firms are also exploring more sophisticated ways to link hardware and software, using cutting-edge technologies such as artificial intelligence and augmented reality (AR). As industrial products such as cars and aeroplanes increasingly resemble computers, so the factories that make them are taking on a digital character. Machinery is becoming autonomous, with each part of the assembly line connected with the others using data and cloud infrastructure that can be linked to the company’s broader CAD and PLM systems, allowing it to monitor the entire installed base to analyse data and quickly identify issues.

While they hold great promise, these systems can be fiendishly difficult (and expensive) to roll out. Consider the example of General Electric’s Predix, which was launched in 2013 as the company aimed to transform itself into a hybrid industrial-software firm. GE called Predix “a first of its kind industrial strength platform that provides a standard and secure way to connect machines, industrial big data and people”.12

Despite GE’s heavy investment into Predix – over $5 billion a year – the platform struggled to connect machines across GE’s global systems, partly because of their differing vintages and distinct coding. Although it is persisting with Predix, GE spun off its main digital division into a separate company in 2018.13

Industrial firms usually prefer to collaborate with third-party digital specialists rather than build in-house platforms

Given these difficulties, industrial firms usually prefer to collaborate with third-party digital specialists rather than build in-house platforms. UK-based digital services provider Aveva, for example, has expertise in the oil and gas industry, and offers predictive maintenance technology to its customers. By using connected hardware installed at refineries, energy firms can monitor the status of their facilities and fix problems remotely.

“A decade ago, oil giants would have to fly staff out on helicopters to fix components at their refineries. Now, with digital maintenance methods, this work can be done from afar, and that’s particularly useful given the current travel restrictions,” says Green. “The savings in terms of costs and reducing downtime are huge; greater efficiency improves the sustainability profile of the project.”

Aveva is also among the companies that offer AR applications, a method of visually overlaying digital information on physical environments. The best-known example is the mobile video game Pokémon Go, which uncannily deposits fantastical creatures into real-world scenes. But AR has a range of more serious applications in industry.

At defence and aerospace contractor Lockheed Martin, for instance, engineers building F35 fighter planes and NASA spacecraft now wear AR glasses equipped with sensors and cameras, which display virtual renderings of components with instructions on how and where they should be installed. The glasses have improved accuracy and allowed engineers to work 30 per cent faster, bringing substantial savings in labour costs.14 The company reports that using AR saves $38 in labour for each metal fastener it installs on its spacecraft – to put that figure in context, it buys around two million fasteners every year.15

Digitalisation is transforming the ways in which products are marketed and distributed

Meanwhile, the US-based industrial software company PTC says its AR tools can help manufacturing teams quickly monitor the status of equipment, simulate the effects of new component installations or provide immersive training experiences for staff. The company has forged strategic partnerships with tech giant Microsoft and hardware specialist Rockwell Automation. This is indicative of a growing trend for collaborations between software and hardware firms across the manufacturing industry, says Parkinson.

Further along the supply chain, digitalisation is also transforming the ways in which products are marketed and distributed. For example, German manufacturer Klöckner has launched XOM, a digital marketplace on which companies can sell steel, metal or industrial products to a wider range of customers than might be accessible using their own proprietary sales platforms.16

Investment implications

While there are parallels between the digital tools being rolled out across construction and manufacturing, equity investors should be mindful that the competitive dynamics of each industry are very different.

The construction market for digital solutions is concentrated around a few providers

In construction, the market for digital solutions is concentrated around a few providers. These first movers have a significant advantage, partly because construction engineers and architects who have trained on one BIM platform tend to be reluctant to switch to another. These firms also tend to have significant brand recognition, as reflected in industry parlance; “to Trimble” has become a verb referring to any form of sophisticated digital upgrade in construction, whether or not Trimble is involved.

By contrast, the structure of the manufacturing industry militates against the supremacy of any one software platform. Digital providers tend to leverage their expertise in a particular field – Aveva in oil and gas, PTC in consumer goods, and Dassault Systemes in car-making and aerospace, for example – in which they can consolidate their positions in CAD and PLM and upsell value-added services in areas such as predictive maintenance and AR. But expanding across the verticals into new territories is difficult.

The complex nature of the manufacturing ecosystem creates opportunities for more specialised firms, including so-called “historians” that collect, aggregate and interpret data from multiple industrial sources.

One historian firm, OsiSoft, was acquired in 2020 by Aveva in a $5 billion deal, a transaction that could herald further M&A activity across the industry. Aveva itself merged with the industrial software arm of French energy group Schneider Electric in a $3 billion deal in 2017.17

Another recent deal saw Capgemini, a European consulting firm, acquire industrial technology specialist Altran, increasing its exposure to end markets in the aerospace, automotive, defence and energy industries. The company aims to offer IT services that help manufacturers connect disparate hardware and software components and speed up the digital transformation process.18

Proprietary ‘walled garden’ platforms are less likely to succeed in a diverse ecosystem

“Unlike office-based IT, where a blockbuster product will sometimes come along and dominate a particular function – think of the way Salesforce emerged to corner the market for customer relationship management software – industrial manufacturing is a much messier, more complicated environment, and there will be opportunities for companies that can connect the dots,” says Way.

“Proprietary ‘walled garden’ platforms are less likely to succeed in this sort of diverse ecosystem, which may be why GE’s Predix failed to resonate. In a way that’s good for investors, because they can focus on the value opportunity in each vertical without worrying too much about a new competitor coming in and changing the landscape overnight,” he adds.

Both construction and manufacturing rely on myriad relationships between customers and suppliers, and investors conducting due diligence should be prepared to speak to companies across the supply chain in order to assess risks and identify pockets of value. Whether meeting with contractors or developers, Parkinson recommends asking questions about the problems the pandemic exposed them to and how technology is being used to address them.

Most companies are aware they don’t have a choice now but to digitalise

Giles Parkinson

Global equities portfolio manager

“The damage COVID-19 inflicted due to companies’ lack of preparedness was so clear and obvious that most are aware they don’t have a choice now but to digitalise; if they don’t, they will fall behind, and not just if there’s another global pandemic. Competitors that go digital are going to realise efficiencies in their business operations and develop competitive advantages. Firms are going to have to invest aggressively to keep up.”

Green agrees. “In their meetings, investors need to make sure company managements are embracing digital technologies. They need to be clear: companies in construction and manufacturing that don’t invest for the future will lose their competitive positioning. The momentum behind this digitalisation trend is only going to build over the coming years,” he says.

References

  1. Scott Galloway, ‘Post corona: from crisis to opportunity – winners and losers in a world turned upside-down’, Penguin, 2020
  2. Jared Spataro, ‘2 years of digital transformation in two months’, Microsoft, April 30, 2020
  3. ‘The quickening’, McKinsey & Co., June 2020
  4. ‘Technology budgets: From value preservation to value creation’, Deloitte, November 28, 2017
  5. M J Ribeirinho, et al., ‘The next normal in construction: How disruption is reshaping the world’s largest ecosystem’, McKinsey & Co., June 4, 2020
  6. M J Ribeirinho, et al., ‘The next normal in construction: How disruption is reshaping the world’s largest ecosystem’, McKinsey & Co., June 4, 2020
  7. M J Ribeirinho, et al., ‘The next normal in construction: How disruption is reshaping the world’s largest ecosystem’, McKinsey & Co., June 4, 2020
  8. ‘Tekla helps Wayne brothers tackle web of complexity and build Sierra Nevada’s east coast multi-structure brewery’, Tekla, 2020
  9. ‘3 ways contractors are using technology to reduce waste — and increase margins’, Trimble, 2020
  10. M J Ribeirinho, et al., ‘The next normal in construction: How disruption is reshaping the world’s largest ecosystem’, McKinsey & Co., June 4, 2020
  11. Jonathan Bayfield, ‘Remote working is on the rise, but the office remains indispensable’, Aviva Investors, October 26, 2020
  12. Ted Mann, Thomas Gryta, ‘The dimming of GE’s bold digital dreams’, Wall Street Journal, July 18, 2020
  13. Ted Mann, Thomas Gryta, ‘The dimming of GE’s bold digital dreams’, Wall Street Journal, July 18, 2020
  14. Alexander George, ‘Lockheed is using these augmented reality glasses to build fighter jets’, Popular Mechanics, February 6, 2015
  15. Isaac Maw, ‘How Lockheed Martin is using augmented reality in aerospace manufacturing’, Engineering.com, August 13, 2019
  16. ‘Trailblazing the steel industry’, World Economic Forum, 2018
  17. ‘AVEVA agrees to acquire OsiSoft’, AVEVA, August 2020
  18. Harriet Agnew, ‘Capgemini in €3.6bn merger with smaller rival Altran Technologies’, Financial Times, June 24, 2019

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