This report is a detailed economic analysis of the Sheet Metal Tool Box Industry of Western Australia. In order to accurately analyze this industry and compile this report, the business activities and functions of a leading tool box manufacturer MW Sheet Metal Pty Ltd (MW) have been studied extensively. In particular, this report concentrates on MW’s operations in Western Australia only and analyzes the current market trends, demand and supply, industry’s competitive structure, current economic issues.
And finally it discusses the industry’s economic situation in the next five years and how MW would need to react to cope with these challenges. Background MW is primarily a manufacturing company, specializing in designing and manufacturing high quality aluminum tool boxes, trailers and other sheet metal products. The entity first started its operations in Sydney back in 1998 as a sheet metal fabrication workshop manufacturing air-conditioning vents only. A few years later, MW discovered the growing demand for metal tool boxes mainly used by tradesmen on their utility vehicles.
MW quickly diverted its focus on designing and manufacturing high quality aluminum tool boxes to cater for the increasingly strong demand. During the past few years, MW has enjoyed great success and has been able to extend its business from New South Wales to Victoria, Queensland, South Australia and Western Australia. As of today, MW is the leading tool box manufacturer in Australia with 15 factory outlets across Australia and one manufacturing unit in Sydney. MW is relatively new in the Western Australian market since it only began operating about one year and a half ago.
Western Australia has experienced tremendous growth in the recent years and MW has been able to capitalize on the fact that there is no other major manufacturer and supplier of metal tool boxes competing in this market. Demand and Supply Analysis Demand In order to understand the key factors driving the demand, it is important to identify the end consumers. The main purposes of a tool box are to provide storage space and protection for valuable tools from theft and environmental damages.
The analysis of MW’s sales records and customer database indicates that tradesmen such as plumbers, tillers, electricians and roofers etc are one of the largest consumers of metal tool boxes in Australian market. The Western Australian economy has experienced unprecedented rates of growth in recent years due to massive increases in the export of iron ore, natural gas and other minerals to China and India. Mining corporations have amassed huge profits and governments, state and federal, have enjoyed rapidly rising revenues.
This boom has resulted in a very strong growth in the construction and manufacturing industries particularly in Western Australia and in fact has led to a crisis in the housing market due to the shortage of houses and offices in the Perth metropolitan area. Consequently, the number of tradesmen and laborers has sharply increased creating a strong demand for tool boxes for the utility vehicles. There are a number of factors that are directly linked with the increasing metal tool boxes demand.
Firstly, as mentioned earlier the building industry and mining industry is growing strongly which is resulting in a higher the number of utility vehicles required by the industry tradesmen. Secondly, due to the shortage of labor, the wages and salaries have increased dramatically, giving the purchasing power, willingness and the ability to the tradesmen to buy high quality metal tool boxes to protect their valuable power tools. The theft problem is another factor that is creating the demand for tool boxes.
The problem is so serious that it leads to an increase in the demand for strong and lockable tool boxes encouraging innovation and creativity in the industry. Another interesting factor is the life cycle of the utility vehicles. Since most of the tradesmen and companies depreciate their utility vehicles from 3 to 5 years, this results in the requirement for a new tool box. These customers are usually classified as “Repeat Customers” and normally MW does not merely rely on them for its profits.
Therefore, it is critical for the success of this industry and MW that in the future, not only the repeated buyers continue to do business but more importantly the demand from new tradesmen and utility vehicles shall continue to rise. However, the level of income, price of raw material, customer’s preferences and the prices of substitutable goods would be major factors in determining the demand in this industry. Supply Initially, the tool boxes were made of steel and galvanized steel due to the low cost of the raw material.
However, the characteristics of rustiness and heaviness pushed this material out of the market as it required heavy maintenance. Soon, hunt began for a sustainable raw material that would be economically viable for the business and practical for the consumers. Stainless steel and Aluminum were identified as the potential raw materials to manufacture tool boxes. While stainless steel is an excellent metal, its fabrication technology requires higher investment and skill which make it very expensive.
Finally, aluminum became the raw material of choice for the whole industry since it is found and produced in abundance in Australia and has some exceptional qualities such as malleability, light weightiness, rust resistance, durability and most importantly affordability. Currently Australia is producing Aluminum to its full capacity at all of its smelters and exporting a large portion of its produce. Aluminum prices have been increasing steadily over the past few years but due to the recent strong demand, there has been a sharp rise in prices which is likely to have an impact on the supply and prices of aluminum sheets in the future.
A report from ALCAN – one of the world’s leading aluminum producers indicates that this demand is mainly generating from China’s voracious hunger for aluminum and this trend is expected to continue for the next two decades (Evans R. B 2005). The chart below from ALCAN tells the story by comparing China’s consumption of aluminum to USA. While MW is currently confident of meeting the strong demand in the short run in the Western Australian market, the future capacity of producing affordable tool boxes would largely be driven by the demand and supply of aluminum in the world market.
Right now, imported and locally made products are serving the demand in the market. The strong growth of Western Australia is likely to attract more investors to this market. The price of aluminum metal sheets, manufacturing technology, the availability of labor and number of competitors will impact the supply in this industry. The next section will discuss these issues further on the current competition structure and the market share in Western Australian’s market. Industry competition structure
A detailed analysis on the current competition structure of the metal tool box industry suggests that WA market is currently divided into three main segments as High-end, Medium-end and Low-end. It is interesting to note that different business entities have captured each of these segments and have established the ability to control the price in the market within these segments. The graph below depicts one view of the segmentation and the market share. By estimation (as in Figure 2 above), MW is currently enjoying an enviable market share of 60% to 65% in the whole market.
Since there is no other major player currently competing in the medium end market and not many substitutes available, it would be fair to say that MW has some characteristics of a “monopoly”. There are a few local workshops in each state manufacturing and selling very high quality products. Normally, their products are only available in their workshop outlet shop. These workshops are relatively much smaller in size and capacity, and mainly targeting the high end market. In the low end market, there are imported tool boxes manufactured in overseas.
These products are cheaper in price with lower quality and low security level. Usually, these imported products are distributed in national wide or state wide hardware shops, such as Bunning’s warehouse and Super Cheap Auto. However, there are few major competitors operating outside Western Australian market which remain serious threats to MW. For example, there is a large tool box manufacturer based in Brisbane Queensland, named as Diamond T. Both MW and Diamond T have similar product lines and close pricing strategies.
As a matter of fact, MW and Diamond T are having fierce competition in the eastern states particularly in the medium-end market, which is the major part of the entire metal tool box market. While Diamond T is mainly focusing on Queensland market, it is distributing its products through a well established Australia wide hardware franchise Repeco into other states. Since Diamond T does not have a dedicated dealer or outlet shop in WA, it is not able to provide customization services and competitive prices for its products.
This is one strategic advantage for MW, as it is selling its products through two outlet shops in the Perth metropolitan area. Thus, MW is not relying on any third-party distribution channel in WA and is able to build direct relationships with large enterprises to capture and strengthen its position in the WA market. By avoiding third-party dealership or distribution channels, MW is able to offer broader selections of its products within WA and better prices that none of its competitors are able to match.
To further analyze the competitive structure of the metal tool boxes industry, a Porter’s Five Forces Analysis has been carried out. The details of this analysis can be found in Appendix A. It is clearly showing the current threats to MW in WA market. The substitutes are imported products or products manufactured by other local manufacturers. Potentially, Diamond T and newly imported brands will be the strongest challengers to MW’s market share. Also, MW will face enhanced bargaining powers from both buyers and suppliers.
Due to the high entry and exit barriers, it determines that it is going to be an industry with fierce competition, and every player will have to fight for its survival at the end. As an early comer, MW is taking the advantage of good timing. It is now the major player in WA market with dominant market share and is having the ability to influence on the prices in the market. As a result, the current market structure has Monopoly features. WA has been experiencing economy booming in the recent years, and it is forecasted the boom would last for years.
The tool boxes market will grow rapidly driven by the fast increasing of tradesmen population and number of utility vehicles. However, as Porter (Porter 2008) warns that high industry growth rate may empower all the five forces to squeeze the profit of an existing player’s. The competition in the market will become more and more furious. As we can anticipate, the market structure would be reformed into Monopolistic in the future. Current Economic Issues As we discussed earlier, MW is currently enjoying an enviable market share of the toolbox and sheet metal products industry in a rapidly growing Western Australian market.
Whilst the buoyant economic growth in Western Australia means more business and increased revenue, there are also a number of new economic challenges faced by MW including but not limited to: ?Increasing production costs ?Skilled labor shortages ?Growing inflation pressures ?Interest rate rises ?Threat of increased competition ?Transportation costs As a result, it has become increasingly important for the MW management to monitor both local and global economic situation and devise strategies to overcome the short-term and long-term economic challenges.
The following paragraphs will highlight some of the main economic issues currently faced by MW and the sheet metal industry and the strategies MW will need to employ to deal effectively with these issues: Increasing Production Costs MW heavily relies on the availability of metal sheets made out of aluminum to produce quality tool boxes and other products. Aluminum has become a very popular raw material in a number of industries due to its exceptional properties such as malleability, resistance to corrosion, light weightiness and the infinite capacity for being recycled.
Even though, the production of aluminum has doubled in the last two decades around the world (Figure 3 in appendix B) (Aluminum Association of Canada 2007). The current upwards trend in global demand is driving the aluminum prices further up and consequently squeezing the profit margins in the toolbox and sheet metal industries. Figure 4 (McGuigan, Moyer & Harris 2008, p430), below depicts how the price of aluminum pushes up the average total cost and impact the company’s profitability in the long run.
The graph on the left shows the current situation where the company sets its price at P1, thus making a profit (shaded area). As the price of aluminum is increasing, the cost of producing the toolboxes (ATC) will increase; which will then reduce the profit as shown on the graph on the right. As a result, MW is investing a lot of time and resources to monitor the pricing and product quality of its competitors, and also reviewing its own pricing strategies and product line to identify and maximize profits on the products that have higher profit margins.
Furthermore, MW is concentrating on manufacturing “fit for purpose” products instead of expensive and top-end products while still continuing to supply top-end products on special orders. Rising fuel prices continually present challenges for MW as its manufacturing unit is based in Sydney and products are transported to at least 15 factory outlets around Australia. To remain competitive and offer low prices for all its products MW has recently started to transport its products by sea to Western Australia as it has become far more expensive to transport products y road. Threat of Increase in Competition Western Australian economy continues to grow at an unprecedented pace and it is likely to attract new investors to the market. The demand for toolboxes remains strong and there is an increasing threat of potential new entrants to the market. MW’s competitors are employing the following strategies to gain their market share: Substitutes Firstly, there has been an increase in substitute products recently that are low in quality and some of those products are also made of different material such as fiber glass.
This obviously is a growing concern and threat to MW’s large market share. Since the imported goods are manufactured in China and other Asian countries, therefore their prices are too low and MW is not able to drop its prices to that level. Secondly, the competitors are continuously building distribution channels in Western Australia and collaborating with well established large warehouses to sell their product to the consumers. This is something MW has not previously considered as involving a third-party is likely to decrease its profits.
However, in the given market situation, MW is planning to build relationships with different companies to expand its sales network even further. Innovation In order to continue its strong market hold, MW is innovating and creating better quality products and devising strategies to remain competitive in the market. Currently, there is no toolbox available in the market which has remote locking features. MW is working with a number of electrical and technical goods and services companies to develop a new product with remote locking and automatic locking features.
This product is likely to attract more buyers in the market as it is more secure, smarter and easy to use. There are a number of other advancement opportunities such as the introduction of smart keypad systems with a maximum pin-code try limit. MW is confident that it is necessary to innovate in order to remain competitive in the future market space. Branding Branding could be used to signal product quality and different types of products. It is also a way of communicating with the customers and promoting the product at the same time.
Introducing brand loyalty programs to retain business is another strategy that attracts more customers due to some incentive attached with each purchase. MW is currently not paying much attention to these techniques, however in the future it is likely that a unique brand image and customized brand look and feel would pay its dividends in a fiercely competitive market. Economies of scale Since there is no other major competitor in the market, therefore MW has increased the rate of output to reduce long-run average costs and is now achieving economies of scale. Network Effect
Since MW is enjoying such a large market share in the Western Australian market, it is constantly building relationships with commercial vehicle dealer and offering incentives to reach the “critical mass”. The current “Trace Act Practices” prohibit the practices of lock-in type deals where a consumer could be forced or pressured to purchase a third-party product in order to gain some sort of benefit from one purchase. MW is carefully able to propose attractive deals to both consumers and business partners to increase its revenue through network effect. Asymmetric Information
Since MW has already established its stronghold in the Western Australia market, naturally it is going to have the advantage of asymmetric information as any potential entrant would need to overcome this obstacle in order to reach new customers. Because MW has managed to exploit the economies of scale, it is able to develop a cost advantage over potential entrants. One of the strategies that MW applies in conjunction with this advantage is “Limit Pricing” to cut prices if and when new suppliers enter the market, moving away from short run profit maximization to strengthen long run market position.
Skilled labor shortages According to the Australian Bureau of Statistics, there was a massive 487% increase in the metal trades between 2002 and 2005 and 304% increase in electrical trades (ABS 2005). The shortage of skilled labor presents significant challenges to any business in Australia. MW has been experiencing an increase in staff turnaround due to attractive wages in the mining and resources industry and record low unemployment. To deal with this situation, MW has developed plans to train workers, offering bonuses and incentives at the completion of apprenticeship to retain staffs.
The rising wages is another component that pushes the production cost upwards. Inflation and Interest Rates The inflation and rising interest rates are growing concerns for MW in both the short and long term. A large proportion of MW’s customers are tradesmen who service the construction industry in some capacity. There has been a significant drop in the number of new homes being built in Western Australia due to the rising interest rates. While MW has not experienced any significant drop in its sales, however it is closely monitoring the market situation to plan future production levels.
It is also interesting to note that the number of toolboxes MW sells each quarter of the year varies significantly due to a number of factors. The Figure 5 (in appendix B) indicates some of the peak and low sales months. It has been noticed that during the taxation period companies tend to invest in tools and equipment to claim back some tax. Furthermore, some tradesmen invest in equipment after they receive tax returns. This trend significantly pushes the demand for particularly higher quality toolboxes upwards and the demand for inferior quality products declines.
Refer to Figure 6 below for a more detailed analysis: It can be seen that demand curve D shifts rightward to D1, resulting in increasing quantity demanded. Therefore, it can be said that during the peak months, there is a positive income elasticity of demand associated with the high quality products, such as MW’s products. In reality, MW does not increase prices during this period of time. Since it is taking a monopoly position, MW is normally charging higher prices than equilibrium prices. When the demand curve shifts to right, the unchanged prices actually are getting closer to equilibrium prices.
If the prices are lower than the equilibrium prices, it generates demand surplus, as shown in Figure 6 above. In fact, MW usually runs out of stocks and delays a few orders during this period of time, due to warehouse and factory capacities. These are the reasons causing demand surplus in the real world. Industry changes in the future The factors influencing demand and supply in the industry will be changing in the following years. Demand side issues Potential customer population growth As the target consumers are tradesmen, the tradesmen population determines the market size of the sheet metal products.
WA has been experiencing economy booming, which generates great amount of employment opportunities especially for skilled labors. From 2001-2002 to 2004-2005, 35800 potential workers (aged between 15 and 65) migrated to WA from overseas and other states (ABS 2006). At the same time, 14207 vacancies for tradesmen and related worker were still unfilled (ABS 2006). As the booming economy is forecasted to last for years, WA will attract more and more trades coming to take those high wages but unfilled positions.
Therefore, MW’s potential customer pool is getting enlarged dramatically. Utility commercial vehicles growth From 2003 to 2007, the growth rate of commercial vehicles and all kinds of trucks in WA is higher than Australian average, and the number of such registered vehicles per 1000 population in WA is much higher than Australian average and most of eastern states (ABS 2007a). As MW tool boxes are designed for these utility vehicles, the demand generated by the increasing number of commercial vehicles and all kind of trucks is very strong.
With the economy boom continues and trades population grows, the demand of tool boxes driven by the increasing number of utility vehicles will be significant. As a matter of fact, trades and companies normally depreciate commercial and utility vehicles every 3 to 5 years. The repeated customers, due to replacing vehicles, will be another power driving the demand of tool boxes higher. Demand from relative industries In WA, mining and construction industries have been developing very fast. This is a result caused by overseas demand for Australian natural resources – especially from China.
Expectations are that China’s GDP will continue to grow at high rates for in the coming years, so there is a reason to expect that local demand for tool boxes from these industries will continue to be strong over that period. Income elasticity and cross-price elasticity In the past three years, the wage price index (WPI) kept between 4% and 5%, which was higher than Australian average. In 2006, WA also became the state with the highest average wage in Australia (ABS 2007b). The higher wage increase rate is expected to continue, due to labor shortage.
The tradespersons, as the biggest beneficiaries, are having stronger purchasing power to buy tool boxes and other sheet metal products to protect their power tool. As income elastic products, tool boxes are facing higher demand driven by the increase of income. MW now is the only major tool boxes manufacturer targeting in medium-end market, with imported products and local workshops are servicing the low-end and high-end markets respectively. In the future, if the prices of both low-end and high-end products are reduced dramatically, MW will be facing extremely furious competition with its profit squeezed out.
To keep the same market share, MW will have to drop its prices accordingly. Threat of inflation While many of the drivers of demand for aluminium sheet metal products continue to be very strong, inflation poses a significant threat, at least in the short-term. Strong domestic demand in Western Australia, driven by high levels of public and private investment and household spending has created considerable inflationary pressure. On the demand side, these inflationary pressures, if they continue, are likely to slow the rate at which trades people replace their current vehicles and equipment.
To drag inflation rate back into a comfortable range, Reserve Bank of Australia’s (RBA) raised its official cash rate in consecutive 12 times, and the cash rate has been pushed up to a historical high of 7. 25% in 12 years (RBA 2008). If the interest rate keeps on rising, the pressure on housing for trades persons will be passed on to the purchasing power to buy tool boxes. Rising transportation costs are also likely to be passed from motor vehicle companies to the purchaser, leading to an easing in new motor vehicle sales.
Together, all of these factors may lead to a fall-off in short-term demand for associated sheet metal products. Economic downturn The sheet metal products industry’s reliance on its niche of trade customers does however leave it open to the threat of economic downturn. There has been considerable media debate about when both the Chinese and Australian economies will turn. The most recent OECD (OECD 2007) and IMF (IMF 2007) forecasts are that the Australia’s GDP will steadily decrease from the highs of recent years to around 3% to 3. 5% in 2008 and 2009.
Should this decline continue thereafter, and the Chinese economy also slows, then demand from local construction and mining industry for sheet metal products will most probably also fall. To maintain current levels of demand, the industry may need to break out of its niche market position, by extending its product reach to other market segments – such as the home handyman or sporting/recreational trailer/utility user. Supply side issues Increased number of suppliers in the market Since the market of sheet metal products is still growing, it will attract more competitors coming into this market.
Overseas and interstates competitors will share the WA market with MW. All sorts of products in different price tiers will be serving customers in different market segments. MW will face the challenge of price war to keep its position. Raw material As matter of fact, the demand of raw materials is increasing in the international commodity market, and the price of aluminum has been soaring in the past six months. The average price rose 40% than a half year ago (see Appendix B, Figure 10), and is approaching to the historical high point happened nearly two years ago (Global InfoMine 2008).
If raw material price is kept high and the competition in the industry becomes more furious, MW will not be able to pass the increased cost to its customer but only cut its own profit down. Inflation influences on supply Inflation is also a supply-side issue for the industry. Rising labor costs and transportation costs are both creating upward pricing pressures for MW Toolboxes, adding to the risk of driving down demand. This combination of inflationary effects is likely to reduce the industry’s profitability in the short-term.
Whether it continues into the longer term will depend on the Reserve Bank’s capacity to rein in inflation, and whether a new or existing player emerges with a viable, lower cost substitute. Change of market structure As analyzed in the appendix A, the current industry structure is monopoly. MW is a major player taking the dominant position in the market. However, WA market is still growing rapidly and more competitors will be attracted to this market. If MW does not do anything in advance to protect its position, the market structure will be reformed to monopolistic.
In short term, MW will be involved into price war and its profit will be cut off. In a longer term, MW’s profit would be squeezed further and would be kept at break-even level. To keep the dominant position, MW should think about strategies to protect itself. Limit pricing strategy Being a player with characteristics of monopoly, MW is charging prices higher than equilibrium prices for its products in WA market. Since MW has built up an efficient retail network in major capital cities across Australia, the sales volume is considerable.
As a result, the fix cost, such as machineries, premises leases and labor costs have been spread to every single product. With economies of scale, MW has absolute cost advantage comparing to any other local manufacturer. To prevent potential competitors ruining the market, MW could pre-empty the market by charging less on its products. There are a few advantages for this strategy. First, potential entrants, such as Diamond T, will have to consider carefully how to enter WA market. Since the potential margin on the market is reduced, potential entrants may leave WA untouched to avoid potential loss.
Second, as MW is charging prices higher than equilibrium prices and the sheet metal products are price elastic, more customers will be attracted from low-end and high-end markets by the lowered prices. It will help MW selling larger amount of products and gaining higher revenue. The demand will move downwards along the existing curve as shown in Figure 11 below. Differentiation & new products Since the sheet metal products are durable products, they could not be replaced even if tradesmen trade in their vehicles for new ones.
MW should work on products differentiations, for example, power coated aluminum tool boxes in color or electronic locking system on tool boxes. Also it should put its energy on new products development. Product differentiation and newly developed products will help MW to discover new demand in the market. As Figure 12 shows below, demand curve will become more inelastic for differentiated or new products. Since there are no or very few substitutes in the market, customers would be less sensitive to the prices’ change.
In this case, MW could keep its prices to gain a bigger quantity of Qc1, or alternatively it could keep its quantity at Qc but charging higher prices at PN. In either way, MW will be better off with more revenue. At the same time, MW could outsource cheaper products from overseas and make very high quality products to extend into both low-end and high-end markets. In this way, more demand for MW’s products will be generated. Advertisement & brand Advertisement is a good for MW to build reputation and brand name, which is an effective way to avoid the adverse selection for its potential customers.
No only good reputation and brand loyalty will attract new customers and keep existing from repeatedly purchasing, but also it sets higher entry level to potential entrants. New channels, market penetration & market development Currently, MW is selling its products through two outlet shops in Perth metropolitan area and is not replying on any distributor or reseller. To reinforce its market penetration and extend its coverage, MW should develop dealers or reseller in Perth metropolitan area as well as in other regional areas in WA.
Strategic alliance should be formed especially with commercial and utility vehicles dealers. Then, customers could be reached from different channels. It will help MW increase demand on its products. Solution provider To strengthen its current position, MW could also develop itself to a solution provider, who will provide not only products but also installation, maintenance and after-sale services. Price bundling could be applied to packages including products and together with different services.
The bundled price will increase profit for MW, and also it helps building up reputation and brand loyalty. Reduce logistic cost MW is manufacturing all products in Sydney and then gets them transport to Perth. As products are mainly transported on pallets or by big trucks, the transportation fees are very high. To reduce the logistic costs, containers should be employed to transport all the products from Sydney to Perth. The saved costs will leave MW with higher margin, so that MW could utilize the price limiting strategy without losing much of its current profit. Transfer factory to China
To reduce manufacturing cost, MW could even think of setting up a new factory in China to manufacture standard products and then ship back to capital cities in Australia. To keep providing employment opportunities, MW could still keep or shrink the existing factory in Sydney to process customized orders, which normally require very short lead time. The fixed cost for the new factory in China would be spread to the big volume of products very quickly. After that, MW would enjoy higher profit generating from every product sold in Australia. Then, MW would have absolute cost advantage over every player in every market segment.