2Switz.682021Equity ResearchFortnightly ThoughtsJanuary 17, 2013Issue 47Making things faster, stronger, leaner, betterFrom the editor: In this edition we make the case for a new era of manufacturing as noveltechnologies enable the innovation in products and processes necessary to resolve the worldsrising constraints. We have four interviews around this theme and contributions from ouranalysts along the industrial value chain.Manufacturing is always evolving, but atpresent it feels like the pace of change isaccelerating. New technologies such as 3Dprinters and nanomanufacturing are helpingcreate new products, and are improvingprocesses as mass manufacturing shiftstowards mass customisation. And so, thecost of innovation is falling, while its speedincreases and its scope widens. Thismatters because the incentives toinnovate were probably lower over the last20 years: manufacturing lived offdeveloping economies by pursuing labourand environmental cost arbitrage viarelocation to those regions, while alsoenjoying a growing market that was lessdemanding in terms of product quality. Thisphase may be over, and it is coinciding withincreasing resource scarcity, makingsolutions to constraints of immediateimportance. This is why the future ofmanufacturing is so critical. Winners in thevalue chain will be those owning materialsor creating new materials, enabling morepowerful design and changing the energypart of the equation. This leads us tocompanies like Oxford Instruments, ABB,BASF, AZ Electronics, Dassault and a fewothers that we profile at the end.More DMs than you would expectChange in per capita trade surplus/(deficit) of manufactured goods,between 1984 and 2011, in US$ 000sWhats insideFaster, stronger, leaner, better: our leadarticle on the future of manufacturingS. KoreaJapanFinlandItalyAustriaChinaDenmarkGermanyInterviews with:Peter Marsh of the Financial TimesProf. Neil Hopkinson of Sheffield UniversityIndiaIndonesiaS. AfricaThailandAvi Reichental, CEO of 3D SystemsJonathon Flint, CEO of Oxford Instruments1316BrazilTurkeyArgentinaSpainFranceGreeceUKManufacturings next stage: Daniela Costaon the implications for capital goodsAutomation: Not just an EM story: Yuichiro1015N. ZealandCanadaUSIsayama on the nuances of automationNorwayAustraliaValue in productivity and differentiation:18(800)(600)(400)(200)0200400Will Wyman on niche winnersSource: World Bank (Spain and Austria 2010).Staying competitive with software: Tech andHugo Scott-Gallhugo.scott-gallgs.com+44 (20) 7774 1917Goldman Sachs InternationalSumana Manohar, CFAsumana.manohargs.com+44 (20) 7051 9677Goldman Sachs Internationalmanufacturing is converging says Perry HuangEuropean winners: Innovators from chemicals,hardware, software and medtechGoldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider thisreport as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, seethe Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are notregistered/qualified as research analysts with FINRA in the U.S.The Goldman Sachs Group, Inc.Goldman Sachs Global Investment ResearchSimpleAdditivemanufacturingComplexDifficultAutomation2Equity Research: Fortnightly ThoughtsFaster, stronger, leaner, betterIssue 47To argue that there can only be minimal economic growth over thelong term is to be bearish on innovation and the potential for solvingthe constraints that weigh on economic growth. Its our belief thatthere is a great deal of innovation happening in all sorts of places,and we detect a distinct divergence in optimism levels between theworld of science and the world of finance. If we definemanufacturing as a combination of materials, energy and design,then all three areas are seeing change. Against a backdrop of risingprices for scarce commodities, lighter and stronger materials suchas rare earths and graphene are being developed and put tobroader use, while existing materials are being used moreefficiently in everything from planes to shoes. New forms andsources of energy are also a key area of progress, as the worldrecognises the twin problems of waste and inefficiency. A moreglobalised world is creating new end markets with unique demands,and also tougher competition, which has led to greater focus ondesign. Greater use of technology here is helping reduce time tomarket and is cutting inventory along the supply chain. Technologyis also enabling more people from more places in the world tocontribute ideas and this democratisation of design means thatsolutions to problems can be found faster than ever before.So the speed, cost and breadth of innovation in manufacturing istechnology. But machines are becoming more capable of digesting,analysing and acting on large swathes of data, and are moreconnected with other machines. As automation allows for moreflexible manufacturing, tailoring products to unique needs cangradually become a reality for more products than we see now.Below, we have very broadly categorised (a limited set of) thingsmade in the world by complexity and uniqueness. The caveat isthat this classification is subjective, and for each of these products,different versions can fall into other boxes. Nevertheless, we hopeits a good starting point for considering where 3D printing use oradditive manufacturing (mostly complex and one-off productscurrently) could move as it becomes more economical (autoparts,components), and also where automation could be used as roboticsbecome more capable (customised consumer electronics, mining).This also gives us an indication of where greater choice can beconverged into customisation (appliances, apparel). While aquantum change in the manufacturing process of some of theseproducts could be a decade away at least, we expect newtechnologies to keep taking share of some parts of the value chain.These obviously come with important broader implications.Mapping out manufacturingchanging, from both a product and a process perspective. ProductMassChoiceCustomisedPersonalisedpioneers, i.e., those that can command pricing power as a result ofa superior or differentiated product, will probably see benefitsaccrue more narrowly and more visibly. On the other hand, processToys,books,pencilsConfectionaryLighting,bricksBeer,teaApparel,shoesPersonalcare,paintsFurniture,tyresWine,otheralcoholCredit/debitcardsSpectaclesHighendluxuryTailoredsuitsinnovators, i.e., those that are able to constantly tweak theirmanufacturing processes to produce more efficiently, often seetheir efforts being replicated more easily by others. But they areequally important to the evolution of manufacturing. And the twodont have to be mutually exclusive. For instance, Apple and Dellare probably quite distinct in terms of their competitive strengths,BallbearingsOTCdrugsSolarcellsFertilizers,pesticidesSmartphones,tabletsSemiconductorsAutopartsAgriequipmentTVs,camerasHomeappliancesCars,trucksEnginesInstrumentationSteelElevatorsScientificdevicesShipsAircraftCranesHearingaidsDentalimplantsSupercomputersRocketsHipreplacementbut Inditex has used both product and process innovation to stayAutomationAdditivemanufacturingahead of the pack. Either way, we believe that the changes inmanufacturing that we are seeing now will, over time, enable thedelivery of products with the same or higher economic benefitsusing less material, at a lower cost, at a faster pace or of greaterquality. So, an industrial revolution of sorts.One for all, all for oneLooking at the emerging new manufacturing technologies, acommon thread between them is mass customisation. The idea ofmass manufacturing, in which manufacturers decide what to makein huge volumes, and customers adapt to a narrow suite ofproducts, has been the predominant model for decades. So far,producers have often responded to the need for customisation withthe provision of greater choice, e.g., apparel comes in a range ofsizes and colours, chairs are adjustable to our requirements. But,the capabilities of new manufacturing technologies allow for greatercustomisation at much lower cost than was previously possible. Ofcourse, this concept is not new; cars are now more customisedthan we perhaps give them credit for (not all cars from Ford areblack these days) and so are our mass-produced phones. Eventhough the hardware is becoming more commoditised, we canrefashion it with applications and features based on our uniqueneeds. Improved automation, widespread penetration of theinternet and even some areas of artificial intelligence allowmanufacturers to adopt mass customisation in the production ofvarious other goods. And they can go even further with masspersonalisation. Currently, this is almost unique to high endmachines and medical technology. But these are also the areas inwhich the use of additive manufacturing is most advanced, makingthe delivery of one-of-a-kind solutions faster and more economic. Isthis true for all types of products? Certainly not. The economics ofcustomisation will differ depending on what price consumers arewilling to pay for differentiation, and also on the capacity ofGoldman Sachs Global Investment ResearchSource: Goldman Sachs ResearchFirst, mass customisation needs closer relationships withcustomers as manufacturing becomes more prescriptive. Theserelationships are likely to act as a key means of attracting andretaining customers, and require many more people within anorganisation being skilled at marketing, designing and engineering.This approach should also promote better inventory efficiency, asproduction is only to customer orders. Economies of scale matterless too, which means that in some areas, entry barriers may belowered. That is, smaller companies can more easily gain access totechnology to allow for affordable customisation at lower volumes.This could make for a much longer tail of manufacturers anddesigners than is currently the case in many industries, and couldalso mean that a much longer tail of customers can be served.MachinationsAutomation in itself is a broader theme. In its first stage, automationis a response to higher labour costs, but it is much more aboutproduct quality, reliability and consistency. The machine to machineeconomy will see a much faster way of changing design andeliminating errors. And automation continues to evolve thanks toconvergence with other technologies. The use of instrumentationand tools capable of more precise manufacturing on a muchsmaller (and sometimes nano) scale, allows robotics to be usedmore effectively in a wide range of areas. Automation also includesmachines that are more capable of changing design faster thanbefore, and increasingly able to independently and intelligentlyrespond to unique situations (the US militarys AlphaDog is anexample of what we could see in a few decades). This means thatdemand for labour with a broad range of skills will increase, butopportunities for less skilled labour will diminish as automationnegates some of the need for the human touch in themanufacturing process.85Korea, 3%US, 36%UK, 5%Japan, 23%3Equity Research: Fortnightly ThoughtsLeaner timesDM-listed industrials, inventory days, 5-year moving averageCarbon intensityDistribution of the type of holders for graphene-related patentsIssue 47105Individual, 5%Government/ NGO,2%Agency, 1%1009590Institutes, 8%807570Academic, 29%Corporates, 56%199019921994199619982000200220042006200820102012Source: Datastream.Scarce new worldEfficiency will likely be the mantra of this phase of rapidmanufacturing change. That the world needs to become moreefficient and environmentally conscious is not news, but a biggerworld with more people wanting more things means constraints areemerging in many resources (half the periodic table according toJonathan Flint, CEO of Oxford Instruments on page 16). Thus,energy and material efficiency is a fertile area for innovation: wethink solutions are needed in three directions (1) the need tomake the same products with fewer resources; (2) to makeproducts that use less energy; and (3) to find new, alternativematerials to replace those that are running out.Technologies working in the first direction include nanotechnology,which uses more precise tools to use far fewer elements in aproduct, without changing (and sometimes even improving) itsfunctionality. Additive manufacturing by its very definition reduceswaste significantly versus the traditional reductive manufacturingprocess. Fuzzy control systems have been used previously inwashing machines, to optimise the amount of water (energy anddetergent) used, and in engines to reduce fuel consumption. Toyotarecovered energy usually lost while braking to make its Prius carmore efficient, while Peter Marsh mentions heat engines as aninteresting technology in his interview on page 6. The idea of cradleto cradle manufacturing is likely to become more prevalent, withgoods made with a view to being recycled so that scarce industrialmaterials arent wasted. Unlike today, scrap value will matter muchmore.On the other hand, new substitutes are also being found. Carbonfibres high strength-to-weight ratio makes it an attractive materialto be used in aerospace and sporting goods (albeit once itbecomes less expensive). Progress on graphene, a two-dimensioncarbon material about 100 times stronger than steel and a betterelectricity conductor than copper, is continuing. The predominantrisk to this argument is cost: many resource-efficient technologiesremain expensive. So it remains to be seen when, not if, risingenvironmental regulation and resource cost inflation will togethermake a stronger argument for a more widespread adoption of thesetechnologies.Source: Intellectual Property Office.Globalised ideas, de-globalised manufacturingGiven much more mass customisation (which needs access to theend consumer), more automation (which relies less on labour costarbitrage) and resource efficiency (which argues againsttransportation and shipping energy costs), the next question iswhere will manufacturing will be based? There has been only oneanswer to this for the last 20 years, given the fully loaded labourcost differential between China (and some other parts of SouthEast Asia) and the West, helped by differences in environmentalcosts, speed of planning and access to capital. Now there are someforces working the other way; if labour costs are falling as apercentage of overall costs (with the share of energy costs rising atthe same time), then the differential matters less. And the gap itselfis narrowing as US wages stagnate in real terms (its important toremember that beneath the averages there are meaningfuldifferences in wages). So what do companies need to considerbefore building a new manufacturing facility tomorrow?Small wondersNanotechnology patents granted at the European Patent Office by 2009Sweden, 1% ROTW, 6%Canada, 1%BRICS, 1%Italy, 1%Switzerland, 2%Netherlands, 3%France, 5%Germany, 12%Source: OECD.We believe that proximity to end markets will be a crucial elementin the thinking going forward. Intellectual property theft risks,complexity of supply chain, cost of idle working capital, inventorymaintenance and environmental regulation will also take moreprominence. Energy costs and reliability of supply will also be afactor, which boosts the argument for greater energy-intensivemanufacturing activity in the US, as its shale resources have thepotential to structurally reduce its energy bill. Add gooddemographics, talent inflow via immigration, clusters and access torisk capital, and it looks likely that the USs share of globalGoldman Sachs Global Investment Research198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008200920102011900FinlandJapanNetherlands0EditorTel:4Equity Research: Fortnightly Thoughtsmanufacturing could rise again, especially to satisfy its owndomestic market. Its closeness to the US should also be beneficialto Mexico, if it is able to combine lower energy costs with lowerwages, and improve infrastructure and skill levels.This is an opportunity for China too. Rising costs mean that it facesthreats at the very low value added end from its South East Asianneighbours. But its push up the value curve could become easier ifit is able to access, adapt and replicate new technologies. What itcant replicate it is likely to seek to buy. And it shouldnt be forgottenthat China will soon have a domestic market of an enviable sizeand economic profile. Satisfying domestic demand should ensureongoing growth for manufacturers in China. But rising labour costs,environmental costs and energy costs all need to be watched.Moving further east, the greater use of technology, particularlyrobotics and precision manufacturing, provides an opportunity forJapan (see page 15), given its demographic profile.For Europe, theres hope if it can remain innovative, and its highnumber of global industry leaders allows some optimism. Thestrength of its education system is an advantage, given the risingrents available to defendable IP, but a lack of creative destructionand diminishing incentives for entrepreneurs are all cause forconcern. With falling labour costs, and the declining importance oflabour costs, perhaps its relatively high energy costs should be agrowing concern. Its comparative lack of resources is also a relativeweakness vs. the US, so it may be that it loses share ininternational markets to the US. Perhaps the real fight is betweenthe US and Europe, not the west and the east. Overall, the next eraof manufacturing could be de-globalising, i.e., the flow of goodsaround the world may change shape, with inter-regional tradetaking a much larger share.Tracking improvementIssue 47extensively in additive manufacturing, while Victrex accounts for80% of PEEK whose light weight and superior strength lends itselfwell to energy exploration, aircraft bodies and the repair of shoulderjoints. Owners of scarce materials that cannot be replaced willcontinue to extract disproportionate rents (potash, copper andhelium), but here we need to be careful about those economies thatare predominantly exposed to a narrow set of commodities thatcould be substituted away (oil-based economies; copper accountsfor 30%-40% of Chiles exports). In terms of design, the field ismuch broader; the makers of software that enables quicker design,easier, more powerful and more integrated manufacturing, shouldbe beneficiaries from more people being involved in the designprocess and faster, shorter product cycles.Of course, the seductive sight, whiff and feel of new technology cancause a momentary lapse in economic reason. There are quite afew impediments that can slow innovation or leave good ideassitting in their wrappers. If corporates, which are currently enjoyinghigh levels of profitability and on average have robust balancesheets, dont invest, then the introduction of new processes andproducts may slow. And of course, corporates have not beeninvesting recently, as evidenced by low capex and rising assetages. M&A has quite often involved large companies buying verysmall ones to access new technologies. In some ways this is good,as it provides stable funding, but it may also stifle change,particularly where there is internal institutional resistance.Protectionism remains a risk, particularly to domestic champions,i.e., labour-intensive employers lose share to those selling betterproducts. Tax rates can disincentivise innovation, as can aproliferation of regulations, so innovation in manufacturing is morelikely to be found in countries where property rights are protected.There is also a risk that innovation leads to a longer life for productsthat eventually lengthens product cycles.A nice finishManufacturing output per hour, indexedOur closing thought is on economic growth. If the price of energyand food halved overnight, would economic growth be higher in800700600500400300200100S. KoreaTaiwanSwedenUSUKFranceGermanySpainItalydeveloped economies? The answer is clearly yes. So, if the futureof manufacturing is really about the battle to make value-addedgoods more efficiently and cheaply, but with rising economicbenefits, then it must involve innovations allowing the world to enjoya productivity surge to either mitigate rising resource costs andscarcity, or even to defeat them. Simply looking at manufacturingas a percentage of GDP is misleading. It is the second order effectsof more efficient manufacturers and their impact on living standardsthat are important. The incentives for innovation are higher nowthan in the last 30 years, technology has progressed, there aremore people connected to each other than before, and there arehigh incentives for solutions provided to constraints. Thats reallyNorwaySource: BLS.The losers and the winnersFrom a resources point of view, creators of new types of materialswill be interesting. A recent parallel would be the sharp rise in thewhat weve been talking about here, and if the scientists are right,then maybe the levels of growth implied in asset prices are too low.Thats a nice thought to start the year with.Hugo Scott-Gallprices of rare earths following the consumer electronics revolution.BASF makes thermoplastic and butadiene styrene, which is usedemail:hugo.scott-gallgs.com+44-20-7774-1917Goldman Sachs InternationalGoldman Sachs Global Investment ResearchCanadaArgentinaAustraliaTaiwanAfricaIndiaVietnamRussiaJapanChinaN.ZealandSingaporeUSHKSwedenGermanyNetherlandsPortugalJapanBelgiumNorwayFinlandDenmarkGreeceFranceSwitz.Austria PolandSpainIrelandTurkeyUKItalyUSThailandS.KoreaEU-275Equity Research: Fortnightly ThoughtsSix charts made-to-orderIssue 471900 was the peak for DMBreakdown of world manufacturing value-added (in 2005 US$)Chinas restorationShare of world manufacturing output (%)DMOthersChinaUSJapanGermanyUKOthers100%90%80%70%60%50%40%30%20%10%100%90%80%70%60%50%40%30%20%10%0%1800183018601900197019801990200020100%180018301880190019701980199020002010Note: DMs include N America, W Europe, Japan, Australia; Until 1970, Japan isconsidered in others and Russia in DMSource: The New Industrial Revolution, Peter Marsh, 2012.A pick upTotal employees by industries in the US, indexed to 2003Source: The New Industrial Revolution, Peter Marsh, 2012.Heavy metalSteel use per capita (kg crude steel)15020022011World average, 2002World average, 2011140Oil and gas1,200130120110100908070GovernmentMiningAll industriesAgricultureUtilitiesFin. ServicesConstructionManufacturing1,00080060040020002003200420052006200720082009201020112012Source: Bureau of Economic Analysis, BLS.Seeking expertiseEmployment in high-tech manufacturing, as % of total employed10%9%8%7%6%Source: worldsteel.org.Who makes what?Share of global exports, 1980 and 201170%60%50%Germany5%4%3%2%1%0%40%30%20%10%0%UKJapanS. KoreaUSIndiaChinaManufacturingChemicalsAutosMachineryOffice equip.TextilesSource: OECD.Goldman Sachs Global Investment ResearchSource: WTO.6Equity Research: Fortnightly ThoughtsIssue 47Interview with.Peter MarshPeter Marsh is the Financial Times manufacturing editor and the author of The New IndustrialRevolution. His previous books include The Silicon Chip Book, The Robot Age, and TheSpace Business.Hugo Scott-Gall: Why do youthink were now at the inflectionpoint for a new era inmanufacturing?Peter Marsh: How we make thingsis changing in several differentways right now, which gives mereason to believe that we couldsee a boost to globalmanufacturing. In the book, Iexplain them as the seven tenetsof the next era of manufacturing. They are the increasing use oftechnology, mass customisation, convergence of the value chain,the importance of niches, focus on environmental sustainability, theemergence of new manufacturing geographies and the critical roleplayed by clusters. Not all of these concepts are new, but theres anincreasing number of anecdotes and examples to indicate thatthese ideas are becoming more prevalent. Taken together, theymake me optimistic about the outlook for manufacturing. And theycould also provide opportunities for growth in other relatedprofessions.As capabilities and technologies becomemore widely shared around the world, we aregoing to see a better balance betweencountries proportion of world population andtheir contribution to global output.Going forward, you should be able to look at and evaluatemanufacturers by understanding how many of those seven thingsthey do. A lot of them already follow five, six or even all seven ofthem. Take Jaguar Land Rover for example. Its a UK carmanufacturer thats leading in the niche area of micro-turbineengines. It also has access to other technologies, including novel,high-strength forms of steel (which comes from a range of steelcompanies, including Tata Steel, like JLR, owned by Tata Group ofIndia) that will become increasingly important as auto producersfocus on building lighter, fuel-efficient cars.What were seeing now is what I call the fifth industrial revolution.The first was a confluence of things to do with new automationmechanisms, with some technology and changes in the waymanufacturing was organised. The second one, which happenedaround 1850, involved transportation; the advent of railways andeven communication, with the invention of the telegraph. The thirdwas a scientific revolution starting at the end of that century. Itinvolved electricity, chemicals and better ways of making steel,which triggered a number of other industries. The fourth one, whichmost of us will be familiar with, is the technology revolution, whichtook shape around the 1940s and 50s. The electronic computeremerged at this time, followed by semiconductors. And wereseeing the impact of these revolutions even now. So whats next? Ithink were seeing a new revolution now, in terms of those seventenets coming together. And this revolution only began around2005, and should go one for the next 40 years or so.Goldman Sachs Global Investment ResearchSo there are opportunities. But we need to be careful aboutprophesying a boom. Theres certainly reason to be optimisticabout global manufacturing, but obviously so much depends on theglobal economy, and to some of the more pessimistic things linkedto it. The more important point is that those who seize theopportunity to be part of this revolution will do very well. And thiswill create opportunities for a broader set of winners outsidemanufacturing, who will benefit from such innovation and aproductivity surge. To think that there is little growth or feweropportunities looking forward is not right, given that so much ishappening.Hugo Scott-Gall: Are we going to see another shift in the location ofmanufacturing, not just in terms of volume but also value?Peter Marsh: As capabilities and technologies become more widelyshared around the world, we are going to see a better balancebetween countries proportion of world population and theircontribution to global output. The nineteenth century was anamazing 100 years for western nations because they were able touse the proceeds of the first and second industrial revolutions toramp up productivity in manufacturing. And so, even though theyhad a relatively small population, they were able to punch abovetheir weight in terms of global manufacturing output. That trendcontinued through much of the twentieth century. Towards the endof the century though, some of those advantages were starting tobe shared with the lower-cost economies. Now, China accounts fora fifth of the worlds output and also about a fifth of its population.At the beginning of the last century, China accounted for about 3%of global manufacturing, even though it had a similarly hugepopulation. Going forward, China is not going to lose this share.theres a big chance that China couldimplode. There are so many things that it isdoing now that dont seem sustainable.But, what were going to see is some of the advantages thatWestern nations had in the past reassert themselves as China triesto maintain the surge in its manufacturing. China will continue togrow, but it will find it difficult to sustain the same pace of growth ithas seen in the last two decades. In 2010, 59% of manufacturingoutput was in rich or developed nations and 49% in so calledemerging economies. By 2050, however, the share of developing oremerging economies will be considerably more than half. Theirshare may even go up to 60%-70%, but that will be in line with theirshare of worlds population.At the same time, the innate advantages of the advancedeconomies will remain in the West. Added to that, theres a bigchance that China could implode. There are so many things that itis doing now that dont seem sustainable.Hugo Scott-Gall: Some EM manufacturing will be owned byWestern companies presumably?Peter Marsh: True. This is one of the nuances that is hidden innational statistics. Its difficult to find the data that will give the exactdetails.7Equity Research: Fortnightly ThoughtsHugo Scott-Gall: Which parts of the manufacturing value chain willbe attractive going forward?Peter Marsh: Design and product developments will attract morevalue, but we should not ignore manufacturing processes. Thereare constant improvements here. You could say that some of thatinnovation is also a part of design, and Western companies dohave an edge here. Which isnt to say that economies like Chinawill not catch up. But I still think that the US, Western Europe andJapan have competitive advantages in these areas. They need torecognise that and act to maintain those strengths.As a sector, Japanese chemicals tells thesame story. It is excellent at providingsolutions, but lacks the skills to take themforward on a global basis.Take Japan for example. It has always been excellent at improvingmanufacturing processes and producing high-end products, but ithas been slipping in recent times because it has been unable toadapt to globalisation. Even in instances of Japanese companiesbuying foreign firms, in most cases they tend to impose their styleof organisation, rather than adopting best practices. Toyota is aclassic example. As a sector, Japanese chemicals tells the samestory. It is excellent at providing solutions, but lacks the skills totake them forward on a global basis. Its more a behavioural issuethan a technological one. And theres a possibility that China couldgo down the same path. It is very restrictive in some ways andthats a huge risk for China. If you look at certain global Chinesecompanies, such as Haier, Geely and Lenovo, they have goodproducts, they have good technology. But there are too few ofthem. And theyre not getting very far, very fast. Working out how tooperate successfully in other countries is going to be very importantin this new industrial revolution.Hugo Scott-Gall: How do you think about the role of governments inthis context?Peter Marsh: Smart governments will understand what is going onand facilitate or assist the development and adoption of these newtechnologies. There are number of ways that governments canparticipate in this without being too heavy handed. This could bethe provision of grants for R&D, tweaking regulation, small businessgrants etc. But obstructive governments, those that are seriousabout blocking change, will find their countries slip down the leaguetable. They will get what they deserve.Hugo Scott-Gall: What three technologies are you are most excitedabout?Peter Marsh: The first would be 3D designing, which allows peopleto design and visualize on their screens what theyre making inthree dimensions. That is fascinating technology, full of potential. Itis a 50-year old technology, but it is becoming more and moreingrained in all types of manufacturing, including 3D printing. Thesecond area is the molecular manipulation of materials such ascarbon. Everyone talks about silicon and iron, but I think thatcarbon is the element of the 21st century. For example, you canmake several types of synthetic diamond which can be used fordifferent purposes, from cutting metals to acting as sensors. This isGoldman Sachs Global Investment ResearchIssue 47often referred to as nanotechnology, but Im looking at it in a moregeneric way. The third one is combustion engines. This goes backto James Watt, who was the first person to work out how to useheat engines, but it is only becoming technologically andcommercially viable now. This is an example of how most of theinnovation were seeing now is just a tweaking of previous newideas (like semiconductors becoming smaller and smaller). Theseengines could be used in a variety of areas and could have a hugeimpact on the efficient use of energy.Hugo Scott-Gall: Are these factors reducing barriers to entry? Willthey allow smaller companies or entrepreneurs to compete better?Peter Marsh: The idea of a lone designer in his or her garageworking on 3D modeling or designing the next generation aircraftnozzle is an appealing one. But that person will have to be pluggedinto the global value chain to make a difference, for GeneralElectric or Rolls Royce to access their input. He or she cant do italone. Technologies like 3D printing are certainly fantastic, but wemust be careful not to exaggerate their disruptive impact ontraditional manufacturers. The designer needs to be connected tothe grid.obstructive governments, those that areserious about blocking change, will find theircountries slip down the league table. They willget what they deserve.Small or niche companies could potentially have access to a muchwider market for their products. Holovis, which is a UK-based, 3Dvirtualisation and design company is an excellent example. Thereare lots of such companies that have come from nowhere and arenow facing a multitude of opportunities. But I dont think any ofthem expect to become multi-billion dollar businesses overnight. Insome areas, barriers to entry will be lowered because it will becomeeasy to pick up someone elses technologies, but not in all of them.Big companies have scale and this will remain an advantage. And alot of them are aware of whats going on and have changed the waytheyre thinking. You should look at Volkswagen and GeneralElectric as a conglomeration of several interconnected nichemanufacturers. And they benefit from knowledge sharing within theorganisation. Of course, the problem is sometimes that largecompanies become too bureaucratic, which hinders their ability toadapt. But thats not new.My view would be that theres something in it for everybody; smalland big companies, high-cost and low-cost countries. As long asthey organise themselves well, they can definitely get somethingout of the way manufacturing is changing. You should judge thesemanufacturers by looking at how many boxes they tick in terms ofhow niche their product is, how they are utilising global locations,how sustainable their processes and end products are, how wellthey use technology, how close they are to the consumer and howmuch access they have to other fields and pools of talent. Theseare the important facets of the new industrial revolution. I wouldntbe surprised if the companies you want to invest in will be thosethat tick many of these boxes. We should learn to look at thesecompanies differently.8Equity Research: Fortnightly ThoughtsIssue 47Interview with.Neil HopkinsonProfessor Hopkinson graduated from The University of Nottingham in 1993 with a degree inManufacturing Engineering and Operations Management. He completed his PhD in 1999. In2011 he took the post of Professor of Manufacturing Engineering at The University ofSheffield. Neils research field is additive manufacturing.Hugo Scott-Gall: Can you gothrough the basics of additivemanufacturing?Neil Hopkinson: Additivemanufacturing is a family oftechnologies that uses 3Dcomputer design models to create3D products. The computer modelcan be designed in computeraided design (CAD) software or itcould be something like apatients MRI scan. Similar to a 2D printer, which uses a sourcedocument such as a word processed file or spreadsheet to print onpaper, this technology uses the three-dimensional digitalrepresentation of the required product as a starting point to createthe object. The technology then slices the design into thin layers,so that a machine will be able to print it, layer by layer. Thats abasic description of additive manufacturing.The industry, which has seen compound annual grown in excess of20% since its inception in the late 1980s, is diverging into two veryclear parts at the moment. The first is low-end 3D printing. Theseare cheap machines that produce parts that may not be of thehighest quality, but certainly better than they used to be. Becausethey are easy to purchase, these machines are springing upeverywhere and gathering a lot of media interest. The other part isthat of the industrial production machines which are more suited tocreating final products that get sold individually, or as componentswithin other products.Hugo Scott-Gall: How do you see the application of these industrialmachines evolving? Will they be used for high-end, low-volumecomponents or for mass production?Neil Hopkinson: Historically, this family of technology has involvedhigh-cost machines and expensive materials, making itcommercially viable only for manufacturing low-volume products.Even today, the majority of the parts made with these machines areprototypes. But thats changing quite rapidly; more and more partsare being manufactured as end-use products. Today, thetechnology can be used across different sectors, to makenumerous parts including environmental control ducting for aircraftand various components for racing cars. The applications at thelow-volume and high-added-value end have remained dominantsimply because the price of the industrial machines is still very high.There have also been some niche applications, notably theproduction of personalised hearing aids, where the technology hasbeen used to create millions of units of product, with each productbeing unique.Will that continue to be the case? I dont think so. The cost of theseprocesses are falling, making it economically viable to make agreater volume of products in series production. Currently, it stillmakes a lot more sense to use this technology to make small,complex products in low quantities, as opposed to producingsimpler and bigger geometries in larger volumes. But with time, asincreased competition in the market drives down cost further and asprocesses become quicker, these machines can be used tomanufacture millions of products. And in the not too distant future,they can replace a small but significant chunk of the existing marketGoldman Sachs Global Investment Researchfor processes like injection moulding, rotational moulding andmachining.Hugo Scott-Gall: In the longer term, how will this impact differentparts of the manufacturing value chain?Neil Hopkinson: Its difficult to be specific about the implications ofthis technology, as it is still quite early and because we dont knowwhat other technologies will arise in the future. But Im certain thatsome portions of the manufacturing sector as it stands today will beimpacted, and that will be felt by the supply chain too.For instance, in the case of injection moulding, the parts of a carmade today may have been moulded from a tool in a facility locatedin China and subsequently shipped elsewhere to be assembled. Ifyou need to replace a part made by that tool, it should again bemade in the same location. However, with 3D printing at yourdisposal, it would make a lot more sense to print that replacementproduct close to where the car is. Once that happens, it wouldmake sense to start manufacturing the product close to the enduser, and we will increasingly see such distributed manufacturing,(rather than a centralised approach) where the transportation ofproduct will be digital rather than physical in nature. We could emaila file to a machine somewhere, print it up and transport the physicalproduct a very short distance to where it is actually needed.Hugo Scott-Gall: So the speed of innovation is increasing and thecost of innovation is falling?Neil Hopkinson: Yes. So far, the cost barrier has limited the use ofthis technology predominantly to prototyping, but even this ratherrestricted use of the technology has helped companies innovatesignificantly. By prototyping quickly and relatively cheaply,companies can experiment making far more complex products. Itgives them a chance to test the feasibility of their products beforeactually investing in the tooling. By allowing companies to try muchmore creative, complex designs, the technology has already had aprofound effect on manufacturing and the products that companiesmake. Its important to point out that additive manufacturings abilityto eliminate physical tooling from the manufacturing process letsus create geometries that would otherwise be impossible. This is akey benefit which will not only have a significant impact oncreativity, but will also affect the range and quality of products weproduce by reducing the risk of being creative and innovative.Therefore, when this technology goes beyond prototyping, it indeedenables a far higher degree of design freedom than before.Hugo Scott-Gall: So would this democratise design going forward?Neil Hopkinson: Absolutely. At the moment, if you design a plasticpart that is to be manufactured in high volume, it will invariably bemade by injection moulding. That puts some serious designconstraints on what can be made so todays designers need tohave a very detailed knowledge of the constraints they are workingwithin. If we remove these constraints, suddenly one doesnt needto be an expert to design a product. Even if there is a significantreduction of constraints, instead of a complete elimination, it willallow people to design products with a much lower level ofknow-how in terms of the requirements for manufacturing.Hugo Scott-Gall: Who in the value chain could extract the largestrent from this technology?9Equity Research: Fortnightly ThoughtsNeil Hopkinson: People often believe that design will be the mostvaluable area. But, the availability of good design tools and designcapability itself is increasing enormously at the moment. Today,even school children know how to use computer aided design, sowhile they can certainly add value, the uniqueness of having designskills will diminish. Designing a geometry and making a part thatcould not have been made before certainly grabs attention, sopeople naturally feel that design is the most crucial aspect. But theyoften overlook the fact that we would still need to create a high-quality product from the design. Thats why I think a lot of themoney and value to be created will be in the materials portion of thevalue chain.The business model of the 2D printing industry, where the printersare sold at a loss and money is made on the consumableafterwards, is very much applicable to additive manufacturing. Thephysical artefact will still be the desired end product, but thematerials that can be processed by the technology will have to fitcertain requirements, making specialist knowledge and know-howof designing materials a much-prized asset that is not readilyavailable today. Just as we cant put any liquid into a printer andexpect it to print, using a material for additive manufacturing is notthat straightforward either. So, a number of companies are lookingto develop and tune their materials for them to work effectively andreliably in these processes. These companies, which harness thecapability of producing such materials, will extract the maximumcommercial value out of this technology.Hugo Scott-Gall: What about copyright risks and IT theft issues asmore people have access to a 3D printing technology?Neil Hopkinson: The 3D printing industry has a lot to learn from themusic industry in this case. However, I think the most profoundimpact of the low-cost 3D printing market wont be in its products,but rather the way that school children learn to appreciate thewhole process of thinking up a shape and then making it. Thiswould naturally help in the future, if they get into the industry andwork on higher-end systems.Hugo Scott-Gall: Given developments in additive manufacturing,and the broader changes happening in the industry, do you thinkthat the future of manufacturing will shift back to the west?Neil Hopkinson: Undoubtedly so. Id say additive manufacturing isprobably the prime example of bringing manufacturing back to thedeveloped economies. With this technology, it would make a lot ofsense for manufacturing to take place closer to the point of market.However, the question of where those end markets are will remainand so we definitely shouldnt dismiss the growing size of theChinese market. People often forget to consider the amount ofadditive manufacturing that will occur in the BRIC countries, butoverall, the balance of manufacturing should certainly swing backtowards the developed economies.Hugo Scott-Gall: Particularly for an economy like the UK, which isstruggling to find sustainable growth, could such technology bring ameaningful change in the complexion of economic output?Neil Hopkinson: Yes, absolutely. The UK is strongly positioned interms of design capability and we have a strong base of companiesthat already know how to use this technology. The impact of this onour economy may be small at first, but will grow and become moreprofound with time. The impact may get lost in the noise that existson a macroeconomic scale, but its something that is definitelygoing to be of benefit to the UK in terms of its trade balance.Hugo Scott-Gall: The labour impact is evident with 3D printing, butwhat about the energy part of the equation?Neil Hopkinson: The cost of energy is likely to become a higherpercentage of the overall part production cost, but how significant itGoldman Sachs Global Investment ResearchIssue 47is will depend on the scale and volume of production. Thistechnology creates a trade off between energy and transport cost.As industrial machines become capable of churning out highvolume, and become more responsive, we can start manufacturingcloser to the end markets, thereby reducing the transportationcosts. The energy costs will then naturally gain higher visibility. Inmost cases, the conversion of raw material to product usingadditive manufacturing is better than in other technologies such asmachining where the majority of the raw material becomes scrap;this reduces the energy cost incurred in preparing raw material forthe process. Its also evident that design freedoms are allowingreductions in part weight, that significantly reduce the cost ofenergy required during the life of products in the transport sector.Taking a holistic view, additive manufacturing will be able to reduceenergy demands, and hence costs, when compared with todaysmainstream manufacturing processes.Hugo Scott-Gall: And inventory is going to look different as well.Neil Hopkinson: Completely different. Today, if you break acomponent of a washing machine, that moulded part probablyneeds to be manufactured in a far-off nation, stored somewhere inbetween and then delivered to you. With additive manufacturing,instead of bulk-storing replacement parts, we can simply print themout when needed and reduce the huge amount of inventorycurrently managed to near-zero value. Spare parts will be storeddigitally and delivered efficiently, costs significantly reduced andvalue added to the customer.Hugo Scott-Gall: In an environment of high unemployment, do youthink that governments may see such technologies as a threat tojobs and create regulations that inhibit their growth?Neil Hopkinson: Its possible. But governments may also say that tosell products in their country, a certain amount must bemanufactured there too. Given the relative ease of working with thistechnology, and the fact that if it develops elsewhere a nation mightfall behind, governments might find it quite hard to stifle thedevelopment of this technology. Instead, they will need to ensurethat they are progressively competitive in this sector.Hugo Scott-Gall: How will this technology change the kind ofproducts that a consumer will own 10 years down the line?Neil Hopkinson: That is going to depend a lot on the income andthe ability of the consumer to pay. Much of where this technologygoes may not be apparent to the consumer. Today, hundreds ofadditive manufactured parts are used on the 787 aircraft, which wejust dont see. This should increasingly become the case with thehigh-end automotive industry over the next ten years, and even thecase with lower-end automotives in 30 years. So, a lot of the usemay be hidden under the bonnet of their Mercedes, and later theirFord, the consumer just wont be aware of it. And there will be noneed for them to be aware of it either.197219741976197819801982198419861988199019921994199619982000200220042006200820102012Employeesinmanufacturing(inthousand)Manufacturingoutput(base100in1972)300150 100 - 200 50 - 100 50 - 100 200 - 4005,0000Source: Company Data, Goldman Sachs Research estimates.500Automation is not just about replacing a cheap person, but anPharma, cosmetics, medicalenormous source of data that gives you enough informationabout a process to improve its quality, speed, and cost. If aPackagingFood, beverage 5010 years10 yearsRevolutionuntil the 70sfrom nowfrom nowWinnersWorkersLarge scale manufacturersTraditional Capital GoodsTraditional automationRobotics providers (e.g., ABB,3D printer manufacturersSuppliers of complex chemicalmanufacturersmanufacturersKuka, Fanuc)and composite materialsIndustrial software providersHardware makers (e.g., ITsuppliers)Industrial software providers(e.g., ABB, Siemens, Invensys,Rockwell Automation)Industrial software providersHigh cost country manufacturersChemicals companiesSemiconductor manufacturersNiche manufacturersLosersUnskilled workersUnskilled workersUnskilled workersUnskilled workersLow cost country manufacturers. Ultimately companies withlack of ability to adapt due toSmall size manufacturingshops unable to adaptSmall size manufacturingshops unable to adaptSmall size manufacturingshops unable to adaptManufacturers of cuttingtools and machines, hand toolseither weak competitivepositioning or low cash(e.g., Sandvik)Manufacturers of spare parts andsupplies (e.g., SKF, Atlas Copco,Vesuvius)Discrete automation manufacturers?Robot manufacturers?(e.g., ABB, Schneider, Siemens).returnsCapital Goods companies mainlybenefited from changesCan Capital Goods companiesstill benefit from here? Which ones will be able to use thesetechnologies to lower their cost bases and time-to-market?Source: Goldman Sachs Research.Winners and losers from future manufacturing? The capital goods sector is full of examples of companies that were forced to adapt (for anexhaustive list see our report, “EM Competition Roadmap”, September 7, 2012)XIX century and before1900-193030s40s50s60s70s80s90s2000sAtlasCopcoNewbusinessesDivestmentsFixed steel structures,railway cars, steam anddiesel enginesMachines tools,compressorsRailway cars, steamenginesDiesel enginesMining and constructionequipmentIMI plcNewbusinessesPercussion cap, lamps,printing works, brassrolling mill, soap,bicycles, metaltechnologiesCarburettors andradiators, zip fasteners,copper and copperalloys production, heatexchangers, sportingammunitionTitanium productionPipes, tubes and fittingsSevere service, fluidpower, indoor climate,beverage dispense andmerchandisingMetal smelting, metalDivestmentsfounding andconstructionNewPhilips businessesLampsX-Rays, radios, vacuumtubesElectric shaversTransistors, TVs,cassettesIntegrated circuitsMusic recording, videorecordersCompact DiscDVDHealthcareElectronicsDivestmentsMusic recording,appliancesSemiconductors, TVsNewbusinessesSteel production, rock-drilling equipmentSteel belts, razorblades, wires, springsCemented carbideCemented carbidetools, sports equipmentTechnical consultingUmbilical tubes,medical productsSandvikDivestmentsSaws and tools,process systemsWire products and wearplants, welded tube,medical productsUPS, buildingNewSchneider businessesElectricDivestmentsFoundry, armament,electrical equipmentElectric motors,construction, iron andsteel worksArmamentIron, steel works,marine constructionElectrical distributionautomation, security,smart grid, missioncritical infrastructuresoftwareSiemensNewbusinessesTelegraphs, electricalequipment, railRadios, TVs, electronmicroscopes, powerstationsMilitary equipmentComputers,semiconductors,washing machines,pacemakersNuclear powerTelephones, avionics,radar and traffic control, Banking, medicalautomationAutomotive, industrialgas turbines, windpower, buildingautomation, solarDefence, aerospace,Automotive, nuclearDivestmentssemiconductors, retailbankingpower, mobiles andcarrier services, lightingNewbusinessesSaw mills, iron millsPower productioncement production,miningWires, shipbuilding,paper machines, locks,diesel enginesCeramics, pumps,radiosGlass, ready-mixconcrete, TVsFactory automation,paint and printing ink,caravansSteelPower plantsWartsilaDivestmentsPaper machines,shipbuildingCeramics, Electronics,power production,paper machines,building materials,Steellocks, caravansSource: Goldman Sachs Research.Goldman Sachs Global Investment Research13Equity Research: Fortnightly ThoughtsIssue 47Interview with.Avi ReichentalAvi Reichental has been the CEO and President of 3D Systems Corp. since September 2003.Prior to joining 3D Systems, he served as Corporate Officer, VP and General Manager ofSealed Air Corps Shrink Packaging Division. He is the recipient of the regional 2011 E&Yentrepreneur of the year award and holds 25 US patents.Hugo Scott-Gall: What are thecurrent applications of 3D printingtechnology? And how do youforesee further adoption?Avi Reichental: Since 3D Systemsinvented 3D printing a fewdecades ago, it has been usedmostly for modelling andprototyping products as aprecursor to real manufacturingapplications. Today, 3D printing isused in fields such as automotiveand transportation, aerospace anddefence, general consumerelectronics, durable goods andeducation. Another important and growing area is personalisedmedical devices and healthcare applications, which includeshearing aids, dental restorations, aligners and a variety of implantand surgical applications. In all these verticals, over time we havesuccessfully transitioned and evolved the technology frommodelling and functional prototyping into tooling and fixtures, andinto manufacturing of functional end-use parts. This includesaround 90 parts on board every F-18 thats in service today, andthere are about 900 parts now qualified for the Lockheed Martin F-35, a 10-fold increase for this new fighter jet. We also provideprinters and materials to Align Technology, which prints millions oforthodontic aligners annually, each one unique, as an alternative totraditional wire braces. Our technology is also used to manufacturethousands of hearing aids that are delivered on a monthly basisworldwide.Concurrent with that, in the last few years we made some inroadsinto the consumer space, both in terms of home use and how it hasevolved into classrooms around the world. This effort is focused ondemocratising access to 3D printing and 3D content by first offeringextremely user-friendly plug and play, and very affordable 3Dprinters, like the second-generation Cube that we launched at theConsumer Electronics Show in Las Vegas last week, and byoffering a gamified experience for kids and adults alike, so thatthey can harness the magic and power of 3D printing. We havedone this by systematically removing the need for expert user skillsand know-how. In a way, we are creating a colouring book likeenvironment for people to begin to create, develop and harness themagic of 3D printing.Hugo Scott-Gall: Can 3D printing evolve from being used mostly forcomplex, low-volume products to mass production?Avi Reichental: There is no question that scale can be built up.Look at the sectors that are currently using this technology, likeaerospace, automotive and medical devices. Products in thesefields can be scaled to very high volumes with the added benefit ofmass customisation, along with the advantages of just-in-timemanufacturing that is completely flexible. That means they onlyhave digital inventory and no set up costs or additional time neededbetween the different varieties of products produced. Plus, with 3Dprinting complexity is free. It doesnt make a difference to theprinter if it is a simple geometry or a complex geometry. There is noextra cost for complexity.Over time, I do believe that mass customisation can become areality and an interesting, growing trend is that customers want tocustomise, they want something bespoke, they want somethingthats unique to them, and manufacturers are increasingly lookingfor ways to address that. For example, if you want to order a newMini Cooper, there are over 10,000 customisation options that youcan select from. That is the level of solutions that consumers desiretoday. Their appetite and demand for customisation means that inthe future we will be looking at companies that will manufacturemillions of one-of-a-kind products, instead of mass producingmillions of a single design.The trend of re-localisation of manufacturing in a more distributedway, possibly closer to the point of use is a favourable trend. Andwhen you look at the convergence of robotics, artificial intelligence,infinite computing and 3D printing, it begins to suggest that there isa very disruptive, industrial renaissance in our future that can makeall this possible.As designs become more complex andcomponent count increases, 3D printingbecomes the enabler that allows companiesto deliver this complexity in a highly functionaland cost-effective way, and to do it in a fairlyshort amount of time.Hugo Scott-Gall: This speeds up manufacturing innovation, whilereducing its cost and increasing its breadth.Avi Reichental: Yes, absolutely. If you get access to affordable andreliable printers, as well as ubiquitous information, then companieswill increasingly be able to deliver more functional, morefeature-rich and more complex designs. As designs become morecomplex and component count increases, 3D printing becomes theenabler that allows companies to deliver this complexity in a highlyfunctional and cost-effective way, and to do it in a fairly shortamount of time. This reduces product lifecycles and time to market,which allows our users to gain leadership positions in the variousfields they cover.So, yes, these cycles of innovation will become shorter. Thecomplexity of innovation is going to increase. And then, if youconsider the convergence of exciting technologies, from infinitecomputing on the cloud to mobile devices to extremely precise andvery affordable sensors (like the type that PrimeSense producewhich allow you to measure and digitise almost everything), youcan see the prospects for flexible, localised manufacturing tobecome a reality.We live in a very exciting period and we have a great responsibilityto deliver our technology to empower companies to begin tomanufacture intelligently, locally and flexibly, and to deliver asuperior product that will enhance the quality of life as we know it.In my mind, we have an opportunity in the next five to ten years toinfluence many areas in a good way; how we learn, how we teach,how we create and make, how we manufacture and how we deliverpersonalised medical devices. All of that and many areas that weGoldman Sachs Global Investment Researchwell.14Equity Research: Fortnightly Thoughtsare not even thinking about yet are going to be significantlydisrupted and impacted by the convergence of these technologies.Hugo Scott-Gall: You spoke about digital inventory earlier, how canwe think of the implications of 3D printing on inventories ofmanufactured goods?Avi Reichental: Yes, there will be profound implications. Would yourather have finished goods and parts that must be transportedacross oceans and continents on container ships, and then hauledinto a variety of distribution centres or warehouses, or would yourather have 3D printing firms that can make individual products andcomponents much closer to the point of use, where the onlyinventory is raw materials and a flexible manufacturing platform?You can make the final product just in time, where and when thecustomer needs it. That has implications, not just for the inventoriesof the manufacturer, but through the supply chain. Then there areimplications on freight, environmental sustainability and carbonfootprints, which I believe will improve substantially. Wastegeneration will be reduced too because 3D printing is inherently anefficient process that generates little to no waste. So, if you put allthat together, the opportunity for 3D printing is enormous, not just interms of inventory, but throughout the supply chain.Hugo Scott-Gall: How energy intensive is manufacturing with 3Dprinting technology?Avi Reichental: By and large, the printers that we sell are not moreenergy intensive than traditional manufacturing tools, whichincludes CNC machining, injection moulding and the like. In manyinstances, energy consumption and labour intensity are vastlyreduced relative to some of these traditional methods.There will be continuous improvementand progress and I dont see any technologyroadblocks in the near to mid-term that wouldprevent us from continuing to makeimprovements.Hugo Scott-Gall: If we look at previous product innovations likesmartphones or regular printers, we tend to see a sharp drop in theprice of the product as its capability and use increases. Do youthink that 3D printing machines will follow the same kind of curve?Avi Reichental: Yes. We have dedicated most of our efforts to whatwe call democratisation of access and acceleration of adoption.What that means to us, is that every evolution, every step that wetake in our product development is aimed towards deliveringindustrial grade 3D printers and consumer grade 3D printers thatare faster and more accurate, easier to own and operate, muchmore affordable and capable of printing with more materials.My expectation is that this progress continues and accelerates. Forexample, even last week at the Consumer Electronics Show, withina year since we launched the first consumer 3D printer, we havealready introduced the next generation Cube that still costsUS$1,300 but now prints one and a half times faster and twice asaccurately as its predecessor, and can now print in more materialsand colours. This is just a small example of the kind of progressGoldman Sachs Global Investment ResearchIssue 47that is happening every day and in every way, across not only ourpersonal printers but our professional and production printers asOver the next five years, I expect that 3D printers for bothprofessionals and consumers will be able to print much faster. Theywill be able to print with more materials and deliver comparableperformance characteristics to the traditional manufacturingmethods. I see this as an ongoing evolution. There will becontinuous improvement and progress and I dont see anytechnology roadblocks in the near to mid-term that would preventus from continuing to make improvements from generation togeneration in productivity, speed, accuracy and materialperformance. We have a thoroughly robust roadmap ahead of usand I believe that the same is true for all the players in this space.Hugo Scott-Gall: How much demand do you see from Asia?Avi Reichental: The countries that have led adoption are the UnitedStates, Germany and subsequently other European countries, andthen Japan and South Korea and more recently China and the restof the Asia-Pacific countries. There is certainly increased demandin Asia-Pacific, and there is also increased demand from countrieslike India and Brazil and more recently Turkey; however, we viewall these geographical opportunities as not that significant relativeto the overall marketplace opportunity because its really aboutreplacing and complementing traditional manufacturing methods.And when compared to the available marketplace in traditionalmanufacturing, we are not even scratching the surface yet.Hugo Scott-Gall: Are you threatened by the ability of largecompanies to buy out 3D printing technology to prevent it fromdisrupting their traditional models?Avi Reichental: We are seeing a lot of interest from largecompanies, but that is indicative of the growth opportunity. Whenwe see them beginning to make decisive investments in additivemanufacturing, whether they do it by acquiring printers andmaterials from us, or by making financial investments, the kind thatGeneral Electric recently made by acquiring Morris Technologieswhich is a service bureau, its a validation that leading globalmanufacturing companies have begun to understand that additivemanufacturing and 3D printing is strategic to their growth andsustainability in the future, and for us, moves like that are verypositive and very validating.Hugo Scott-Gall: And are you seeing interest from governments?Avi Reichental: Its actually interesting to note that countries arebeginning to look at it as strategic to job creation andcompetitiveness. As you know, the Obama administrationannounced a manufacturing initiative late last year, that will resultover time in the creation of 15 manufacturing centres of excellenceacross the US. Its starting with US$70 mn invested in additivemanufacturing in the first manufacturing centre in Youngstown,Ohio, focusing on the practical, industrial deployment of additivemanufacturing for the benefit of job creation, differentiation andtechnological leadership in the United States.We also see that other countries, including China, are looking toadopt similar measures, and to me thats another very strong signalthat in the next five to ten years 3D printing will become an enablingplatform that will change the create and make process as we knowit across many, many fields.OthersLessParts &serviceTireBetterTel:15Equity Research: Fortnightly ThoughtsAutomation: Not just an EM storyIssue 47Yuichiro Isayama, our Japanese machineryanalyst, focuses on the nuances ofautomation and what it means for Japanpreviously off limit, because of cost constraints or danger toemployees. This kind of automation could provide the miningindustry with considerable benefits.Automation lowers cash cost of minesCash cost comparison of mining operationsOn many previous occasions we have argued that three catalystsdrive factory automation - labour cost increases, the need for betterproduction efficiency and growing demand for quality. We have alsostressed that demand for quality would be the strongest of thesedrivers. However, we believe that we might need to revise ourexpectations for the speed of automation in developing countrieslike China, where labour cost increases are becoming a problem.While demand for higher quality remains the main automationdriver, sharp increases in automation in EM could see quality levelsabove and beyond the needs of those markets, resulting in excessinvestment and overspend. The result could be a reactionary fall-back in automation investment.Too much, too fast could create problemsFor example, do EM auto assemblers need the same level of robotLaborFuel & oilInitial cost ofmining equipmentlabor costsproductivityand fuelefficiencyHigherinitial costsautomation as their DM counterparts in the most competitivesegments of the EM market (vehicles priced at under US$10,000)?Probably not. Small entry-level vehicles like the Tata Nano and theArea AArea BManual mechanical dump trucksArea CCash cost withautonomous truckAutonomous dump trucksToyota Ethios were developed specifically for emerging markets.They represent an entirely new segment of the auto industry. Itwould therefore make sense that the automation needed toproduce these unique products is introduced at a pace that meetsthe demand of the specific market in terms of end-product qualityand price, and reflecting consumer purchasing power. In “ReverseInnovation” Vijay Govindarajan claims that there is no need for EMto follow the same development path as the DM before them. Wethink this difference in approach will mean that EM introduceautomation at a different rate than the DMs.The risk of a shift to even cheaper labourThe biggest risk to progress with EM automation is the possibilitythat manufacturers move on to other countries with even lowerproduction costs. The main incentive for most companies to set upsupply bases in EM is cheap labour. The most common examplesof EM automation are Chinas high-tech and auto industries.However, more basic manufacturing industries such as clothing aremoving to countries with even lower labour costs (e.g., Vietnam andBangladesh). In auto-related manufacturing industries, Bridgestonedecided in 2011 to set up a production/export base for cheap tiresin Vietnam. This is one example of how a rise in labour costs doesnot necessarily lead directly to increased automation demand. Inshort, we believe that some expectations for automation (as a cure-all for a wide range of problems such as rising labour costs) areunrealistic. The move toward automation is inevitable we believe,but it is not going to change the world.Dramatic cost innovation from mining automationWe believe that too little is made of automation in the mining sector.Previously impossible, it now promises cost innovation. We see amove to automated mining machinery as natural, and needed to cutlabour costs (hundreds of thousands of dollars per person pa) andto reduce danger in the mining process. Komatsu has begun full-Source: Company data (Komatsu).Automation in DM to accelerate further moreIgnoring automation in DM is unthinkable given ageing labour andexpensive labour costs, new plants are being built in NorthAmerica, led by the shale gas revolution, given domestic demandrecovery and a rebound in the manufacturing industry. The currentrebound in US manufacturing industries has resulted in theresurgence of investment in state-of-the-art plants withcomprehensive automation, including Apples in the high-techsegment and a Tesla plant in the automobile sector. If factors suchas FX rates are favourable, DM could reclaim leading roles in theglobal economy, or at least in the US.Automation and FX a new breath of life for JapanFujio Mitarai, Chairman of Canon, recently underlined thesignificance of factory automation for cost innovation when he saidthat Canon could rely on its fully automated domestic plants withoutany need for cheap overseas labour, if the yen fell back sufficiently.We see a number of good reasons for Japan to maintain domesticproduction bases in its core technology areas, including stableelectric power supplies, ease of facility and material procurement,the high quality of the workforce, and unsurpassed technologicalcapabilities. Will Japanese manufacturing really revive as a result ofincreased automation and a fall-back in the yen? We believe so, aswe have seen the evolution of factories automated to a level atwhich robots are producing robots, an entirely new standardrepresented by companies like Fanuc, the global leader of theautomation industry. The yen is showing signs of entering adepreciating trend, and this is raising hopes that we couldeventually see the green shoots of a recovery.Yuichiro IsayamaJapan Machinery analystscale supply of autonomous dump trucks to Rio Tinto, and the costreduction possible, in our view, could change the industrys view ofcash costs, costs that define competitiveness at mining operations.email:yuichiro.isayamags.comLtd+81-3-6437-9806Goldman Sachs Japan Co.,More specifically, this equipment allows mining in areas that wereGoldman Sachs Global Investment Researchhuge.16Equity Research: Fortnightly ThoughtsIssue 47Interview with.Jonathan FlintJonathan joined Oxford Instruments as Chief Executive in April 2005. He has a BSc in Physicsfrom Imperial College and an MBA from Southampton University. He is a fellow of the Instituteof Physics, the Royal Academy of Engineering and the Institution of Engineering andTechnology. He sits on the Council of the Institute of Physics and is a member of advisorypanels to the UK Science and Technology Facilities Council.Hugo Scott-Gall: Why willnanotech play a bigger role inmanufacturing in the future?Jonathan Flint: I believe that in thecoming decades, nanotechnologywill gain more and moredominance and traction inindustry. There are a lot ofreasons to support this argument,the most basic of which is thatwhile there is only a finite amountof resources and a limited numberof atoms that exist on earth, we expect GDP to grow continuously.The only way we can reconcile the two things is by extracting morevalue from the fixed amount of resources, by working at a smallerscale. By doing more with less.The dollars generated per atom have to go up, and for this we needtools which can operate right down at an atomic level. This is aninevitable long-term trend and we believe that a business thatprovides such tools has an attractive future.Hugo Scott-Gall: How do your tools help in using materials moreefficiently?Jonathan Flint: I can explain with examples. Your smartphonesurface needs to be completely waterproof because any moisturewill destroy it, while at the same time it needs to be see-through.That requires specific use of materials. A technique we use iscalled atomic layer deposition or ALD, which lays down elementsone atom thick producing thin film materials. So a tiny fraction ofraw material is used on each mobile phone instead of the heavy,thick films that were used only a few years ago.Soft drinks cans used to be quite rigid just a few years ago,whereas nowadays you can crush them between two fingers.Thats not because you have become stronger, its because the thinfilm layer inside has become much thinner and uses fewermaterials, and thats possible because the tools have becomemuch more accurate and capable of making thinner layers. The canof today uses a fraction of the material that it did a few years ago.Hugo Scott-Gall: What is the scope of this technology currently, andin the future?Jonathan Flint: That depends on the industries were talking about.We have a good presence in the semiconductor industry forexample. You may be aware of Moores law, which says that thecapacity of a chip doubles every 18 months that has been quiteaccurately reflected in this field. This means that, despite being thesame size, weighing the same amount and having the samenumber of atoms, a microprocessor chip today can be a milliontimes more powerful than it was 30 years ago. The big differencebetween now and then is in the tools we use to design andmanufacture the chips.We are seeing that more and more industries are starting to moveup that exponential curve, from a very low base. That includesenergy, pharmaceuticals and cosmetics. These new areas areexperiencing a similar change and the fundamental driver is theGoldman Sachs Global Investment Researchcommon concern that there is only a limited amount of materials,which will keep getting more expensive. It is this concern thatmakes people use them more wisely and in more intricate ways, toderive the most value out of them.There are other reasons too. Let me give you an example from theaerospace industry. An estimated 2% of all aircraft parts aresupposed to be counterfeits. Given that a plane has close to sixmillion parts, this adds up to a very high number. In some cases,the only way of detecting these counterfeit parts is by carrying out adetailed atomic level analysis. Increasingly, equipment of the sortthat we produce is used for such quality control. For example, wehave a series of small handheld x-ray fluorescence analyserswhich, when pointed at a material, can tell you exactly what it ismade of, right down to the atomic level. You may not think of thatas nanotechnology, but it actually does involve looking at individualatoms to discover whether or not the right atoms are in the rightcomponent. This is how they play a massive role in safety-criticalenvironments.Hugo Scott-Gall: What about developing new materials? Is that apotential growth area too?Jonathan Flint: It certainly is. A big portion of our sales come fromtools used to develop new materials. Graphene is an excellentexample. Its a nanomaterial that was first isolated only a few yearsago. It is a two dimensional carbon lattice similar to a diamond, buthas some properties which are completely different from anymaterial that weve seen before. It is about 200 times stronger thansteel for example. Such unique electrical and thermal propertiescan find very interesting uses in the field of electronics. It is stillvery early days. At the moment it is made in small amounts tomaintain high quality and also to ensure that it is compliant withvarious safety standards for different industries. But it couldrevolutionise a whole bunch of industries, starting with electronicsand then moving up to larger products. We might even see agraphene suspension bridge one day, so the potential is absolutelyElsewhere, a lot of paints use nanomaterials, where very smallparticles affect their pigmentation. Deodorants and sunblocks usethese materials too. In fact, the reason why you can get factor 50sunblock now is because the material has been impregnated withnanomaterials. Another application is self-cleaning windows, whichuse this technology to apply nanofilms on top of glass.Hugo Scott-Gall: What are the main limitations or impediments tothe growth and adoption of these kinds of new materials andtechnologies?Jonathan Flint: As with most new technologies, the risk is that wedo not know how successful they are going to be. Just because anew process or material is better doesnt mean that it will beadopted widely by an industry. A lot of existing industries areactually quite conservative and if their model is working well, theysee no real incentive to write-off their entire production capabilityand the know-how of their workforce to shift to a totally newparadigm. And so, the new process or material needs to besignificantly better and provide long-term competitive advantages17Equity Research: Fortnightly Thoughtsfor it to be accepted. Only a compelling business case can forcesuch a shift.Hugo Scott-Gall: With new technologies changing, which parts ofthe new manufacturing value chain will be most valuable?Jonathan Flint: Design is a much bigger element today simplybecause the new materials and ways of doing things can enabledesigners to take decisions that can massively change the eventualprofitability of a product. With piecemeal incremental improvementsthat have happened since the Second World War, a lot of factoriesworldwide are already pretty efficient and so design will become adominant cost driver going forward.Hugo Scott-Gall: How do adoption levels and R&D spend onnanotechnology differ across the globe? And how involved aregovernments in this effort?Jonathan Flint: If you consider the sales map of our company to bean appropriate corollary to understand where R&D and high-techmanufacturing is going on, then the answer is that it is quite global.About a third of our sales come from the US, another third fromEurope and the rest from Asia. However, within this, Asia hasconsistently been the fastest growing market and is increasinglyproviding a larger fraction of our turnover as more and moremodern factories are built there. Asia is certainly hungry for newhigh-tech products.the new process or material needs to besignificantly better and provide long-termcompetitive advantages for it to be accepted.Only a compelling business case can forcesuch a shift.In China, which is our second biggest market after the US, there isa big push from the public sector. In fact, the distinction betweenthe public and private sector, along with the line where thegovernment stops getting involved in private industries, is not asclear as it is in the West. But it is these strong and clear long-termgovernment strategies in China that have pushed them rapidlyforward. Compare that to the UK and other developed economies,where there arent too many scientists in the government. Theydont understand the key paradigm changes in technology. Isometimes find signs of short-termism even in companies here thatare hence reluctant to invest in something which may not pay off for10 or 15 years, and understandably so.The UK has put 50 mn into graphene and, while it is a goodamount, Singapore, which is a much smaller country, is alsoinvesting on the same scale. I wont even start on the scale ofChinese investments. Having said that, the UK government isbeginning to get the right idea and is trying to do its best. Eventaxation legislation in the UK is favourably skewed towards thehigh-tech companies and we very much approve of that. On theother hand, weve seen a slowing in the US on public funding whichhas made the difference between Asia and the US greater.Hugo Scott-Gall: How do you track innovation and retain talent?Goldman Sachs Global Investment ResearchIssue 47Jonathan Flint: Staff engagement is critical and it is at the core ofwhat we do. We need to give people interesting work and we needto ensure that our strategy is understood by our scientists. It is avery important parameter for us and we work hard to ensure thatwe remain ahead of our competitors on this front.A key parameter that we regularly keep track of is the vitality indexi.e. the fraction of products that come from new launches within thelast three years. A number between 25% to 50% is where a rapidlygrowing business should be. If it drops below about 25% it is a signthat the company is living on yesterdays discoveries. If the numbergets too high, it is a sign that the products are not sufficientlyradical and need to be replaced in a little more than a year, which isagain a matter of worry. Even on this front, we are well placed withthe number being c.40%.Hugo Scott-Gall: What other exciting scientific developments couldimpact manufacturing apart from nanotechnology?Jonathan Flint: I find biotech extremely interesting. And it is prettyclose to nanotech except for the fact that it deals with organicmolecules. Constructing smart molecules and pharmaceuticalsfrom the atomic level up is a pretty exciting area. More broadly, Ibelieve that the use of advanced IT embedded in everything will bean important change. That includes smart tags in everything fromour mobile phones to pens, making everything traceable. The hugeamount of data will make a big change to manufacturing,particularly to the supply chain.Hugo Scott-Gall: There are a lot of economists who are verypessimistic about the medium-term growth rate of the world.Jonathan Flint: That is because they assume that there will be noinnovation. I agree that resource constraints and demographicsprovide a pessimistic backdrop, but if we can find more effectiveways of using them then the skys the limit. There is an argumentthat China and the rest of Asia will overtake the West because theyhave resources and a young population. But long-term economicgrowth is about innovation, it is not about resources. Silicon is dirtcheap, it is sand on a beach. It is the innovation that converts ahandful of sand that costs a fraction of a cent into a microprocessorthat is worth hundreds of dollars.Most progress in science still happens in Europe and America. Ifwe look at Nobel Prize winners or genuine scientific breakthroughs,Asia lags behind. But we are seeing a number of new universitiesbeing set up throughout Asia, and it will only be a matter of timebefore they start generating some truly world-class scientists.Hugo Scott-Gall: What areas of resource scarcity are your clientsmost focused on and hence demanding solutions for?Jonathan Flint: Rare earth is an obvious field. But beyond that,about half of the elements in the periodic table are running out. Sothere are actually very few materials that can be used for a longperiod of time in our domain. One such element is helium, which isin particularly short supply. But again, we have developed atechnology which completely obviates the need for liquid heliumand I am sure there are other breakthroughs that will come throughfor other constraints. Water is also going to be a problem. We needclean water and so technologies related to purifying and re-usingwater will be important.1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 202110 mn80010,000,0001,000,00010,0001,00010010118Equity Research: Fortnightly ThoughtsValue in productivity and differentiationIssue 47Will Wyman, our European Small & Mid Capanalyst, highlights stocks pioneering newmanufacturing techniquesMass production might be the biggest achievement in the history ofmanufacturing. But in future, the small things will likely take onmore and more importance. Businesses and consumers alike wantmore than just commodity products available in high volume and atlow prices. They will pay a premium for products that fit theirspecific needs. For industry, this means products that improve costefficiency, or that deliver pricing power through better quality anddifferentiation. For consumers, it means products customised tomeet individual preferences.We highlight here opportunities among small and mid-cap stocksthat offer concentrated exposure to key trends in manufacturingbeyond volume production, and toward higher productivity anddifferentiation. We focus on three areas: (1) next-generationmanufacturing techniques; (2) continuous efficiency improvements;and (3) product innovation. Small-caps have pioneering roles innew manufacturing techniques such as additive and precisiontechnologies. They also provide solutions that address criticalresource constraints and productivity challenges. And, they are afertile source of the creativity that drives research anddevelopment.advances in techniques used in diverse manufacturingenvironments. We highlight three broad categories of newmanufacturing techniques with potential volume applications: (1)automated, (2) precision, and (3) additive manufacturingtechniques.Automated Manufacturing: Machine tools controlled usingcomputers (computer numerical control or CNC) are increasinglydisplacing mechanical or manual systems. These techniques haveenabled the mass production of standardised goods, for example inautos manufacturing, and are penetrating sectors such asconsumer electronics. This process has been driven by risinglabour costs and by a greater focus on quality. Even in theautomotive sector, however, big growth opportunities remain in EMwhere penetration levels are still low. China is expected to producemore cars than Germany, Japan and the US combined by 2016(IHS), yet there are seven times more automotive robots installedacross the triad countries than in China, on our estimates.KUKA (Buy; 27.96) is a leading supplier of robots to theautomotive sector, where it competes with companies such asFANUC and ABB. The groups market share in China for articulatedrobots has grown over the last five years and is now c.33%, on ourestimates, helped by the growing presence of the leading Germanautos manufacturers.Robot penetration in global autos manufacturingRobots per 10,000 workers vs. cars produced in 2011New manufacturing techniquesAdvances in manufacturing techniques require a convergence ofnew technology, tools, know-how and services. New techniquescan deliver increased scale and reduced cost, support theintroduction of innovative products, and increase flexibility thatallows manufacturers to manage capacity more effectively. Perhaps1,6001,4001,2001,000Auto robots per 10,000 workersCars produced 201018 mn16 mn14 mn12 mnthe most striking example of an evolving technology roadmap isfound in semiconductor manufacturing. Moores Law states that thetransistor density on a chip which underpins speed and power should double approximately every two years, as illustrated in thefollowing chart. This requires constant reengineering andminiaturisation across a complex series of manufacturingprocesses. At each step, new tools advance the capability tooperate at standards specified in billionths of a metre.60040020008 mn6 mn4 mn2 mn0 mnJapanGermanyUSUKChinaBrazilIndiaMoores Law transistor density doubles every two yearsTransistor count (thousands, logarithmic scale)100,000,000100,000Source: Goldman Sachs Research estimates.These challenges are not unique to the semiconductors industry.Competitive pressures and customer demand for betterperformance at lower cost are common across all industries, forcingGoldman Sachs Global Investment ResearchSource: IFR, KUKA.Precision manufacturing: Advances in precision machining andcontrol technology mean that more and more tasks can beautomated. These advances enable a level of manufacturingprecision beyond even hand-finishing by skilled workers. Todaysleading mobile phones, for example, rely on automated componentmanufacturing and assembly techniques for tasks that in the pasthad to be performed manually.Renishaw (Buy; 1,901p) is a leader in industrial metrology andprecision manufacturing. The company has developed productsincluding machine tool probe systems that automate manual settingand measurement processes in a manufacturing environment. Thecompany estimates that these systems can reduce set-up times by90% compared to manual processes and therefore significantlyincrease the production capacity of existing plant. Other productsinclude motion control systems and encoder products that enhancethe accuracy and precision of machines in harsh manufacturingenvironments such as assembly systems, metal-working, plasticsprocessing and packaging.Additive manufacturing: Traditional machining processes rely oncutting and drilling away material from a solid block to create a20181614128450040030020010019Equity Research: Fortnightly Thoughtsdesired part. In additive processes, the part is built up by depositingsuccessive layers of material. This technology is already in use tomanufacture products such as industrial design prototypes, low-volume components in industrial and aerospace, and healthcareproducts such as dental implants. Advantages include the ability tohandle more complex parts, improve material efficiency and theincrease speed of production. Additive techniques can be used toproduce structures with interlocking parts or intricate internalstructures that cannot be machined from a single block of materialusing traditional techniques. Material and energy efficiency can behigher compared to milling techniques that cut away and producewaste material from a solid block. By increasing the flexibility ofproduction, these techniques can increase the speed of production,especially for customized designs. Engineers designing, forexample, a new brake pedal mechanism design the product usingcomputer-aided design (CAD) software and are able to produce aprototype version from that design quickly using an on-site printer,whereas previously designs would have been interpreted andproduced by third-party specialists. Such prototyping is an exampleof “3D printing”, albeit printing that is used in relatively smallvolumes at this stage.Renishaw (Buy) has also pioneered additive manufacturingtechniques with potential applications in volume manufacturing.Renishaws laser melting process is a computer-driven process thatuses focused laser energy to fuse metallic powders into 3D objects.It is currently used in the medical (orthopaedics), aerospace, highIssue 47Spectris (Conviction Buy; 1,988p) supplies systems andinstrumentation that measure and control key parameters in theproduction process. Products include, for example, transducers andcalibration tools for torque, force, pressure, strain, displacementand weight. These solutions allow industrial customers to achievehigher yields. The company benefits from strong pricing power,underpinned by technology leadership, high value-add compared toproduct cost, and a technical sales model grounded on entrenchedcustomer relationships. The cost of a calibration system for amanufacturing customer can be small compared to the value that itunlocks in terms of improved yield.Product innovationInnovation is critical to delivering differentiated products andtherefore to manufacturers ability to achieve sustainable pricingpower in competitive industries. The increasing importance ofinnovation in emerging markets long associated with massproduction is shown in the chart below. We estimate that R&Dspending among China tech companies has grown at a 30% CAGRover the last seven years. Growing corporate R&D budgets point toopportunities among those companies selling specialised tools andsystems used in R&D labs.R&D commands increasing share of spend in ChinaChina technology companies R&D spend, % sales 2003-12EChina Technology - R&D as % of salestech and electronics industries. The company also providesvacuum casting systems, which are used to produce industrialprototypes from polyurethane resins, and injection mouldingsystems used to produce small shot components.Efficiency improvements10Labour productivity6800700600Asset/employeeRevenue/employee202003200420052006200720082009201020112012ESource: Company data, Goldman Sachs Research estimates.One area of growing R&D activity is nanotechnology, where OxfordInstruments (Conviction Buy; 1,507p) is a leading supplier ofdevelopment tools and systems. These tools are used to analyseand manipulate material at the level of atoms or molecules. Theyare used in research and development of new materials, such asgraphene, new polymers and pharmaceutical products. In aproduction environment, they are employed in advanced quality0200220052008201120022005200820112002200520082011and failure analysis. Nanotech also has implications for newS&P500STOXX600NIKKEImanufacturing techniques, notably the evolution of semiconductorSource: Datastream.Growing consumption, scarce resources and keen competitionmean manufacturers are constantly under pressure to achievehigher efficiency. Key constraints include not just labour, but alsoenergy and materials. Part of the solution to these challenges issupplied by companies that specialise in technologies that optimiseexisting manufacturing processes. This field includes sensorsmanufacturing, described above. Lastly, the technology cansignificantly enhance material efficiency, exploiting the surfaceinteraction between components dramatically to reduce therequirement for precious materials.Will WymanEuropean mid-cap analystembedded in the manufacturing process to collect data, monitoringsystems that can detect and predict problems, and control systemsthat automate intervention and problem resolution.email:Tel:will.wymangs.com+44-7552-2998Goldman Sachs InternationalGoldman Sachs Global Investment ResearchDesignenterprise20Equity Research: Fortnightly ThoughtsStaying competitive with softwareIssue 47Our US software analyst, Perry Huangdiscusses technology & manufacturingconvergenceThe role of technology in the manufacturing process today hasnever been more critical given the increasing complexity ofproducts. Take mobile phones. These devices must be multi-functional (include a phone, camera, music player, and computer)and compact as well as aesthetically pleasing. In addition to thesedesign challenges, manufacturers are also under pressure toaccelerate innovation while simultaneously producing high-qualityproducts at lower costs, just to stay competitive. To achieve thesegoals, companies have turned to software solutions such asWhile an engineer would use CAD tools to design a car engine, anengineer responsible for simulation would use software tounderstand how the different components throughout the carinteract as the car is operated. These tools target specific physics,such as thermal, structural, mechanical, and fluid analysis. Forexample, simulation can be used to understand an electricpowertrain, which involves a battery (chemical power source),traction motor (electric machine), and gears and shafts(mechanical), with each providing feedback to the others. Inaddition, each system generates heat (thermal management) andhigh-frequency interference (RF processing).Product development cost comparison: Simulation, traditionalanalysis & CAD, and conventional design, build, and testcomputer aided design (CAD), product lifecycle management(PLM) and simulation in their design and manufacturing processes.CAD and PLM: Driving efficiency in product development# of problemresolutionSimulationTraditional analysisand CADConventionaldesign, build, testTo return to the mobile phone example, a manufacturer could useCAD software tools to design a virtual mobile phone and create avariety of 2D designs and 3D models quickly. Any design issuesDesignCost Change(for example, a proposed screen does not fit a certain cell phonedesign) can be identified and corrected early in the developmentDesignCost ChangeCost ChangeDevelopmentphaseprocess before a physical prototype is made, saving valuable timeand costs. After the mobile phone has been designed, PLMsoftware can be used to organise the different designs andspecifications. Importantly, PLM software also enables teamDevelopmentphaseResolution costper problemConceptDesign1XDetailDesign10XProto-typingEvaluation100XProductionramp-up1,000XFullproduction20,000X+collaboration (for example, communication with partners andsuppliers who can provide input on specifications and costs) andchange and configuration management (keep track of designchanges) and provides the necessary sales and post-salesdocumentation (instruction and service manuals).Throughout the production process, a variety of issues can ariseand lead to increased costs and production delays. The exhibitbelow shows key business and production objectives as well as therelated benefits of incorporating CAD and PLM solutions.Benefits of using CAD and PLM solutionsSource: ANSYS.The key benefits of incorporating engineering simulation in theproduct development process are similar to those of using CAD andPLM tools and include reducing costs (identifying problems early),shortening development time (fewer problems to resolve leads tofaster time to market), and improving product quality (gain insightsearly in the process). Importantly, engineers can run multipleiterations and scenarios to test different outcomes.Incorporating simulation earlier and often in the developmentprocess can dramatically reduce costs. According to a study by theAberdeen Group, companies implementing best-in-class simulationanalysis early in the process achieved a 15% increase in profitObjectiveBenefits of Incorporating CAD and PLMBenefits Quantifiedmargins on new products, three times the level of their peers.Improve profitability Identify and resolve problem areas earlier in theprocess where changes are less costly Product Development Increased use of digital prototyping reduces the Costs: Reduced 25-40%need for more costly physical models Increase the number of product iterations inMechatronics The wave of the future?With mechatronics, or the interaction of hardware, software andelectronics, becoming more prevalent in product development, weAccelerate productinnovationless time Improve information sharing with the extendedTime to Design:Reduced 15-70%would not be surprised to see the use of technology in themanufacturing process become even more tightly integrated. ForImprove productquality Identify quality issues early in the process Ensure product changes reflected in alldocumentation for post sales service and supportDesign Errors: Reduced10-25%example, ANSYS (a provider of simulation software) notes thatelectronics account for about 60% of the content value of anautomobile. To address these trends, we would expectIncrease workerproductivityFaster time tomarket Quickly find and re-use information Ensure all information is up to dateShorten the overall production time throughincreased worker productivity and more efficientwork processesProductivity: Increased10-20%Time to Manufacturing:Reduced 10-50%Design Review Process:Reduced 50-80%manufacturing companies to increasingly turn to software vendorsfor assistance, which we note has recently resulted in M&A activityin the software space, with the ANSYS acquisition of EsterelTechnologies (Esterels solutions are used to design and simulateembedded software in the aerospace, defence, rail, nuclear andindustrial verticals) and Parametric Technology Corp.s acquisitionSource: CIMdata.Simulation Will this product work?of MKS (manage the development of software-intensive products).Perry HuangEngineering simulation is closely associated with computer aidedsoftware design tools and is an integral part of productdevelopment. The key distinction between traditional productdesign and simulation tools is that the latter focus on accuratelypredicting how the completed product functions in the real world.Goldman Sachs Global Investment ResearchUS Software analystemail: perry.huanggs.comTel: +1-212-902-6785Goldman Sachs and Co.21Equity Research: Fortnightly ThoughtsIssue 47Seeking European winnersHardware: The future is already here in electronics manufacturing, the challenge is tosustain its pace of development: ARM, ASML and AZ Electronics lead the wayReaders must have been suspicious when Intel co-founder Gordon Moore told subscribers of Electronics Magazine in 1965 that thenumber of transistors on integrated circuits (ICs) would double every year for “at least 10 years” at minimum cost. What he was effectivelysuggesting at that time was that the computing power of chips used in all kinds of devices would consistently double ever year. As it turnedout Moore altered his projection to “a doubling every two years” in 1975 and amazingly, his bold projection has held true until now.Exponentially growing capabilities of devices (such as processing speed, memory capacity, sensoring ability of chips and so on) aretherefore mostly a function of what became known as “Moores Law”: the electronics industry has managed to increase transistor density(processing power) while simultaneously decreasing transistor size, allowing for an exponential rise in processing power for smaller andsmaller chips. The economic flipside to Moores Law was that the cost of an almost fully automated chip factory doubled every four yearsuntil the mid 1990s, to sustain the pace of innovation and to fulfil seemingly insatiable demand for electronic applications in all walks of life.It has also left manufacturers facing huge investment bills to keep the innovation game going: we estimate that Intel (the largest chipmanufacturer in the world followed by Taiwan Semiconductor and Samsung Electronics) faces factory depreciation expenses of almostUS$20 mn a day, suggesting it must spend US$20 mn a day just to keep the factory up to date with the latest innovation developments.This makes it seem as if the future of manufacturing arrived a long time ago. More questionable is whether the industry can sustain thesame innovation curve without incurring physical limitations (further miniaturisation is difficult given available lithography manufacturingtechniques) and/or without significantly lowering manufacturers capital returns by spending ever more money on the problem.Three principle ways to address challenges regarding the industrys roadmap are to (1) increase manufacturers ability to deliver morechips with better performance (either by making each chip smaller or by simply churning out more of them at the same cost and with thesame speed. For example, this can be done by developing smarter lithography equipment steps and/or by enlarging wafer size to 450 mmdiameter); (2) find inherently more “fuel”-efficient ways to design the “engines” (akin to the efficiency per mile debate between gasoline anddiesel engines in cars); and (3) find new materials that enable manufacturers to run processes at lower cost, enabled by high-puritychemical solutions (that are of relatively low cost relative to large fixed cost depreciation expenses) that can raise production yields.While were not going to predict solutions here, we can identify three companies in Europe with well established leadership positions in avery concentrated vendor landscape that should all be involved in shaping the future of electronics manufacturing: ARM Holdings, ASML,and AZ Electronics. These companies have been in part responsible for making the future of manufacturing happen over the last 15 years,and in our view will be part and parcel of the challenge over the next 15 years.ARM Holdings (GS SUSTAIN Focus List, Buy, 843.5p): ARM is a UK-based Intellectual property licensing business for the architectureof fast, low-cost, power-efficient processors. The business model involves the designing and licensing of IP (to customers like Qualcomm,Samsung and Apple), rather than the manufacturing and selling of chips. Its architecture is dominant in chips used in mobile phones,tablets, smart TVs, with large adoption potential in server, PC, industrial microcontroller, and telecom equipment end-markets. We believethat dominant market share is likely to provide ARM with a continuously inflationary blended royalty rate, and that this is still not entirelyreflected in its current valuation. It is a significant swing factor in our DCF analysis, paving the way for royalty revenues to almost triple onour estimates over the next five years. In our view, strong secular tailwinds and market share gains are likely to ensure continuously highearnings growth and solid backlog, paving the way to our 2017 normalized EPS scenario of 43p (implying a 2012E-17E EPS CAGR of23%). We favour structural growth and first-quartile industry positioning, and believe that ARM is likely to continue to be considered astrategic asset, given how disruptive its IP portfolio is for the status quo in the computing industry.ASML (GS SUSTAIN Focus List, Not Rated): Holland-based ASML is the leading supplier of photolithography systems, a machine typeabsolutely necessary to the production of integrated circuits (ICs). Leading chip manufacturers (Intel, Taiwan Semiconductor and Samsung)together own a 23% equity stake in the company, and improvements in lithography techniques continue to be crucial in sustaining MooresLaw, in our view. In our view, ASML is a structural beneficiary of rising spending intensity on lithography equipment. As such, we expect itto be more insulated from cyclical pressures in semiconductor spending, given product cycle drivers into 2013/14 (EUV), and rising lithointensity. A 450 mm driven cycle, more clarity on 450 mm timing and R&D funding from last years customer investment programme areclear secular positives for earnings in our view. While we expect both 450 mm and EUV to likely further pressurise semi capital intensity inthe long term, we believe that lithography is one of the few equipment categories which should benefit from these trends given: (1)significantly rising layer intensity (requiring a higher number of lithography steps); and (2) the balance of pricing is in ASMLs favour givenits clear market share leadership ahead of Nikon in what has become a clear duopoly. While it would likely require significant traction ofASMLs next generation EUV machinery, in a longer-term scenario in which this is achieved, we believe that there is scope for ASML toearn EPS of up to 6.0.AZ Electronics (Buy): AZ is a UK based producer and supplier of high-purity specialty chemical materials, used in ICs, flat panel displays,light-emitting diodes (LEDs) and in the photolithography process. Specialty materials used in these processes account for less than 3% ofchip cost, which is small in comparison to depreciation expenses (Intel is spending close to a third of chip costs on factory depreciation). Inour view, this cost allocation on materials is likely to rise: As Moores law reaches potential physical limitations manufacturing equipment,materials are likely to be a rising contributor to deliver further extensions of Moores Law. A rising number of coating operations in themanufacturing process of chips is likely to drive volumes of materials above the level of increasing chip volumes, allowing for significantprofit growth potential.Goldman Sachs Global Investment Research22Equity Research: Fortnightly ThoughtsIssue 47Chemistry: Acting as an enabler in the future of innovation and manufacturingChemistry acts as an enabler and as such should play an important role in the future of manufacturing, driving both innovation and costefficiencies. For instance, in 3D printing, ink is composed of chemicals derived from Bayer and BASF and in shale drilling, drilling additivesare manufactured by Elementis and pipes derived from materials which can withstand high temperatures and pressures are supplied byVictrex. It is fair to say that all chemical companies will likely play a role, but we highlight three companies which are at the forefront ofdriving commercial change.BASF: As the archetypal chemical company, BASF has been a strong force in driving innovation for its customers. Management estimatesthat the NPV of its research pipeline is over 20 bn. BASF has identified thirteen growth fields such as batteries, water treatment andorganic electronics, which represent attractive business in their target industries. Together, these should represent a market size in excessof 51 bn in 2020 with BASF seeing over 2 bn in potential sales in 2020 from these areas. Furthermore, the company is focussing onthree “pioneering technology areas that provide the technological basis for the development of future oriented solutions: Materials, Systems& Nanotechnology; Raw materials change and White biotechnology.”Croda: Croda is active in a number of areas from personal care to geo technologies. An area of particular of interest in providing growth forCroda is biotechnology. This has the potential to be a significant disruptive technology, leading to step-change opportunities in personalcare, health care, crop care and home care markets. Bio innovation is divided into three areas at Croda: white (biotechnology applied toindustrial processes), green (applied to plant and/or agricultural processes) and blue (applied to marine and aquatic processes). Forinstance, an example of white biotechnology is seen in Crodas O.D.A White product. Here, yeast fermentation helps to transformvegetable oleic acid to dioic acid, a conversion which is not easily achievable by synthetic chemical means can be achieved usingenzymes. The end product is used in skin whitening in Asia. Management are developing global partnerships in all three areas and plan tolaunch biosurfactants in 2013.Victrex: Victrex manufactures PEEK, a high quality plastic of last resort which can withstand high temperatures and pressures Through itsVPS division, Victrex work with its customers to provide technical solutions to help them meet difficult design challenges. For instance, inindustrial applications, PEEK can be used in energy exploration and food processing. Its polymer helps to improve asset performance andutilisation. In aerospace, Victrex PEEK provides a lightweight replacement for metals with one tonne used in each Boeing 787. PEEK is notlimited to industrial applications and used in medical applications. Amongst other uses, its materials are used to provide more durabledevices in the repair of hip, knee and shoulder joints.Medtech: New manufacturing technologies drive innovation and improve patient outcomesin medical devicesPersonalised medical devices represent a growing trend in healthcare. While the use of customised devices was historically restricted toone-off cases, in patients with difficult anatomy, recent advances in manufacturing technologies, such as 3D printing and CAD/CAM, haveenabled sizeable parts of the medical device industry to move towards automated manufacturing of customised devices, often at a lowercost. Personalised medical devices are largely superior to standard-sized ones; since they are specifically tailored to the patients anatomy,they fit better theres no such thing as a normal-sized ear canal and therefore improve the outcome for the patient. In some cases, theuse of personalised devices or instrumentation can even drive down the cost of the procedure, as is the case for personalisedinstrumentation in orthopaedics. We highlight three companies within medtech that have been at the forefront of driving change.Smith & Nephew: Innovation within orthopaedics has been largely incremental over the last 50 years, with the principles of hip and kneereplacements staying the same since their adoption in the 1950s. However, Smith & Nephew has been one of the first companies inorthopaedics to adapt 3D printing to manufacturing patient-specific instrumentation essentially cutting blocks which not only improvepatient outcomes, but also offer significant benefits to both the hospital (shorter surgery and recovery time, i.e., lower costs) and themanufacturers themselves (lower inventory/capex needs, since fewer instruments are required).Sonova / William Demant: The hearing aid manufacturers were the first companies within medtech to widely adopt 3D printing in themanufacturing of customised, in-the-ear hearing aids (these are shaped to fit a patients ear canal). In-the-ear hearing aids represent c.25%of the global hearing aid market, and have recently been gaining in popularity, as development of newer tougher materials from bothWilliam Demant and Sonova has enabled significant miniaturisation of in-the-ear hearing aids, making them essentially invisible.Goldman Sachs Global Investment Research23Equity Research: Fortnightly ThoughtsIssue 47Software: Designing the future of manufacturingProductivity and efficiency gains are the key reasons for increased technology use in manufacturing. Technology is not only an enabler buta core driver of future manufacturing in our view, reducing costs and accelerating time to market. Each technology cycle has facilitated anincreased level of automation, and the shift to the internet has facilitated a step-change, particularly for greater collaboration. The world ofmanufacturing is evolving from using software only for design, to digital mock-up, collaboration, digital manufacturing and now to acomplete integrated 3D experience. In our view, technology of the future will bring the virtual world closer to the real world, and integratethe end product with all its associated processes (design, build, sales, servicing etc.). We believe mechatronics will be the big mega-trend,as products and their control systems become more closely embedded and interconnected. We also believe that increased regulatoryrequirements, environmental pressures and ongoing cost/time pressures will drive the integration of all the systems that manage the entirelife cycle of products and their processes. While there are clear winners and losers in technology, and the US has historically ledtechnology innovations, PLM as a segment has been different: European vendors including Dassault Systemes, Aveva and Hexagon haveemerged as winners in the field of surface and plant design segments.Dassault Systemes: Dassault has a strong position in the PLM segment and robust growth in its end markets, supporting first-quartileindustry positioning. Dassaults high market share, strong recurring revenue mix (c.65% of group sales) and improving margin profileenable it to deliver top-quartile cash returns within the sector. Additionally, we expect its net cash to have reached 1.2 bn by end-2012,and hence we believe that Dassault has the ability to make bolt-on acquisitions that can expand its market opportunity, market share andalso strengthen the product platform. With its focus on the 3D Experience platform, which is the next evolution of Dassaults breadth ofproducts, the company is expanding its addressable market from US$16 bn currently to US$32 bn, further supporting double-digit revenuegrowth mid to long term. There also appears to be a shift in go to market, with a value selling model whereby the company is seeking topush across existing and new industries, packaging its technology into point solutions by industry as it seeks to add new users, leveragingthe collaborative and social content in its products.Aveva: Aveva provides exposure to capex recovery in the oil & gas end market, emerging markets growth and product cycle benefits.Avevas dominant position in the attractive 3D plant design software market, coupled with high BRICs/emerging market exposure (c.65% ofrevenues), underpins its strong industry positioning. We expect Aveva to grow faster than the market, at a 9% CAGR over the next fewyears. We believe that Aveva NET is an important product differentiator for the company, and that it has the potential to double the groupssales in the coming years, owing to the products unique positioning and regulatory demand. We expect Aveva NET to enable Aveva togain incremental market share vs. its competition, and capture a sizeable market opportunity. Aveva has started its new generation productsuite E3D to customers, which should provide meaningful revenue upside in the mid to long term. We believe E3D aimed at enabling leanconstruction by incorporating Avevas traditional strength in 3D and augmenting it with technologies from recent acquisitions (laserscanning, ERM, EAM, steel detailing), as well as mobile/cloud technology, will drive the next leg of Avevas revenue growth.Hexagon: Following the transformational acquisition of Intergraph in 2010, and an improving product mix in the traditionalmetrology/geosystems areas, Hexagon has demonstrated a significant improvement in revenue and operating margin mix. We believe themarket underestimates the positive impact from increased earnings stability driven by a rise in recurring revenues, software/services andEM exposure, and expect the stock to re-rate further as the benefits start come through. We believe the AEC, BIM, CAD and PLM segments are fusing into a new, converged PLM market. This offers a bigger market opportunity, but in our view also creates a more dynamiccompetitive landscape for Hexagon. Given its successful track record acquiring market leaders in new segments and further extending theirreach, we see Hexagon as an acquirer in the space.Goldman Sachs Global Investment ResearchSenegalBangladeshPhilippinesSriLankaGermanyN.ZealandNicaraguaArgentinaIndonesiaMozambiqueThailandPortugalNorwayFinlandPakistanDominicaAustraliaPerformanceofbanksrelativetoindexQ12011Q41990Q31991Q21992Q11993Q41993Q31994Q21995Q11996Q41996Q31997Q21998Q11999Q41999Q32000Q22001Q12002Q42002Q32003Q22004Q12005Q42005Q32006Q22007Q12008Q42008Q32009Q22010Q42011Q320121956 1957 1959 1961 1963 1964 1966 1967 1969 1973 1982 1985 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012S.KoreaCanadaIcelandCroatiaUkraineFranceLiberiaPolandIsraelTurkeyIndiaChileBrazilUK24Equity Research: Fortnightly ThoughtsIssue 47Six of the best our favourite chartsIn our six of the best section, we pull together a pot pourri of charts that we hope you will findinteresting. They will be different in each edition but hopefully always of note.Good intentionsWorld wide web search interest in fitness by week (peak: 100)Where the subcontinent leadsNumber of years that elected or appointed female heads of governmenthave been in power (doesnt include heads of state)100200620082010209590201220131816148512807570651086426005550w1 w3 w5 w7 w9 w11 w13 w15 w17 w19 w21 w23 w25 w27 w29 w31 w33 w35 w37 w39 w41 w43 w45 w47 w49 w51Source: Google trends.Banking on recoveryAbsolute and relative performance of banks worldwideSource: Wikipedia.Glistening collateralGold loans outstanding in India, indexed to 200835%Bank Gold loansNBFC gold loansTotal gold loans16 x30%25%20%UKIndia14 x12 x15%SwedenJapan10 x10%5%US8x0%SpainChina6x-5%ItalyGreece4x-10%-15%Germany2x0%10%20%30%40%50%60%70%0xAbsolute performance of banks in the last 12 months20082009201020112012Source: Datastream.High versus historyRatio of S&P 500 market cap to US GDP1.4Source: Reserve Bank of India.Taxed but not vexed% of people considering the federal income tax they pay to be too high70%1.265%1.060%0.855%0.60.40.250%45%0.040%Source: Datastream.Goldman Sachs Global Investment ResearchSource: Gallup.25Equity Research: Fortnightly ThoughtsIssue 47Financial advisory disclosureGoldman Sachs is acting as financial advisor to Cymer, Inc. in an announced strategic transaction.Disclosure AppendixReg ACWe, Hugo Scott-Gall, Sumana Manohar, Daniela Costa, Yuichiro Isayama, Will Wyman, Perry Huang, Simon Schafer, Richard Logan,Veronika Dubajova and Mo Moawalla, hereby certify that all of the views expressed in this report accurately reflect our personal viewsabout the subject company or companies and its or their securities. 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Multiple is a composite of one-year forward valuationratios, e.g. P/E, dividend yield, EV/FCF, EV/EBITDA, EV/DACF, Price/Book. Volatility is measured as trailing twelve-month volatilityadjusted for dividends.QuantumQuantum is Goldman Sachs proprietary database providing access to detailed financial statement histories, forecasts and ratios. It can beused for in-depth analysis of a single company, or to make comparisons between companies in different sectors and markets.GS SUSTAINGS SUSTAIN is a global investment strategy aimed at long-term, long-only performance with a low turnover of ideas. The GS SUSTAINfocus list includes leaders our analysis shows to be well positioned to deliver long term outperformance through sustained competitiveadvantage and superior returns on capital relative to their global industry peers. Leaders are identified based on quantifiable analysis ofthree aspects of corporate performance: cash return on cash invested, industry positioning and management quality (the effectiveness ofcompanies management of the environmental, social and governance issues facing their industry).Disclosure AppendixCoverage group(s) of stocks by primary analyst(s)There are no coverage groups associated with the analyst(s).Company-specific regulatory disclosuresThe following disclosures relate to relationships between The Goldman Sachs Group, Inc. (with its affiliates, Goldman Sachs) andcompanies covered by the Global Investment Research Division of Goldman Sachs and referred to in this research.Compendium report: please see disclosures at http:/www.gs.com/research/hedge.html. 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