Valve industry profit margin measurement

First, the valve industry profit margin measurement method

(A) the basic profit formula

The basic formula for calculating profit: profit = income - cost. In the valve industry:

Revenue mainly from the sale of valve products. Valve sales revenue = unit price × sales volume. Sales price will be based on the type of valve (such as gate valves, globe valves, ball valves, butterfly valves, etc.), material (cast iron valves, cast steel valves, stainless steel valves, etc.), use (control valves, safety valves, regulating valves, etc.) and market supply and demand and competitive conditions and different. The sales quantity, on the other hand, is influenced by market demand, including demand from various downstream industries such as petroleum, chemical, electric power, construction, etc.1.

Costs include direct and indirect costs. Direct costs include, for example, raw material costs (e.g. steel, rubber, plastic, copper, etc. for manufacturing valves), labour costs (salaries of employees in the production process, etc.) and equipment depreciation (depreciation of machinery and equipment used in the production of valves in the course of their use), etc. Indirect costs cover selling expenses (including advertising, promotions, participation in industry exhibitions, transportation, etc.), administrative costs (management salaries and benefits, office, training and development, etc.), and management costs (including salaries and benefits of management personnel, office, training and development, etc.). , office, training and development, etc.) and other costs such as R&D investment13.

(ii) Calculation of Gross Profit Margin

Gross profit margin = (operating income - operating costs) ÷ operating income × 100%. For the valve industry, operating costs include raw materials, labour, equipment depreciation and other costs mentioned above. Through the gross profit margin can be a preliminary understanding of the enterprise after deducting the direct costs of the remaining profit margin. If the gross profit margin is higher, the enterprise after deducting direct costs still have more gross profit to cover other costs and achieve profitability. For example, if a valve company's operating income of 10 million yuan, operating costs of 7 million yuan, its gross profit margin = (1000 - 700) ÷ 1000 × 100% = 30% 1.

(C) net profit margin calculation

Net profit margin = net profit ÷ operating income × 100%, where net profit = total profit - income tax expense. Total profit is obtained from operating profit plus non-operating income (such as government subsidies, donation income and other non-operating but profit-enhancing income) minus non-operating expenses (such as fines, disaster losses and other non-operating and profit-reducing expenses). Net profit margin reflects the ultimate profitability of the enterprise, taking into account all costs, income and taxes and other factors after the enterprise's ability to earn net profit. For example, a valve company's total profit of 2 million yuan, income tax expense of 500,000 yuan, operating income of 10 million yuan, its net profit margin = (200 - 50) ÷ 1000 × 100% = 15% 1.

Second, the factors affecting the profitability of the valve industry

(A) raw material factors

Valve manufacturing process requires a variety of raw materials, such as metal (steel, copper, stainless steel, alloy steel, etc.), non-metallic (rubber, plastic) and so on. Its price fluctuations have a significant impact on the profitability of the valve industry.

Price fluctuations: when metal prices rise, the cost of raw materials for valve manufacturers to increase. For example, if the price of steel increased by 20%, for a large-scale valve production enterprises mainly based on steel as raw materials, its production costs will increase significantly. If the company is unable to transfer the increase in costs to the price of its products (for example, because it is unable to raise prices at will due to fierce competition in the market), then profit margins will be squeezed.

Quality and Selection: The quality of raw materials varies, and it is often more costly for a company to purchase high-quality raw materials. Failure to select the right raw material substitutes or supply chain partners can also increase costs. For example: some high-end valves need to use special alloy materials to ensure high performance, if the enterprise can only rely on a single high-priced supplier to supply, then the cost response will be more passive, which in turn affects the profit1.

(ii) labour cost factors

Valve manufacturing process requires a large number of human resources, changes in labour costs have an important impact on profits.

Wage increase: with the social and economic development, the labour market gradually increase the basic wage level. For example, in China's valve production concentration areas, with the local standard of living and labour supply and demand gradually change, if the valve manufacturing enterprises to 10% or so of the annual wage increase in workers, which is a greater burden on the enterprise's manpower cost expenditures, and directly reduces the profit margin.

Employee welfare and training: Nowadays, companies are increasingly focusing on employee welfare and training inputs to improve employee stability and efficiency. However, these additional inputs, such as the development of commercial insurance for employees, to carry out targeted technical training courses, etc., have increased operating costs. For example, a valve company invested a year in employee training and welfare aspects of the funds accounted for about 15% of the total manpower costs, which can be counted as an important component of the cost, and thus have an impact on the profitability of the part did not reduce operating costs will affect the profitability of the space 1.

(C) market competition factors

Price competition: the valve market is highly competitive, enterprises in order to compete for market share, may take the price war and other competitive strategies. For example, in a region of the water valves (valves) market, there are a number of valve companies competing, some smaller enterprises in order to obtain a limited number of engineering project orders, it will reduce the price of the product. Once an enterprise to reduce prices, other enterprises may be forced to follow the trend of low-priced sales. So that the product price drop, if the sales volume can not rise significantly or can not efficiently control costs, the industry's overall profit level will be reduced.

Non-price competition: enterprises will be through technological innovation, improve product quality, improve after-sales service and other non-price competition to gain a competitive advantage, but this may involve investment in research and development, quality management investment and after-sales network construction investment. A valve company if you vigorously invest in technology research and development, although it is possible to introduce new products and high-quality valves to occupy a new market share and improve the added value of the product, but the short-term view of the R & D investment will increase the cost of decreasing profit margins. In the long term if the success of winning the market and profit increases will gradually improve the overall profitability 1.

(D) technological innovation factors

Reduce costs: Through technological innovation, valve companies can use new production processes, equipment or management techniques to reduce production costs. For example, the introduction of automated production equipment, can improve production efficiency, reduce the use of labour to reduce labour costs; or the use of digital production management technology to optimize the production process, reduce the waste of raw materials, reduce the cost of raw materials. Cost savings in this case can be directly translated into increased profit margins.

Increased added value: Innovation enables companies to develop new products or improve the performance of existing products. For example, the development of a new type of valve with higher sealing, durability and precise flow control characteristics, such valves can be sold at a higher price in the market due to superior performance, increasing the added value of the product and thus expanding the profit margin. In addition, technological innovation can also bring technical barriers and intellectual property gains for enterprises, such as applying for relevant patents can increase intangible assets, but also through technology licensing and other ways to obtain additional revenue, thereby enhancing profitability1.

(E) market demand factors

Demand changes: the valve downstream applications, the valve demand is affected by a variety of factors. The level of macroeconomic development directly affects the demand for valves in various industries. For example, in the period of better economic growth, petroleum, chemical, construction and other industries, investment growth, the rise in demand for valves, such as the petrochemical industry's new projects will lead to a large number of safety valves, flow control valves and other needs; conversely, during the economic slowdown, such as when the global oil price plunge in oil mining and refining investment deceleration, the demand for valves will decrease, resulting in reduced sales of enterprises to affect profits.

Demand structure adjustment: with the development of the valve market and the application of technological advances in the industry, the demand structure is also changing. For example, in the context of increased awareness of environmental protection, sewage treatment, waste treatment plants and other environmental protection projects on specific types of environmental protection valves (such as corrosion-resistant, high-performance seals, etc.) will increase demand. If companies can not adapt to the demand structure adjustment, product structure and market strategy failed to change accordingly, will lose market share and profit opportunities.

Third, the valve industry cost analysis case

(i) Raw material costs

Iron and steel materials: Suppose there is a large-scale valve manufacturing enterprise, mainly producing large valves for industrial use. The enterprise produces a certain type of gate valve, the main part of the gate valve steel raw material costs account for about 30% - 40% of the total cost. Steel prices have fluctuated frequently in recent years, up and down fluctuations can sometimes reach 15% - 20%. In the event of a period of rising steel prices, such as the relatively high steel prices during 2017 - 2018, the enterprise spent about 20% more than usual on steel raw materials for this type of gate valve. However, due to a certain period from procurement to production, the price of the order signed by the contract could not be adjusted instantly, and the enterprise could only absorb this part of the cost by itself, devouring the corresponding profit margin, resulting in a decline in profitability from the original about 18% to about 12% - 13%.

Sealing materials (rubber, plastic): For some small precision valves, the quality of seals is crucial. When the enterprise produces small ball valves, the cost of sealing materials may account for 10 - 15 per cent of the total cost. In this case, high-quality rubber is more often used as sealing material. As the price of rubber is greatly affected by supply and demand in the international rubber market, in some years rubber shortages have led to a 50 per cent spike in price. This has led to a sharp rise in the cost of producing small ball valves. Although companies try to find alternatives, the development and testing of new alternatives has a long lead time and may involve additional costs such as mould replacement. Therefore, in a short period of time, rising production costs directly compressed the profit margins of valve products, enterprises small and medium-sized ball valve product line profits from the original 15% or so fell to 5% - 8% 13.

(ii) Labour costs

New employees and training costs: in a medium-sized valve companies, the new recruitment of a number of workers without work experience to expand production scale. Once the new employees are on board, a lot of time and resources must be invested in technical training to enable them to master the valve production process and process requirements. For example, if the company expects a 20% personnel growth rate, it will organise special skills training for new employees, including lectures by internal senior engineers and practical instruction. The total training costs (including materials, equipment, trainers, etc.) spread to the head of the new employees, each about 800 - 1000 yuan. If the total manpower cost of this enterprise is 5 million yuan per year, this increase in new employees to bring training and new employees in the early stages of low productivity and so on, so that manpower costs directly increased by about 20 - 300,000 yuan, so that the product profit margins are reduced, if you can not quickly improve the efficiency of new employees to the level of mature employees or orders can not be fast-growing digestion of new manpower costs will affect the overall profitability.

Manpower Salary and Benefits: With the increased competition in the local labour market, the valve company decided to increase the salary and benefits package to retain skilled employees. By increasing the average salary of employees by 15% and the benefits package (e.g., insurance, paid leave, etc.) by 20%, manpower costs have risen to 30% - 32% of total costs from about 25% in the past, which directly leads to a decline in the company's profits. In the case of difficult year-on-year growth in revenues, the original profit margins are occupied by the manpower cost part of a larger share of the net profit margin which was originally about 10% may fall to 7% - 8% or so.

(iii) Cost of sales

Marketing activities costs: still take this medium-sized valve companies, for example, in order to expand market share, the enterprise decided to participate in the industry's large-scale exhibitions and organise a number of promotional activities. In an industry exhibition, the enterprise invested in booth fees, exhibition costs, staff travel expenses totalling about 15 - 20 million. In addition to promotional activities (e.g., giving discounts to dealers, buying products with free accessories, etc.), it is estimated that this part of the promotional costs totalled 50,000 - 100,000 yuan. These marketing campaign costs were hoped to be exchanged for an increase in orders, but in reality the increase in orders did not reach the expected value. If the total expected profit point of view, marketing activities consumed this 20 - 30 million yuan, could have become part of the profit, but now it consumes part of the profit, so that the actual profit margin of the product is reduced by about 5 - 8% or so.

Transport costs: Valve products due to the weight and in some cases the volume is also larger transport costs are higher. Assuming that the enterprise products transported to 500 - 1000 kilometres away from the main customer areas using road freight transport, transport prices due to fluctuations in oil prices, vehicle operating costs rose 10% - 15% year on year. The proportion of transport costs to the cost of sales rises from 5 - 8 per cent to 7 - 10 per cent. In the case of the order price is not easy to adjust (by competitors offer, customer purchasing budget constraints, etc.), this part of the increase in transport costs is to squeeze the profitability of the product, especially for long-distance order profit compression is more obvious.

Fourth, the valve industry market size and profit relations

(A) market size growth and profit opportunities

Positive impact: when the valve industry market size growth, companies face more business opportunities. If the expansion of market size is driven by the demand for some emerging areas (such as large-scale data centre cooling system in the demand for high-tech content valves, or emerging chemical industry on the demand for valves to withstand special environments), the enterprise is able to seize the emerging market share, then, may be able to obtain higher profits. For example, the market growth rate of 15 per cent, and if the enterprise in the emerging market share of 20% - 30% of the share of growth, because the emerging markets may be higher value-added products, then the enterprise's profit growth rate may be higher than 15 per cent or even more than 20 per cent. In addition, market size increases the overall efficiency of scale, for example, by increasing production volume, companies can reduce fixed costs per unit of product (e.g., lower depreciation costs per unit of product, etc.), thereby increasing profit margins.

Complicating factors: However, market growth does not necessarily lead directly to profit growth. Profit margins may be eroded if market growth creates more competitive players or leads to price increases due to tightening of raw material resources. For example, if the market grows by 10 per cent with the addition of 5 - 10 new competitors, the increase in supply may create downward pressure on prices if it is accompanied by a 5 - 8 per cent increase in the price of the tight raw materials required for the capacity expansion. In this case, the enterprise product price reductions and raw material costs at the same time, the enterprise's profits may not increase with the growth of the market size, and may even appear to be decreasing.

(ii) Market Saturation and Profit Tightening

Excessive competition and low-priced dumping: in a saturated market, valve companies often face fierce competition. Market saturation after the limited number of orders, a number of enterprises to fight for a limited number of orders to compete. Some companies may use low-priced dumping strategies in order to maintain production operations and employee employment in the hope of surviving in the long term. For example, in a certain region of the building valve market saturation, some local small valve factory may be reduced to cost price reported, so that the price of the downward pressure led to other enterprises also had to reduce prices in order to survive, resulting in the industry's profit margins shrinking significantly.

Cost recovery difficulties: sub-saturated market, equipment and other fixed cost recovery will also become difficult. To a production of high-end industrial valves, for example, if the market saturation makes the order to reduce its production equipment investment is huge, but the use rate is insufficient, the unit of product borne by the depreciation of equipment, maintenance and other fixed costs of apportionment will be very high. In the cost is difficult to reduce and sales prices are compressed under the double pressure, enterprises are facing a serious profit crunch, such as originally able to achieve 18% - 20% net profit margin of the enterprise may only end up in the control of 5% - 8% or so.

(iii) Impact of market segment differences on profits

High-end valve market: In the valve industry as a whole, the high-end valve market size is relatively small but high value-added profit margins. The market is mainly for petroleum, chemical, nuclear power and other safety, quality, precision and other high requirements of the high-end industry. Because of the high demand for product performance and reliability, the entry threshold of this market is also higher (such as technical standards, quality certification, etc.), the competition is relatively less intense. Enterprises producing high-end valves can get higher value-added products, if the market demand is stable or rising steadily, the product gross margin can reach 35% - 50% or even higher compared to the low value-added some general-purpose valve products.

Low-end valve market: low-end valve market size is usually larger, but the competition is fierce and serious product homogeneity. The market is mostly for some building water supply and drainage, small general industrial facilities and other scenes. Many companies in this market lack the ability to innovate and mostly focus on price competition. Therefore, although the total market size is large, but the profit margin of individual enterprises is limited. In order to cost competitive advantage, companies often in raw materials, labour and other costs are constantly compressed. For example, the product gross profit margin may only be in 10% - 15% or so and market fluctuations (such as the construction market by the macro-economic and government investment policies have a huge impact) will produce large fluctuations in corporate profits.

Five, the valve industry profit forecasting model

(A) linear regression model based on historical data

Model construction principle: first collect the valve business or the entire industry for many years of historical data, including but not limited to operating income, costs (raw material costs, labour costs, cost of goods sold, etc.), market size (sales volume), price and other data. Assume that we believe that profit (Y) and operating income (X1), raw material costs (X2) and market size (X3) and other major factors have a linear relationship. Then the profit forecasting model can be simply constructed as Y = a + b1 * X1+ b2 * X2+ b3 * X3+ ......+ ε (where a is a constant term, b1, b2, b3 are the coefficients corresponding to their respective variables, and ε is a random error term). For example, through the past years of data analysis found that a valve enterprise profit and operating income of b1 coefficient of about 0.2, with the cost of raw materials of b2 coefficient of - 0.15, and the market size (sales expressed in terms of the number of products) b3 coefficient of 0.05. If we predict that the next year, the enterprise's operating income of 12 million yuan, the cost of raw materials for the next year is 4.5 million yuan, and the market size of 8 million units, then we can predict profits based on this model. However, this is only a simple example model and more variables may need to be included to improve the accuracy.

Data Processing Requirements: The accuracy and completeness of the data is critical. When collecting data, you need to ensure that the data source is reliable and covers a long enough time period to reflect the cyclical and trend characteristics of the valve industry. And for outliers (such as a year for special reasons the market suddenly appeared abnormally high or very low prices for sale) need to be identified and processed (such as the use of weighted average or rounding off specific unavailable data points, etc.), otherwise the outliers may seriously affect the accuracy of the model.

(ii) Coupled prediction model based on market demand and competition

Considerations: This model focuses on the consideration of market demand, market competition pattern on the impact of corporate profits. First of all, for the market demand, analyse the impact of various factors on the valve demand changes in the mechanism (such as macroeconomic growth to drive the growth of industrial construction demand for valves; enterprise environmental protection facilities upgraded to drive the demand for special performance valves), the establishment of the market demand forecasting equation (can be a complex function of multiple factors). For example, in a regional market, if the chemical industry investment (G) and the construction industry growth rate (C) on the valve demand has an important impact, the demand equation can be expressed as: D = f (G, C). Secondly, considering the competitive structure of the market, to quantify the impact of competitors‘ entry or exit, competitors’ price competition behaviour, etc. on the market share (S) and price (P) of the enterprise, a moderately complex game model can be established. Profit can be predicted using the formula: Profit = P * S * D - Cost (where Cost represents various costs, e.g. based on the cost structure analysed above).

Dynamic adjustment of the model: The model needs to be dynamically adjusted to the market environment. Because factors related to market demand (e.g., new macroeconomic policies, new technological changes in the industry, etc.) and the competitive landscape (e.g., entry of new competitors, changes in the strategies of established competitors, etc.) are in a constant state of flux, it is important to periodically (e.g., annually or quarterly) re-evaluate and recalibrate the parameters in the model in order to make more accurate profit forecasts.

(iii) Forecasting model based on internal efficiency improvement of the enterprise

Decomposition of Internal Efficiency Indicators: This model focuses on the impact of production and operation efficiency improvement on profit forecasting, mainly from within the enterprise. Decomposition of internal efficiency indicators such as production efficiency PE (the number of products produced per unit of time), quality qualification rate QE (qualified products accounted for the proportion of the total number of products), cost control efficiency CE (the rate of cost reduction through cost management) and so on. It is assumed that there is some mathematical relationship between these metrics and profit. For example, a simple hypothetical relationship: Profit =k1* PE + k2* QE - k3 / CE (here k1, k2, k3 are the corresponding obtained coefficient constants, which are obtained through historical data regression or empirical analysis). If the enterprise improves productivity through technological improvements (e.g. automated equipment increases productivity by 20%), quality pass rate increases (from 90% to 95%), and cost control is enhanced (e.g. costs decrease by 10%), the approximate profit improvement can be predicted based on this model.

Factors affecting the potential for improvement: Calculating the potential for improvement within a firm is constrained by a number of factors. Technological innovation is the key. If the R&D team is strong and constantly innovates processes and technologies, the potential for internal improvement is high. Employee quality and management levels also have a significant impact. Dedicated and highly skilled employees are more likely to achieve efficiency gains under effective management. For example, if a company introduces a lean management philosophy of continuous improvement and staff training is adequate, then productivity and quality improvement will be more achievable and have a greater positive impact on profitability, based on which the forecasting model can be used to make better profit projections in the context of the company's strategy and change.