The HVAC market is changing. To succeed in service OEMs must up their game, expand their offerings and upgrade their sales and operational capabilities. And the competition is not standing still.
The HVAC market
The HVAC sector is a highly competitive space, with numerous vendors operating at significant scale. Yet, a reasonable concentration exists with the leading 10% of companies accounting for roughly half of the market. The industry is global, with an estimated market size at US$130-150 billion for products (plant and equipment) — encompassing furnaces, boilers, chillers, air conditioning units, ventilation systems, and humidifiers among others. Prominent players include the US-based companies Carrier, Trane, and Johnson Controls, alongside their Japanese counterparts such as Daikin, Mitsubishi, and Toshiba, as well as South Korea’s Samsung and LG. Recently, Chinese firms have made spirited forays into this domain, initially focusing on smaller systems before venturing into more substantial offerings. European companies tend to be smaller and focused more on heating than cooling or air conditioning -with Atlantic (FR), Bosch (DE) and Electrolux (SE) having a presence in AC and a plethora of medium-sized manufacturers, mostly German, (Viessmann, Vaillant, Buderus, Wolf, and others) playing a prominent role in the heating systems market.
Complementing plant and equipment, the automation and control domain is gaining traction, buoyed by the escalating significance of energy efficiency and other advanced functionalities within building operations. Notable companies in this sub-sector include Honeywell and Siemens, along with Carrier’s Automated Logic. Furthermore, there is a large derivative market for products and components that constitute the bill of materials of HVAC systems, incl. compressors, pumps, motors, coils, filters, condensing units, burners or sensors.
Geographically, the broader Asia-Pacific region stands as the preeminent market, outpacing North America — predominantly the US — and Europe. Asia’s more pronounced growth rates are attributed to a burgeoning necessity to augment installation density, though these figures do not vastly outstrip those recorded in other territories.
However, the HVAC landscape is facing structural transformations: Global warming, alongside other climatic effects and localized meteorological shifts, has spurred latent demand. For instance, the previous summer’s heatwave in the northern hemisphere propelled air conditioning unit sales to unprecedented heights — 20-30% above the benchmarks of 2022 — benefiting manufacturers with both volume and price surges but also exposing the sector’s technical staff shortages. This trend shows no signs of abating. At the same time, regulatory initiatives to curtail CO2 emissions have ushered in rigorous energy efficiency mandates for both new and existing buildings. These regulations are designed to phase out traditional fuel combustion technologies in heating, whilst bolstering the prospects for alternative solutions like heat pumps.
Moreover, the COVID-19 pandemic has ignited a sustained remote working trend. Despite receding from its zenith, this paradigm shift endures, profoundly impacting the construction and building markets. There is a palpable decline in demand for commercial spaces — office and retail (as also e-commerce gains in importance). These structural shifts are compounded by the surge in interest rates, inflation and low economic growth rates, further straining the industry.
The initiated transition within the HVAC sector from traditional combustion systems to heat pumps mirrors, the automotive industry’s shift to electrification, albeit on a slightly less dramatic scale. Heat pumps, which transfer heat rather than generate it through combustion, stand out for their efficiency and reduced environmental impact: They are operated by electricity—ideally sourced from renewables or nuclear energy. Though at present they are more expensive than their combustion counterparts, their reversible nature, offering both heating and cooling functions, presents a compelling, cost-effective alternative to separate systems. And as they are at an early stage on their developmental trajectory, heat pumps are poised for significant cost reductions through scaling and technological advancements.
According to the European Heat Pump Association, the uptake of heat pumps has surged, with sales in 21 European markets reaching 3 million units in 2022—an impressive 40% increase from 2021, which itself marked a 34% rise from 2020. While 2023 may see a plateau or even a dip in sales, attributable to high electricity costs relative to natural gas and heating oil prices, steep installation charges, and the lack of sufficiently robust incentives or regulatory mandates, the European Union’s target of 60 million installed units by 2030 remains achievable. Across the Atlantic, the narrative is similar: the United States observes robust growth, albeit in the single digits, with heat pump sales surpassing gas furnaces for the first time in 2022, accounting for 53% of all heating systems sold.
HVAC manufacturers find themselves therefore, on the one hand, navigating a burgeoning demand for comprehensive indoor climate control, mainly cooling, solutions, bolstered by global warming. Additional demand is driven and being shaped by efforts to decarbonize and is shifting towards a different core technology, all within a market currently bracing against sluggish economic growth, high interest rates, and the unpredictable volatility of energy prices. It is not therefore surprising that OEMs are vying for strategic positioning in this space through new technology and capacity investments and launch of a stream of new products in important markets. Carrier’s acquisition of Viessmann, a major German player in heating systems and heat pumps, earlier this year can be understood in this context.
HVAC service strategies
For strategies in competitive markets to succeed, it is necessary to have clear intent and objectives, anticipate the competitive repercussions and responses, and harness the resources needed in a way that enables the desired outcome. Furthermore, it is necessary to decide on the basis of the competitive approach. In service markets this boils down to “skills vs. scale”: A skills-based approach hinges on superior technical expertise to address complex problems. This is a high price (and margin), low volume approach. Conversely, a scale-based approach relies on extensive logistics systems, standardized processes and robust infrastructure to resolve (simpler) problems en-masse, a low price (and margin), high volume approach. Traditionally OEMs have been closer to the skills than to the scale approach. If they move across this continuum towards the other side, they need to consider that the two approaches require distinct operational frameworks and support systems (incl. personnel and technology strategies, as well as different management metrics) and compete under different market conditions. Otherwise, there is high risk of trying to sell premium branded products to commodity buyers. This usually doesn’t succeed well.
In any case, HVAC OEM service expansion strategies intensify competition in already well contested markets. They must demonstrate superior value to be successful. Other OEM competitors are compelled to react as encroachments on their installed bases increase the likelihood of these eventually transitioning to rival brands. Third-party service providers are also under pressure to respond. Part of the recent consolidation in the sector may be attributable to OEMs’ increased targeting of service markets. This spurs contractor efforts to differentiate service offerings, often by expanding the scope to include other building trades, thus presenting customers with comprehensive, one-stop-shop solutions for service and facilities management.
OEM vendors can adopt various counter-strategies. These may range from defensive, e.g., limiting their competitive efforts to an ‘optimal’ level – to maximize profitability while achieving reasonable service growth and maintaining good relations with channel partners to offensive, e.g., acquiring service capacities and significantly expanding service sales and technical networks to cater to a broader range of customer segments and applications or diversifying and expanding their service portfolio, e.g., by adding remote services, predictive maintenance or energy management.
Of course, in some cases, OEMs -as product suppliers- have an inherent advantage in differentiating their total offer and demonstrating superior value through Product-as-a-Service offerings: These are usually outcome-based solutions that intertwine products and services while the customer pays for an agreed level of performance. In this case of HVAC-as-a-Service, customers eschew the traditional purchase of HVAC systems. The OEM installs the system and retains ownership, akin to an operational lease, while the customer pays for the service rendered. This service extends beyond basic heating and cooling to encompass at least maintenance, repairs, upgrades, and energy optimization. Performance-based contracts sit at the heart of this model, with payments tethered to the attainment of specific performance benchmarks such as overall availability, maintaining designated temperature and humidity levels, ensuring air quality, and meeting energy efficiency goals. This incentivizes OEMs to guarantee optimal system operation. And customers reap considerable benefits such as diminished initial outlays, predictable operational expenditures, access to the latest technology and upgrades (facilitated by OEMs to meet performance standards). OEMs, in turn, benefit from recurring revenue supplanting one-off sales, longer and strengthened customer relationships, enhanced ability to collect data and insights on system performance, which can inform future product development and service improvements and last, but not least, a dominant share of the service revenue from the installed base over time, a high customer wallet share and a neutralization of competition.
Of course, servitized business models carry inherent risks:
- Customer acceptance in some cases may be low as customers may not want to be too dependent on one supplier.
- The capital intensity is high and can be a burden for the balance sheet.
- Performance (execution) risk lies with the supplier necessitating careful management and potentially higher resource demands squeezing margins.
- Competition, lack of transparency or unrealistic expectations may lead to pricing that does not fully cover performance risks leading to low margins or even losses over long contract terms rather than one-off sales.
But successful OEM service strategies are not only dependent on differentiated offerings and superior value propositions. They also require building superior operational capabilities while keeping costs at appropriate levels and service delivery capacity high. Technology implementation and investment in infrastructure is another formidable challenge, as is the orchestration of an efficient supply chain and spare parts inventory, and, indeed, a high quality salesforce which can actively pursue and win orders under intensely competitive conditions.
Finally, the quest for skilled field personnel remains an uphill battle, given the demographic shifts and evolving job preferences. To succeed in service OEMs must therefore leverage technology and organizational designs to ensure service excellence with a leaner workforce. Strategic partnerships with external contractors may also provide a stopgap for labor shortages.
In sum, for OEMs to navigate this service-centric trajectory, they must be adept at balancing cost, technology, and talent, all while cultivating enduring customer relationships and broadening their service offerings to meet the ever-evolving demands of the market
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