Digitization offers the opportunity to create a new competitive structure that promotes the rail system as a whole and makes companies active in the rail market more competitive and innovative. In this regard the German railway industry faces new structural challenges.
In the past, the established rail industry companies have already contributed significantly to the increasing automation of rail transport. In the future, however, the role of IT-intensive activities will become more and more important, so that even current non-industry players will discover the rail sector as an attractive industry for themselves. By that, the market is facing a new form of intense competition. For the associated structural change in the railway sector to generate positive impact for productivity and innovation, a move towards open systems that allow for fair competition at the module level is needed. The technological concepts of digitization offer unprecedented opportunities for this, but also create challenges that the established companies have to face.
More and fair competition through open systems
In order to understand what a structural change really means, one must consider the starting point first. Looking at the current structure of the German railway industry shows us that the railway market is characterized by a broad base of small and medium-sized companies, which have been operating as subcontractors of the large-sized railway system houses for decades and thus have in-depth application know-how. These companies have made a significant contribution to making the German rail industry one of the leading markets for innovative rail technology today – in all segments.
Above all, it is clear that the future viability of the German railway industry crucially depends on the question whether small and medium-sized enterprises – under the influence of digitization – are able to continue to create innovative and profitable businesses in their typical function as subcontractors to the system houses. Until today, the development of the industry has so far been a success story.
The basic conditions to continue with this success story in the future are given. The current development is driven by global megatrends, most of which can be assumed to have a fundamentally positive impact on the development of the rail market too. Only the continuing increase in international competition poses a potential risk for domestic providers with regard to future addressable market volumes.
The effect of another trend is completely open: namely the question of whether rail systems will continue to be more customer-specific in the future. There may be proprietary solutions, or there will be an increasing trend towards standardization, which is already much more widespread in other industries, such as the automotive or aerospace industries.
Digitization and standardization are moving the German railway market
In order to be able to better assess the actual significance of megatrends, in 2016 we asked players in the German-speaking rail market the question: how important and how urgent are the megatrends for your strategic orientation?
The result was clearly visible: Digitization was rated as the most important trend that has to find its way into corporate strategies. To our surprise, however, the competition between proprietary systems and solutions based on agreed standards was seen as the most pressing trend. The outcome of this competition seems completely open. Asked, whether they would in the future rely on standard components or not, half of the participating companies answered with “yes”, the other half with “no”. So far, the market seems to be deeply divided.
These two aspects, i.e. the progressive digitization and the possibility of increasing standardization, led us to ask ourselves the question: What does that actually mean for the future of the German railway industry market regarding its structure? When it comes to questions of this kind, you always come to the point where you have to answer two things in particular: First, what is digitization in this context? And second, which aspects have an influence on market and industry structures at all?
Basic Technologies of Digitization – Smart Connected Products
With a clear focus on the industry-wide, structural impact of digitization, we have chosen the following fundamental understanding:
Above all, digitization is an ever-expanding network of the future, which connects people with people, people with machines, machines with machines and, in the future, more and more frequently machines with objects and lets them communicate with each other in a variety of ways.
Digitization is therefore – and not only in our case – particularly a continuation of the IT innovation waves that have been observed over decades. After all, the core of what we see today as digitization in new dimensions has been part of our society for quite some time. The first wave of innovation in the 1960s and 1970s saw the gradual automation of simple manual activities. The second wave then brought the commercialization of the Internet and with it for the first time worldwide communication possibilities and the “quasi-omission” of communication costs. Both waves of innovation were particularly process-driven, be it production processes or communication processes.
Today we are in the middle of the third wave, the digital age. And for the first time not only processes, but the products themselves will be fundamentally changed. In the future, products will primarily consist of the combination of five basic technologies or concepts that make digitization technologically significant. These products can then also be referred to as Smart Connected Products.
The first technology in this context is the Internet of Things (IoT), where communication is at the center. Components are increasingly exchanging data via sensors and transmitting their respective status. The data collected will then be used to gain new insights using big data technologies and machine learning applications, resulting in greater efficiency or better capacity utilization (e.g. through predictive maintenance strategies).
For the first time, Industry 4.0 allows mass-customized products and therefore flexible, cost-effective yet individually tailored production. The concepts of augmented and virtual reality, however, create new human-machine interfaces and represent a kind of digital extension of the human sensory organs, which can lead, for example, to new simulation and training methods. Finally, the autonomous systems like robots or machines operate with their own context intelligence and decision-making ability in a system or network. In the rail system, the fully automated train operation or the fully automated single freight car are typical examples.
In the future these five basic concepts will increasingly converge and together form the group of Smart Connected Products. Products that are complex systems and that combine hardware, software, sensors, data storage, processors and much more in a variety of ways. This leads on the one hand to completely new possibilities to create new product functionalities. At the same time, the requirements and thus the development environments that are necessary to develop these products are changing with the products. This is because the new possibilities create products and systems that will be characterized by much greater complexity than we know today. That’s why companies need to build an entirely new IT infrastructure, also known as a technology stack.
Rising demands on IT infrastructures: the technology stack of the future
On the one hand, the technology stack describes the modified hardware, software and the necessary safety and security requirements that are embedded in the products themselves. The products themselves communicate via network communication by using cloud services of the so-called product cloud, in which the intelligent product applications, the functions of machine learning, the platform applications and the necessary databases are available. Across all layers of the stack there is a safety and security structure that must ensure the data, operation and failure safety of the applications, which are particularly important in the railway market. There is also an interface for external information that provides access to data and tools such as ERP or CRM systems.
The complexity of the infrastructure clearly shows that the design and operation of a technology stack requires one thing in particular: Extensive investments and a range of completely new skills and qualifications in areas such as software development, systems engineering, data analytics and many more. Skills that today are still rare in small and medium-sized established companies of the German railway industry. For these companies a lot will change. The development costs and thus the fixed cost share in the industry will continue to rise in the future. Especially for small companies this creates an additional market risk.
Often it is even said that digitization changes everything. But that’s a too simple conclusion. Even though digitization with its Smart Connected Products generates a whole range of new technological opportunities, risks and requirements, one thing above all still applies: the rules of competition and competitive advantages remain the same.
Therefore, it is important that as technology and innovation life cycles become ever shorter, companies must be aware of these rules of competition, systematically observe their effects and know their current and future market. Only in this way the right strategic conclusions can be drawn for your own company.
Industry structures: New technologies and customer requirements are driving change
To assess the impact of digitization on competition with its smart, connected products, we need to look at the structure and competitive forces. These are, according to Porter, the buyer’s bargaining power, the threat of new market players, the threat of substitution and the bargaining power of suppliers. Together they determine the competitive rivalry of the industries and their established market players and thus the structure and ultimately the profitability of an industry.
Basically, structures change whenever new technologies and customer requirements affect the market forces.
So, the question is: What influence does digitization have with its effect on increasing system complexity, increasing demands on development environments and thus rising development costs in terms of fixed costs on the German railway industry, which is primarily characterized by small and medium-sized enterprises?
When we first look at the impact on buyers or end customers – Train Operating Companies (TOCs) and infrastructure managers – it shows: Smart Connected Products expand the possibilities for product differentiation. In the future the established system providers in the market will be able to offer more and more customer-specific products. On the one hand, this increases the possibility of adapting product functionalities more closely to customer requirements, on the other hand, it creates a more specific solution orientation and thus also a higher degree of customer loyalty. For TOCs and infrastructure managers as end customers in the rail market the costs of switching to another supplier will increase, so that in the future they should rather lose bargaining power.
Next, there is the danger that incumbents will have to compete with new, previously non-rail industry market players in the future, although the entry barriers would tend to increase even further due to the complex system requirements for IT infrastructures mentioned above. These barriers will especially increase when established rail system providers can consistently use their “first-mover advantage”, i.e. they are in a position to expand their application specific know-how by IT components and develop Smart Connected Products early on to market maturity curve.
If today’s market players hesitate, the likelihood of new players, which are already largely meeting the requirements of the technology stack, entering the market increases. In this case the intensity of competition increases.
The same applies to the risk of substitution products. That is, Smart Connected Products can themselves be the substitutes of the future. Therefore, the danger of substitution may decrease if today’s market participants take the path of “cannibalization” and serve the new customer requirements themselves by early developing intelligent products.
Finally, there is the bargaining power of the suppliers and thus the future competitive role of today’s medium-sized supplier industry in the railway market. As we have already seen, the German rail industry is strongly influenced by small and medium component suppliers, especially in the rolling stock market. With the increasing demands on companies in terms of system complexity and rising fixed costs, these small and medium-sized enterprises face special challenges with their comparatively thin financial background. Especially in relation to the large manufacturers and system houses of the rail market, small and medium-sized companies face the risk of losing bargaining power or even be pushed in a direct competitive role with the large system houses.
Summarizing the findings so far: Under today’s conditions of digitization, the increasing bargaining power of TOCs and railway infrastructure managers is decreasing due to increasing product differentiation and thus greater customer loyalty. The increasing demands on IT infrastructures also generate further rising development costs and thus fixed costs, which will increase market entry barriers. The same applies to the danger of substitution products, which can be created by the digital products themselves. This means that the established market can itself use the strategy of substitution. Last but not least, the bargaining power of the supplier industry is twofold. Small and medium-sized enterprises are losing bargaining power due to limited financial resources and rising development risks, while financially strong and IT-experienced system houses will increasingly strengthen their market position.
Successful digital transformation needs standards
It is clear that if nothing changes, the structure of a vital and dynamic rail industry market in Germany with a strong community of small and medium-sized companies is at risk. It therefore needs two things in particular, namely an improved political and economic framework and consistent digitization of medium-sized, established railway industry companies.
The task of small and medium-sized companies in the German railway market is therefore to create a customer-based and systematic handling of digitization which considers the existing basic technologies of Smart Connected Products. This particularly includes the fact that the existing application competence is systematically and consistently supplemented by ever-more important IT know-how. Only in this way the requirements for the new products can be met in the future.
The expected strong increase in fixed costs creates a special challenge that needs to be addressed. That is why it is equally important that even small companies open up new forms of cooperation, such as strategic alliances – whether within the industry or across industry borders – and thereby reducing development risks.
In order for companies to be able to fulfill their tasks, however, fundamentally new, improved political and economic conditions are required. For us, that means the success of a digital transformation in the railway market crucially depends on the availability of standards. All elements of a market in which the future products can be seen as “systems of systems” need a common language and common interfaces. Only in this way a fair and solution-oriented competition can emerge at the module level, which can continue to ensure the future industrial competitiveness of the railway market and promote and continue the success story of its players in Germany.
This article is based on the talk “Von der Preis- zur Lösungsorientierung durch Digitalisierung im Bahnmarkt”, which was part of the ASTRAN Innovation Symposium on September 21, 2017 at Maschinen-Museum Kiel-Wik. Further information is available at www.astran.de.
Liggesmeyer, Prof. dr. Dipl.-Ing. Peter (2015): IoT, Industry 4.0 and Big Data. URL: https://kosse-sh.de/wp-content/uploads/2015/06/Keynote-Liggesmeyer.pdf, last accessed on: 05.10.2017.
Porter, Michael E. and Heppelman, James E. (2014): How Smart, Connected Products Are Transforming Competition. URL: https://hbr.org/2014/11/how-smart-connected-products-are-transforming-competition, last accessed on: 05.10.2017.