The COVID-19 pandemic resulted in a severe economic downturn in 2020, and engineering service providers certainly suffered the effects of the slowdown. The following chart presents the performance of select engineering service providers – Alten, Cyient, HCL Technologies’ Engineering and R&D Services, KPIT Technologies, and L&T Technology Services – during this period as an indicator of the overall market.
Phase 1: Pre-COVID-19 sluggish growth phase – While the pandemic began taking its roots in Q1 2020, many engineering services vendors were growing at a slower pace from the second half of 2019. This can be traced back to a slowdown in key engineering verticals such as automotive, aerospace, and telecoms.
Phase 2: COVID19-led downturn – Growth began declining severely in the first quarter of 2020, and the dip in the chart shows that Q2 was when the pandemic’s effect became most pronounced. Interestingly, a deeper analysis of these companies’ portfolios reveals that service providers with greater exposure to the automotive, aerospace, and industrial verticals suffered a greater dip in their revenues. This is because these assets and hardware-heavy verticals are the ones where enterprises have reduced their R&D budgets the most. Consequently, these were also the vendors who suffered a greater dip in Q3.
Phase 3: Signs of recovery – The results the vendors reported for Q4, however, indicate that after multiple quarters of declining growth, the engineering services market has finally bottomed out and is headed upwards from here on. While the vendors have continued to report negative YOY growth numbers, revenues and growth figures have, without exception, improved in comparison to Q3.
ER&D services Y-o-Y growth for select service providers (Q1 2019 – Q4 2020)
There are several reasons for this improved performance.
Broader macroeconomic recovery – The rollout of vaccines towards the end of 2020 increased hopes of a return to some semblance of normalcy, leading economic bodies to project a strong recovery to the global economy in 2021. Enterprises across most verticals have started reinvesting in R&D projects, and service providers have acted quickly to capture some share of this growing market.
Digital product engineering – Enterprises in verticals such as healthcare, communications, media and entertainment, and even automotive have increased spending on cloudified, connected, and personalized products. Due to their expertise in software and digital themes, engineering service providers have benefited. Moreover, the data-driven nature of these products brings about a continuous revenue source for these vendors.
Industry 4.0 – Early adopters of Industry 4.0 were able to recover and restart operations faster after the lockdowns as a result of their investments in robotics, augmented reality systems, digital twins, and so on. The success and resilience of these early adopters encouraged other enterprises to also invest in Industry 4.0 themes as a means to reduce costs and improve efficiencies in the long run. Thus, multiple service providers were able to win Industry 4.0 deals in Q4 as enterprises looked beyond mere proofs-of-concept and towards large-scale implementation and rollouts of those initiatives.
Cost-takeout initiatives at enterprises – The pandemic forced enterprises to adopt aggressive cost-cutting initiatives within their engineering organizations. While this resulted in the temporary cancellation of R&D projects and budgetary cutbacks, the enterprises also began examining some of the work being carried out at offshore captive centers more closely. This benefited service providers, who were proactive in making a pitch to take over these captive centers. The recent Infosys-Rolls Royce deal in which Infosys is taking over Rolls Royce’s aerospace engineering facility in Bangalore, India, is one such example. Enterprises have also taken the vendor consolidation route to cost cutting, concentrating their engineering spend among fewer vendors, resulting in larger deal sizes for the remaining players.
The robust recovery across the board in engineering services encourages us to believe that this momentum will be carried forward in 2021. In addition, enterprises have now begun to look at service providers as long-term, strategic partners. This has resulted in several large, multi-year deals being signed in the engineering services market towards the latter part of 2020. The effects of these factors noted above, particularly vaccine rollouts, cost-takeout initiatives, and large deals, will truly be felt only in 2021, leading us to conclude that the worst is behind us and that the engineering services market is poised to register better than expected growth this year.
ER&D spend growth outlook across industry sectors
ER&D spend and spend growth by industry
Key ER&D investment priorities across sectors
In New Paradigm in ER&D Services: Convergence of Engineering and Technology – Part 1, we talked about the emerging trend of convergence of engineering services and new technologies, and why it is important for enterprises to deliver an enhanced customer experience. Now, let’s turn our attention to the steps and measures enterprises and service providers are taking to tap into the trend and enhance their value proposition.
Implications for the industry
So what does this all mean for the ER&D services industry outlook, and for players in the domain? As it becomes increasingly crucial for enterprises and service providers to gain new capabilities in engineering and technology, there will be increased merger, acquisition, and partnership activity. Enterprises will look at partnering with niche technology firms or innovative startups for new product development. Service providers will pursue targeted acquisitions, and try to strengthen their value proposition for clients by increasing investment and focus on the segment. It will be exciting to see what happens in this space in the next 5-ten years.
For more insights and information on the ER&D services industry, please refer to our latest report, “The Evolving Demand Paradigm in the Engineering and Research and Development (ER&D) Services Industry.”
It is interesting times for the engineering services and R&D (ER&D) market. Industry demand for engineering services coupled with technology innovations is transforming the market landscape, and leading to the emergence of new business models – in particular, the convergence of engineering services with new technologies, such as digital, IoT, and analytics for product development.
The proliferation of digital technologies is compelling enterprises to relook at their product development strategy, and integrate new technologies with products to deliver an enhanced customer-centric experience. Service providers in the ER&D industry are looking to expand their engineering service offerings by tapping into new technologies that can help them differentiate their position in the market and deliver increased value to their clients.
The convergence trend is manifesting itself in many ways in the industry, and fundamentally transforming the normal course of business for both enterprises and service providers:
Time-to-market pressure for product development is making enterprises and service providers look at avenues to deliver enhanced value to their customers. Make sure to visit our blog page later this week to read our follow-up post on the different ways they’re keeping up with this trend.
Engineering and Research & Development: Expect accelerated market growth
The convergence of engineering and technology is creating a new ER&D services demand portfolio paradigm, enabling enterprises in 5 key ways