American industrial equipment has a reputation for being the best in the world. Indeed, equipment manufactured by companies like Caterpillar (NYSE:CAT) was, until recently, considered to be in a league of its own, with no comparable substitutes.
However, the ground has recently shifted, and American companies are now losing out to cheap Chinese competitors, which have been working hard to improve the quality of their equipment during the past few years.
Lower costs, higher profits
It used to be the case that mining companies such as Rio Tinto (NYSE:RIO) would stay away from Chinese heavy industrial equipment, despite the lower price as the kit was usually of an inferior quality.
But now the quality of Chinese equipment has improved, and is, according to some, on a par with that manufactured by U.S. peers.
Indeed, according to comments from Rio's CEO Sam Walsh given in an interview with The Wall Street Journal:
The Chinese manufacturers are really improving in this field and can now be compared to the major US manufacturers... funnily enough [on the rail cars] the quality actually was much higher [compared to the miner's traditional supplier]...Instead of spot welds, for example, on the sheet metal they were actually continuous welds.
As a result, Walsh revealed that Rio had actually been increasing its purchases of heavy equipment from Chinese and Indian companies, stating that the savings were "significant." According to Financial Times, Mr Walsh claimed that Rio has brought "thousands" of Chinese rail cars for the company's operations, along with ship loaders and trucks.
What's more, it would appear that the quality of Chinese mining equipment is only going to improve from here on out while costs continue to fall.
I say this because according to a study entitled "China Mining Equipment Industry 2013-2017" published back in June 2013, China's domestic mining and quarrying equipment manufacturing industry is expected to expand by about 22% by 2017, increasing economies of scale.
The study also reiterates the fact that Chinese producers will emerge as industry favorites due to their low cost.
Other industries are switching suppliers
It's not just the mining industry that is realizing cost savings thanks to a better quality of low cost Chinese equipment. Royal Dutch Shell (NYSE:RDS-A) has recently come out and revealed that it will be using more Chinese equipment for North American shale oil development activities as the company seeks to reduce costs.
This switch by Shell comes at a time when the company is trying to swing its North American business from a profit to a loss. It is hard to fault the company for its choice of manufacturers. In an interview with Financial Times, Shell's chief executive Ben van Beurden explained:
"Why do we have to make our tanks in the US or Mexico?" he said. "I can make my tanks in China and guess what? We take 40 per cent of the cost out."
Shell owns around $21 billion worth of North American shale assets, so it quickly becomes apparent that a 40% reduction in equipment costs can really make a difference for the company.
All in all, it would appear that to stay ahead, American heavy equipment manufacturers are going to have to up their game if they want to stay ahead of Chinese peers.
Unfortunately, this news that miners are switching to cheaper Chinese equipment, at a time when the capital equipment industry is still reeling form a slump in mining activity means that companies like Caterpillar are going to have to think fast to become appealing to customers again.