Management overview

As a global leader in power and automation, we serve utility, industry and transport & infrastructure customers in a combined market worth more than $600 billion per year. In all three customer segments, our combined offering of power and automation provides a unique value proposition for customers as we provide solutions for secure, energy-efficient generation, transmission and distribution of electricity, and for increasing productivity in industrial, commercial and utility operations. As we look at our customers’ value chain, there is a clear trend towards more electricity being transmitted by wire, and increased feed-in points.

This leads to a convergence of power and automation, which then needs to be automated and controlled.

In September 2014, we launched the Next Level strategy which laid the foundation to take ABB to the Next Level aimed at accelerating sustainable value creation. The strategy is built on the three focus areas of profitable growth, relentless execution and business-led collaboration.

Next Level – Stage 1

In Stage 1 of the Next Level strategy we drove toward profitable growth by shifting our center of gravity through strengthening our competitiveness, driving organic growth and lowering our risk profile. We continued to drive profitable growth through our framework of penetration, innovation and expansion (PIE) in targeted geographic and industry segments. Some of our key successes in 2015 can be seen in the section Next Level - Stage 2 below.

To complement our drive for organic growth we also launched five new partnerships in 2015 in different markets such as data centers (with Ericsson), electrical vehicle charging (with Microsoft), grid integration in Japan (with Hitachi), microgrids (with Samsung) and building automation and software for smart homes (with Bosch & Cisco).

In Stage 1, we drove relentless execution by continuing to deliver on our ongoing cost savings program. Significant progress was also made on the previously announced Power Systems ‘step-change’ program. We returned the division to profitability and it reached the target operational EBITA range of 7-11 percent in the fourth quarter of 2015. We are driving our transformation through our 1,000-day programs, to ensure a successful implementation and making our operations more efficient. In order to increase operational performance, a new compensation model was rolled out which better incentivizes management performance by building on company as well as individual key performance indicators (KPIs). As of January 2016 more than 70,000 employees are on this new model.

Our third focus area is business-led collaboration which aims at increasing operational efficiency by improving processes and organizational structures. We have simplified the organization and set clear roles and responsibilities throughout the group.

Our Next Level Stage 1 actions laid a solid foundation for our future development amid a significantly tougher market environment in 2015 compared to 2014. Global GDP growth assumptions were downgraded, oil prices continued to decrease and China’s growth moderated. The market for our full product and service offering, which totals more than $600 billion a year, is now expected to grow 2.5-4.5 percent a year in the period from 2015 to 2020.

Next Level – Stage 2

Stage 2 of the Next Level strategy was announced in September 2015 and is comprised of a significant set of actions to accelerate the shift of our center of gravity toward higher organic growth, greater competitiveness and lower risk while accelerating existing improvement projects.

Profitable growth

Profitable growth continues to be a key focus area to accelerate sustainable value creation and is driven through the framework of penetration, innovation and expansion (PIE).

We continued to drive for growth in 2015 through increased market penetration in targeted geographic and industry segments. For example, we have a pioneering track record in supporting the development of India’s power infrastructure. ABB projects in India include the North-East Agra power link, the world’s first multi-terminal UHVDC transmission system, as well as a smart grid solution for the entire Karnataka state power network. In addition to the first link in the country, we have been involved in five major HVDC projects in India. Furthermore, we have actively contributed to the development of India’s ultrahigh voltage (765kV) network and the local manufacturing of related equipment. Most recently we developed 1200 kV power equipment including transformers and a switchgear for the pilot installation in Bina, India, which is deploying the highest AC voltage level in the world. We are also supporting the rapid urbanization in India through a range of initiatives including solar plants, microgrids and metro rail projects in fast growing cities like Delhi, Bangalore and Jaipur.

Innovation continued to be a focus for growth and we introduced several ground-breaking offerings in 2015, including the launch of our collaborative robot, YuMi®, the 525 kV HVDC cable, the Azipod® D electric propulsion system and the eco-efficient gas insulated switchgear. YuMi® is the world’s first dual-arm robot to be able to work collaboratively on the same tasks as humans while ensuring the safety of those around it. With the introduction of YuMi®, we are pushing the boundaries of robotic automation by fundamentally expanding the types of industrial processes which can be automated with robots. In addition, we commissioned the world’s first high- and medium-voltage switchgear installation for the Swiss utility, EWZ, with a new eco-efficient gas that reduces the global warming potential by almost 100 percent by offering an alternative gas mixture to the conventional sulfur hexafluoride.

We also continue to focus on the opportunities brought by the Industrial Internet, the so-called “Internet of Things, Services and People” (IoTSP). Today, more than 50 percent of our products are software-related. By enabling installations to communicate via the internet, the IoTSP provides connections across company locations and even between companies. As a company with offerings across the power and automation spectrum, we are ideally-positioned to enable the IoTSP and to help customers reach the next level of productivity, efficiency and flexibility. We received an order in 2015 together with the Dutch weather forecasting specialist, Meteo Group, to provide 140 Maersk container vessels with advisory software to optimize routes helping them to drive vessel efficiency and avoid conditions that could be harmful to the ship.

Technology innovation remains a cornerstone of our competitive position and a key driver of profitable growth. We plan to continue investments into research and development of approximately 4 percent of revenues, which in 2015 amounted to $1.4 billion.

Expansion into new high-growth markets is another driver of profitable growth. We, along with Microsoft Corp., have announced the worldwide availability of a new electric vehicle (EV) fast-charging services platform. Combining our leading EV charging stations with Microsoft’s Azure cloud-based services will ensure stability, global scalability and advanced management features for our customers. The collaboration will also take advantage of machine learning and predictive analytic capabilities to drive future innovations. With regard to micro-grids, which are another high-growth market, we won a significant order in 2015 from Socabelec to install a micro-grid solution to boost renewable energy use by a remote community in Kenya. Our stabilization system will be integrated into the existing power network and will interface with existing diesel power station controls. This will maximize renewable energy penetration and utilize any excess wind energy generated.

Complementing the ongoing focus on driving organic growth, we plan to focus on value-creating acquisitions that support the shift in center of gravity and partnerships to accelerate growth in attractive segments.

In line with the shift in our center of gravity, we have realigned our organizational structure effective January 1, 2016, to better address customer needs and deliver operational efficiency. Our new streamlined structure is comprised of four operating divisions: Power Grids, Electrification Products, Discrete Automation and Motion and Process Automation.

The new Power Grids division is focused on meeting the power and automation technology challenges of power grid utilities, such as the integration of renewable energies, growing power network complexity, grid automation, and the development of smart grids and micro-grids. Delivering a broad transmission and distribution offering from a single integrated source supports our organic growth ambitions by providing better customer service while enabling cost and productivity improvements to achieve the targeted operational EBITA margins. The Power Grids division is a leading worldwide supplier of power and automation solutions to power grid customers and comprises our AC grid, DC grid and grid automation activities, as well as our transformer and high-voltage product businesses.

The new Electrification Products division includes our medium-voltage products business as well as the breakers & switches, control products, building products, low-voltage systems and Thomas & Betts activities. This combination opens new growth opportunities by taking one of the industry’s most complete ranges of low- and medium-voltage products, solutions and services to a broader customer base through multiple common sales channels.

All of our control solutions are integrated into the Process Automation division and delivered across our various end markets through focused front end customer interfaces including the transfer of the distributed control system (DCS) business for power generation from the Power Systems division.

There are no significant changes in the Discrete Automation and Motion division.

Relentless execution

In Stage 2 of the Next Level strategy, we aim to close the gap in our operating performance compared with our best-in-class peers. The goal is to further transform our company toward a leading operating model with business processes more focused on customer needs, and an enhanced performance management system, including compensation tied more closely to performance, as well as the development of a world class people and true performance culture.

Our ongoing cost savings program to reduce costs equivalent to 3-5 percent of cost of sales each year, achieved in 2015 approximately $1.2 billion in cost savings or approximately 5 percent of cost of sales.

We continued to drive our focused 1,000-day programs of driving white collar productivity—becoming lean for growth—and working capital management—to provide cash for growth.

Our white collar productivity program is aimed at making us leaner, faster and more customer-focused. Business functions, support functions and organizational complexity are in the scope of this program. Productivity improvements include the rapid expansion of regional shared services and the streamlining of global operations and head office functions, with business units moving closer to key markets. We aim to achieve cost savings at a run rate of $1 billion a year by the end of 2017 and the program is on track to deliver approximately $400 million of cost savings in 2016.

The working capital program is on track to free up at least $2 billion in cash by the end of 2017. Improved collections from customers as well as stronger inventory management resulted in a solid working capital reduction in 2015. Further measures are being taken to drive improvements through the entire value chain, from product design through manufacturing and logistics as well as reducing unbilled receivables in large projects.

Business-led collaboration

We continue to drive our transformation, which is aimed at improving customer focus and increasing agility to support the achievement of our 2015-2020 targets. Our streamlined organization, with a realigned divisional structure, commenced in January 2016. In order to drive sales productivity and collaboration across the group, Salesforce.com was rolled out further as a common sales platform and is now operational in 30 countries. The Group Account Management team has a focused customer approach and initial pilots show proof of success.

Updated 2015-2020 financial targets

In September 2015, we aligned our 2015-2020 revenue growth target with reduced macroeconomic expectations while keeping our ambition relative to the market. The average annual revenue growth rate target, on a comparable basis, over the period from 2015 to 2020, is now 3-6 percent (previously 4-7 percent). The driving factors for this change include the expected continuation of lower oil prices, signs of slowing industrial production growth and forecasted emerging market growth below the levels previously projected in 2014. All other targets which took effect on January 1, 2015, remain unchanged: We expect to grow operational earnings per share at a 10-15 percent compound annual growth rate and deliver attractive rates of cash return on invested capital in the mid-teens over the period from 2015 to 2020. Over the same period, we plan to steadily increase our profitability, measured by Operational EBITA, within a range of 11-16 percent while targeting an average free cash flow conversion rate above 90 percent.

Targeted capital allocation

We maintain our capital allocation priorities, focusing on i) funding organic growth, research and development and capital expenditure at attractive rates of cash return on invested capital (CROI), ii) paying a steadily rising sustainable dividend over time, iii) investing in value-creating acquisitions and iv) returning additional cash to shareholders.

In 2015, we returned $3.2 billion to shareholders in the form of dividend payments and share repurchases, in line with the Next Level strategy to accelerate sustainable value creation. This included $1.7 billion in dividends in the form of tax-efficient distributions out of ABB Ltd’s capital contribution reserves and by way of a nominal value reduction. We are continuing our previously announced two-year $4-billion share buyback program which is scheduled to be completed in September 2016. As of the end of 2015, we had repurchased approximately 106 million shares for a total of approximately $2.2 billion.

Outlook

Macroeconomic and geopolitical developments continue to signal a mixed outlook, with continued uncertainty. Some macroeconomic signals in the United States remain positive and growth in China is expected to continue, although at a slower pace than in 2015. The market remains impacted by modest growth in Europe and geopolitical tensions in various parts of the world. Current oil prices and foreign exchange translation effects are expected to continue to influence our results.

The long-term demand outlook in our three major customer sectors—utilities, industry and transport & infrastructure—remains positive. Key drivers are the big shift in the electricity value chain, industrial productivity improvements through the IoTSP and Industry 4.0, as well as rapid urbanization and the need for energy efficiency in transport & infrastructure.

We believe we are well positioned to tap these opportunities for long-term profitable growth with our strong market presence, broad geographic and business scope, technology leadership and financial strength.