Cause and effect: The impact of the economy on manufacturing
INSIGHT ARTICLE |
- Despite sluggish growth, many manufacturers are optimistic about the remainder of the year.
- Capital expenditures in software and equipment are down overall from where they were a year ago.
- The risks for middle-market manufacturers expanding in foreign markets are even greater now in a volatile global economic environment.
- Manufacturing employment remains weaker than anticipated, yet productivity was up in nearly half of the manufacturing sectors.
For manufacturing executives, volatility remains the watchword for 2016; this theme will likely be seen in the upcoming Manufacturing & Distribution Monitor report in September. World markets are down by double digits, year-over-year, while the U.S. market remains relatively unchanged for the same period. Yet despite lackluster growth and some strong global headwinds, some manufacturers are optimistic about the remainder of the year.
Revenue growth and profitability
A March 2016 report by the Institute for Supply Management indicates that growth in manufacturing rose for the first time since August 2015.[i] Capacity utilization is just over 80 percent, with predictions of growth in both exports and imports. Recent contractions in manufacturing posed a very real risk to the U.S. economy but, with the decline in fuel prices and steady job growth overall, many businesses are anticipating a rise in consumer spending on food and durable goods in the coming months.
Despite some adjustments, residential construction is showing growth year-over-year, which may be fueling the cautious optimism of manufacturers. As long as the country continues to produce nearly 200,000 jobs per month, the demand for housing-related manufacturing such as building supplies and furniture should remain steady. Concern, however, remains regarding the saturation of commercial real estate construction.
Larger manufacturers are turning to buying companies that make the parts they need—or making them in-house—in their efforts to cut costs and maintain their profit margins.[ii] Top-line growth, however, remains a challenge. This may be due in part to the decrease in goods exports in 2015 as a result of a strong U.S. dollar and lower overseas demand. With slow economic growth and low interest rates, companies will continue to see mergers and acquisitions as more effective than organic sales to increasing revenue.
Technology and innovation
While the manufacturing industry in general can point to a number of innovative technologies at work, capital expenditures in software and equipment are generally down from where they were a year ago. Expectations vary by region, where manufacturers in some parts of the country expect to increase spending[iii] while others anticipate contractions.[iv] Overall, compared to expenditures in 2015, the average spending in 2016 is expected to be nearly flat.
There may be a number of reasons behind this low capital expenditure (capex) rate in technology: In the aftermath of the recession, many companies have already made long-overdue investments in new technologies to replace legacy systems or engage in the internet of things. When the global economic crisis intensified in the summer of 2015, many companies pulled back on equipment and software investment associated with productivity; this has continued into 2016. Election-year uncertainties may also be a factor. Executives may be waiting to dedicate money for innovation until after November, when they expect to get a better idea of what tax and economic incentives, or penalties, may come their way. Since 2011, the short-term nature and fear of tax policy changes has put a damper on investments to boost productivity.
Those companies that are investing in new technologies may find that the innovation pipeline is longer for some sectors than it is for others. It remains to be seen whether or not these companies will follow through on their investment plans.
It has never been easy to set up operations overseas and it has been particularly challenging in 2016. The risks for middle-market manufacturers breaking into offshore markets can be mitigated somewhat by following the lead of customers as they expand internationally—a relatively less perilous approach than a company “greenfielding” by venturing out on its own.
But the risks are even greater now in a volatile global economic environment. The eurozone is dealing with inflation concerns in Germany and refinancing in Greece; China has begun a period of debt and deleveraging that could make it difficult to do business there for years; Brazil, once a bright star in the southern hemisphere, is dealing with political and economic upheaval; the Middle East turmoil continues to impede investments. Among the few bright spots, India’s economy appears strong and Argentina is slowly integrating its way back into the financial community.
The challenge over the past few years has been maintaining profitability in a low-growth business environment. While commodity prices appear to have bottomed out, their volatility has created challenges for many businesses. Coupled with easy access to market information, some customers are continuing to put pressure on their suppliers for price concessions, which may exceed the savings from lower material prices. Labor cost pressures have been minimal, but recent decisions by various government agencies have put pressure on staffing plans, labor costs and future hiring.
The unemployment rate in the United States is hovering around 5 percent, but manufacturing employment remains weaker than anticipated. Productivity was up in nearly half of the manufacturing sectors, a more widespread increase than 2015.[v] Yet while manufacturing output since 2009 has increased 20 percent, manufacturing employment has risen only 5 percent in that same time period.[vi] More manufacturing industries are losing jobs than adding.
There may be several explanations for this apparent discrepancy. According to the Bureau of Labor Statistics, productivity increases since 2007 are predominantly the result of a decline in hours worked, rather than an increase in output. After their orderly bankruptcy, U.S. automakers have been able to circumvent union contracts and integrate more technology into production, thereby lowering labor needs and costs. Global headwinds and uncertainty about the overall economy have also stifled hiring. Nevertheless, six out of 10 open skilled production positions are unfilled due to a talent shortage, according to a report by the National Association of Manufacturers.
That said, strong manufacturing job growth has been seen in several states, including Michigan, Tennessee, Georgia, Florida and Wisconsin.
[i] Manufacturing ISM Report On Business, March 2016
[ii] Crain’s Chicago Business
[iii] Empire State Manufacturing Survey, March 2016
[iv] Kansas City Federal Reserve Bank Manufacturing Survey, March 2016
[v] U.S. Bureau of Labor Statistics