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Profitability

A focus on domestic sources and sales

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With nearly half of manufacturers reporting operating profits (before interest and taxes) of 6 percent or more—and most expecting increases to come in revenue—it would appear that manufacturers have some control over one of the industry’s largest areas of concern: profitability, or margin management.

With so many manufacturers focused on the strong U.S. market as the primary source for revenue, it may be surprising to learn that, on average, nearly two-thirds of non-U.S. company products are sold in domestic markets. From sourcing to sales, most survey participants are focused domestically: A majority of supplier goods and materials are purchased domestically—the global median is 61 percent—and most production is located in-country (commonly referred to as “make it where you sell it”). This last point is notable for U.S. manufacturers in particular, where a median 79 percent of production capacity is domestic, a statistic supporting the trend towards onshoring. 

Strategies for increasing profitability

By far the most popular strategy among manufacturers to increase profitability is to make operational improvements and thereby reduce costs. Yet only 46 percent of survey participants are implementing these improvements to increase profitability; only about one-quarter are using supply chain improvements to reduce costs.

Technology also is playing a role to increase profits, albeit a limited one. Emerging technologies such as artificial intelligence, machine learning and robotic process automation are reducing back-office operations and supply chain analytics costs, but only about one-third of manufacturers are leveraging technology in this way.

Pricing for components and materials purchased in the past 12 months have increased for three-quarters of manufacturers. With expectations of rising costs associated with employees, IT and commodities, product pricing has increased in turn. Metal fabrication, building materials and life sciences lead with the highest percentage of product price increases among the manufacturing sectors. Yet some sectors have not seen a direct correlation between these price increases and similar increases in profits. The building materials and metal fabrications sectors, for example, registered among the lowest in terms of operating profitability increases, despite a high percentage of price increases. 

In the midst of the recession, manufacturers knew raising the price of their products meant the risk of losing market share. It remains to be seen just how long manufacturers can offset rising costs with increased prices and still maintain sales. The supply chain is now worldwide, so global economic conditions may affect domestic pricing. There has been a shift in pricing power to the customer, therefore a focus on reducing costs will be a key priority for all companies for the foreseeable future. 

It can be difficult to maintain a stable level of profitability when a company needs to find 40 or 50 percent of its customer base each year. While new customer development is the same on a global basis (about 40 percent of total sales dollar volume for the previous year), there is a wide disparity between countries when it comes to customer retention. Japan leads in this area at 79 percent retention, closely followed by the United States at 75 percent. But China and Australia trail far behind at 57 percent each, and Mexico retains only about half of their customer base year to year.

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Economic headwinds

The U.S. economy is experiencing growth hovering around 2 percent. Manufacturers may, however, find themselves in a holding pattern before moving forward with some investments, as they await policy changes and other reforms to come out of Washington. Until then, manufacturers should not plan on infrastructure spending or other projected reforms by the government to help their businesses. The focus should be on making decisions for the business based on conditions that exist today, with a contingency plan for opportunities that federal and state spending may create tomorrow.

What this means for manufacturers 

Managing the margins
Too often the first margin improvement strategy is simply to increase prices. A refined margin improvement plan will also recognize that some products may require lower prices, whether for new sales channels or to differentiate them as “economy” versions of competitor offerings. Focusing on higher-margin products and reducing lower-margin products will drive overall profitability.  

Most manufacturers are also improving margins by addressing operational efficiency in offices, plants and supply chains via methods such as Lean and Six Sigma. It’s important to note that high-performing processes may require highly skilled individuals, but this is not a given; good process design can often offset issues with the skill level of the work force. Indeed, many middle market companies plateau because they outgrow their internal talent. Executives must make sure that employee recruitment and development practices keep pace with new growth in capabilities and sales, or risk losing profits.

Operational improvements should also enhance agility so an organization can rapidly respond to new competitors, changing economic conditions and emerging opportunities. Similarly, machinery manufacturers are expanding their profit potential via maintenance services. These fundamental changes in business models also require new talent—and new technologies.
 

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