Manufacturing trends to watch in 2019
INSIGHT ARTICLE |
United States manufacturing is forecast to grow faster than the general economy, with the MAPI Foundation predicting production to grow 3.9 percent by 2021.1 Companies in the middle market are investing in innovative technologies and are looking to set up operations overseas in their efforts to stay competitive and thriving.
But recent events are forcing manufacturers to make some difficult decisions regarding their future forecasts, supply chains and compensation, as well as their use of data and cybersecurity. Global growth is showing signs of moderating, with China and Europe expected to decelerate, according to Bloomberg. U.S. GDP growth will continue to increase in 2019, but at a slower pace than in 2018.
What can the industry expect in 2019? Following are five key issues worth watching:
Growth amid uncertainty
With real GDP growth for the third quarter of 2018 at 3.5 percent, and the Institute for Supply Management’s November PMI index at 59.3 (above 50 is considered positive sentiment), the U.S. economy remains relatively healthy. There are, however, some signs of concern: The JP Morgan Global PMI stood at 53.2 for the same period. Demand and expansion remains solid in the manufacturing sector and increases in government expenditures have driven growth in the aerospace and defense sectors.2 Nevertheless, the United States continues to outperform other countries with readings in the high 50s, and demand is likely to remain positive, according to Bloomberg.
Growth in top-line revenues has been a focus for most companies and many different strategies are being employed. Commodity prices are ticking upward due, in part, to increased demand but also to actual and proposed tariffs, and trade agreement modifications. Alternatively, the recent drop in oil prices should have a positive effect on manufacturers’ input costs.
Companies are continuing to leverage technology to identify sales and customer trends and help sales teams drive top-line growth. In addition, low-cost capital is enabling companies to acquire entities in an effort to expand product lines and geographic reach.
From this position of strength, middle market manufacturers should consider possible growth-restricting headwinds that may manifest in 2019. The Fed hiked interest rates four times in 2018 and there is talk of continuing increases in 2019, which will have an impact on the ability of some manufacturers to obtain financing. This could restrict growth potential for some as they plan their capital budgets and expenditures.
As strategic plans look for growth in offshore markets, manufacturers are looking at countries in Asia with a growing middle class, notably India and China, which, according to research by the Brookings Institute, will include the vast majority (88 percent) of the next billion people in the middle class. Due to rising costs in China, manufacturers are evaluating alternative locations for manufacturing expansion or sourcing. Higher interest rates and a strong U.S. dollar, however, could restrain the potential of growth in some emerging markets, where the economies are not as strong.
Amid the continuing signs of a strong manufacturing and industrial sector, there are signs of concern. Companies should consider how they will respond if the current long and positive economic cycle moves into negative territory.
According to the Bureau of Labor Statistics, manufacturing saw job gains rise 37% percent in 2018. By October, manufacturing had seen 296,000 job gains over the year, largely in durable goods industries. Manufacturing income and wages increased by nearly 5 percent in the previous 12 months, according to the Bureau of Economic Analysis. With such a tight labor market, this should not be surprising as manufacturers, constrained by labor shortages, are using a wide range of incentives and strategies to attract talent. In a NAM survey, 73 percent of manufacturers cited an inability to attract a quality workforce as their top challenge, which nearly 30 percent said has forced them to turn down new business opportunities.3
But the relationship between monthly private wage growth and the unemployment rate has been somewhat unstable. Since 2010, wage growth has been lagging behind improvements in employment, suggesting externalities (the development of the global supply chain and the current availability labor) or structural shifts such as the impact of automation on the availability of low-wage manufacturing employment were at work.
Coming out of the recession, wage growth was slow. That trend, however, has changed as wage growth, driven by a tight labor market, accelerates. To meet required production levels and attract or retain employees, manufacturers may find themselves paying even more for the labor they need. Average hourly earnings in manufacturing in the United States were just over $27 in October, according to the Bureau of Labor Statistics—up only 39 cents from the same period in 2017, but near an all-time high.
Manufacturers may also need to look in less-traditional talent pools to find the employees they need to perform analysis and operate high-tech machinery. As people are increasingly interacting with machines, human-centered design skills are needed to bring an understanding of building efficient interactions between people and technology. In fact, according to an RSM survey on digital transformation, most of the top skills sought by manufacturers are for technology, analytical and data roles. An equal priority needs to be applied to the development of retention plans that keep the best employees engaged and leading the digital transformation of the industry. Many companies are so focused on recruitments efforts that they are not focused on retention and advancement of their current team, or staying connected to former employees who might boomerang back in the future.
Manufacturers should expect both wage increases and job openings to continue into 2019, boosting their overhead and squeezing profit margins. Every incremental cost increase can have a material impact on profitability, so manufacturers will need to continue to evaluate the value of labor and to reposition their focus to create the most positive output for each dollar spent. We also expect a continued focus on all costs throughout the supply chain to offset increasing costs of retaining, attracting and training a company’s workforce.
Although manufacturers understand the necessity of digital transformation, some are not prepared to take on such a large-scale change, according to the 2018 RSM digital transformation survey. Internal bias favors familiar, lower-tech systems and processes, and a general lack of understanding of customer needs also may be preventing digital investments. Per the survey, a slight majority have increased digital investments at a rate of 1-to-10 percent over the past three years, a trend that is expected to accelerate over the next three years. Researchers at Morgan Stanley see manufacturers accounting for the lion’s share of incremental IT investment through 2022.4
The technology behind advanced analytics—otherwise known as big data—enables companies to leverage large amounts of useful information that otherwise might be discarded or ignored because there was simply too much data to examine effectively. By bringing together what are often disparate platforms and software, manufacturers are able to analyze customer trends, guide product development, customize products more easily, monitor the status of products down to their individual components, capture information to improve processes and reduce the time it takes to get a product to market.
But technology has its own set of risks. Overall, there has been a 160 percent increase in breaches at midsize businesses since 2015. Manufacturers have long known that their industry is among the top five targets for hackers and unauthorized access worldwide. Yet as late as 2017, Cisco reported that 40 percent of manufacturing security professionals do not have a formal security strategy, nor do they follow standardized information security policy practices. Manufacturers must strengthen their security procedures if they want to stay competitive, let alone secure.
Other key technology elements—including data analytics, internet of things connectivity, enterprise resource planning systems, data hosting and collaboration with customers—have been and remain important. Clearly, technology is transforming and disrupting the manufacturing space at the same time. Manufacturers need to focus on how technology is changing their business in order to be prepared for future changes, whatever they may be.
Tariffs, trade and global tensions
NAFTA modernization represents something of a mixed bag for middle market businesses. While the new United States-Mexico-Canada Agreement includes requirements for improved labor practices, environmental policies, facilitation of digital trade, among other improvements, it also increase rules of origin and wage production thresholds for auto manufacturers; steel and aluminum tariffs were also retained. These factors could contribute to increased prices for end-users.
Some large manufacturers report that tariffs present a significant challenge to global sourcing. Many companies have established their global supply chains over many years, and establishing new supply chains that are not affected by the tariffs may be costly, difficult and time-consuming. Manufacturers are considering moving goods from China through Europe, Canada and other locations where logistics might be more difficult, but tariffs are lower. This may be problematic, as there are no trade agreements with parts of Asia or Europe, and it remains to be seen how trade with the United Kingdom will fare after its assumed exit from the European Union.
Some companies are applying for tariff exemptions; others are evaluating alternative products or vendors in other countries, or bringing some work back to the United States. For some, the best approach is simply to increase prices. According to the National Association of Manufacturers, nearly one-third of manufacturers surveyed by NAM anticipate increases in product prices of 5 percent or more. This is the fastest growth rate for prices since the second quarter of 2011.5
In the fall, NAM released a statement noting that “more U.S. tariffs and Chinese retaliation risk undoing that progress and moving our economy in the wrong direction.”6 Initially, it was noted that some companies were accelerating purchases in advance of the tariffs. We have also seen prices for U.S. products that compete with China imports rising due to increased demand for U.S.-produced goods.
Generally, uncertainty is complicating how companies deal with the trade issues. There may be periods during this trade dispute when buyers will not know what tariff rates will apply when their goods are received in the United States.
Management executives at companies across the country in the industrial space crave certainty so they can plan their business. The current disputes with China extend beyond just pricing; protection of intellectual property is perhaps the most pressing issue. When those issues will be resolved is uncertain. Until the rules are finalized and approved, companies must be nimble and try to stay ahead of price changes on products they produce as well as on prices of goods they sell. Leveraging technology for data analytics can be a significant but necessary exercise.
Transportation and logistics costs are among the primary business challenges for manufacturers, according to NAM. Coupled with the rising value of the U.S. dollar, these costs account in part for the anticipated downturn in exports, which manufacturers expect to increase by 0.8 percent over the next 12 month, the slowest pace since the fourth quarter of 2016.7
Further, tight trucking capacity and West Coast container volume drove up rail traffic originating in North America in November 2018, ahead of the next anticipated round of tariffs.8 Although the Jan. 1, 2019, increase in tariffs was postponed, tariffs are likely to significantly dampen import volume growth in 2019,9 as the list of imports affected by tariffs—assuming they are implemented—includes some of the biggest items by volume for container trade, including furniture, clothing, toys, footwear and televisions.
Driver availability will remain one of the biggest challenges facing the North American trucking industry in 2019, according to Bloomberg. A shortage of drivers should keep truck-utilization rates elevated into 2019, especially given a low unemployment environment. FTR, the freight transportation intelligence service, estimates utilization rates will average 96.1 percent in 2019, well above the 20-year 93 percent average. The tighter market should provide truckers with some pricing power and could result in contractual truckload rates rising in the mid-single digits in 2019; this is on top of the robust pricing of 2018.
Logistics are also significantly affected by overall consumer and business online buying, with e-commerce growth expecting to outpace the global economy by five or six times, according to Bloomberg. Manufacturers are not immune to the “Amazon Effect”—the expectation by customers of the rapid delivery of products—and this increased demand to move consumer goods is creating constraints in the industrial space. We expect this pressure to continue into 2019; autonomous vehicles may someday permeate the logistics industry, but that solution is years off.
1“Full Recovery in Sight: U.S. Manufacturing Predicted to Regain All Output Lost in the Great Recession by April 2019” (March 22, 2018) MAPI Foundation.
2“Analyzing the Global Aerospace and Defense Industry 2018” Research and Markets.
3Manufacturers’ Outlook Survey, Third Quarter (Oct. 5, 2018) National Association of Manufacturers.
4“Tech’s next big wave: Manufacturing” (July 31, 2018) Morgan Stanley.
5Manufacturers’ Outlook Survey, Third Quarter (Oct. 5, 2018).
6Shapiro, M. “NAM Statement on Announcement of Additional China Tariffs” (Sept. 17, 2018) National Association of Manufacturers.
7NAM Manufacturers’ Outlook Survey: Third Quarter 2018 (Oct. 5, 2018).
8Klaskow, L., Roszkowski, A. “Railroad traffic – Week 45, 2018” (Nov. 14, 2018) Bloomberg.
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