U.S. innovation drives manufacturing’s charge
By any standard, 2013 was a big rebound year for manufacturing, and the momentum continues into 2014.
Kurek: Through our annual McGladrey Monitor survey, we’ve seen continuity in the factors that contributed to the economic rebound for the industry.
Certainly, there is a striking correlation between exports and a company’s health. More companies are operating in the global marketplace and, as we’ve noted before, overseas sales are recognized by thriving companies as a key driver for growth. Companies that have expanded their customer bases outside the United States tend to have better financial performance.
Low interest rates have given manufacturers greater access to capital, allowing for more investments in their companies. The key here is that those investments have included new or upgraded information technology, enabling companies to develop innovative products, decrease cycle time, and increase productivity.
Because manufacturing is such a broad category, some sectors have fared better than others because manufacturers in those sectors have been able to capitalize on changes in the economy. Food and beverage manufacturers, for example, have seen regular, steady growth through new product innovation, which is driven by changing demographics and consumer tastes. Growth in building materials can be attributed to the encouraging numbers that are being reporting in new home sales and permits.
Greater access to natural gas is lowering energy costs for production in sectors such as chemical and metal manufacturers. As the unconventional oil and natural gas sector expands, those involved in this supply chain—such as the makers of equipment used in hydraulic fracturing—are seeing a big increase in employment. Additionally, lower energy costs have had a broad, positive impact across sectors.
However, it should be noted that growth in some sectors was tempered, especially if they were involved in the supply chains of large equipment manufacturers such as Caterpillar, where equipment sales were down in 2013.
PE: Factors such as quality, safety, energy management, and logistics seem to have been key differentiators between the U.S. manufacturing market and those in still-developing economies. Is that gap closing, and how do U.S. manufacturers retain that competitive edge?
Kurek: A key differentiator for U.S. manufacturers continues to be their ability to drive innovation in their product development and process improvement activities. For example, more companies are using additive manufacturing, commonly referred to as 3D printing, to go beyond developing prototypes to producing component parts. Nike is already doing this for some of its shoes; others are using 3D printing to reduce the weight while increasing the durability of components incorporated into aircraft.
When reviewing their total cost of ownership, manufacturers are bringing production back to or near the U.S. This “onshoring” or “nearshoring” has a number of advantages that can help keep U.S. companies competitive. Certainly, it reduces the costs of shipping when you move your operations closer to home from an offshore location.
Nearshoring reduces the risks associated with the supply chain, intellectual property, and regulatory compliance, and it allows for greater control over inventory and product quality. As overseas workforce costs have risen, the argument for moving operations offshore is less compelling than it once was.
In fact, demands for reduced cycle times provide an incentive for nearshoring or onshoring. Working in physical proximity with suppliers also allows for greater efficiencies and collaboration among coworkers.
There are a number of manufacturers who are bringing operations back to the U.S. Caterpillar is bringing production of its hydraulic excavators to Texas and Georgia from Japan; GE is making waer heaters in Kentucky rather than China; Whirlpool found it made more sense to produce appliances in an existing factory in Ohio rather than build a new one in China; Bailey International will produce its hydraulic cylinders in Tennessee rather than India. This trend is seen in smaller, mid-size companies as well. These companies are finding that customers are not only willing to pay more for high precision and quality, but they prefer to buy products made in the U.S. Some states are also providing incentives that make moving back to the U.S. more attractive to companies.
PE: One thing we heard from manufacturers throughout the year was: “We’re worried about the global economy and the U.S. economy and what Congress might do… but we’ve never been busier.” Is there a disconnect between the actual strength of American manufacturing and its perceived strength?
Kurek: Certainly manufacturers and distributors are mostly optimistic about 2014. There are a number of good reasons for this optimism. The National Association for Business Economics forecasts about 1.1 million new home starts for 2014. Job creation at small companies almost doubled in the first half of 2013.
The U.S. trade deficit is falling and exporting is up sharply. The Purchasing Managers Index has rebounded up to 57.0 as of December 2013.
Yet there are still a number of challenges. Manufacturers continue to have difficulty finding qualified employees. Material and component prices remain volatile. In a global marketplace, emerging foreign competition is a growing strategic factor.
Of primary concern to manufacturers, however, are government regulations. Right now, it is 20% more expensive to manufacture products in the United States as compared to our largest trading partners. Corporate tax rates, employee benefits, and environmental regulations contribute to this gap.
Executives still feel that legislative issues are dragging down businesses in general and they want more clarity. There are too many unknowns dealing with the U.S. economy and a lack of decision-making from the government is slowing down the growth process as companies do not understand the effect of tax reform (if any), the implementation of the Affordable Care Act, and government spending.
PE: The big, dark cloud on the horizon appears to be health care costs. Can this one issue alone wreck the economic rebound, or are we going through an adjustment period as to how such benefits are going to be paid and administered?
Kurek: Certainly no single issue will wreck the economic rebound. But as we’ve seen in the McGladrey Monitor survey, most companies expect health care costs to rise 10% on average; 1-in-10 anticipate a rise of 20%.
Conversely, some of the participants in the focus groups we conducted, as well as some survey participants, did not expect costs to increase more than 5%. They felt that their providers would not want them shopping in anticipation of the assumed increases due to the ACA. Obviously, with the extension of deadlines, all of this has yet to play out.
In anticipation of the higher costs associated with the Affordable Care Act, some have taken a more proactive approach to health by implementing wellness programs, thereby saving money as well as giving employees a better perspective on the costs involved in health care. For those using this approach, it was found to be very effective in reducing or at least limiting cost increases.
Others are shifting more of the cost burden onto employees, moving to defined plans, or offering health savings or flexible spending plans to employees who are willing to reduce withholding while taking on more risk.
PE: Some of your respondents said that the manufacturing rebound wasn’t as big as they had hoped. Is consistent 4% growth in manufacturing more practical than big gains and then small dips?
Kurek: It’s getting harder to achieve the kind of growth that could be described as flourishing. Some felt that the anticipated economic bounce-back was not as robust as they had hoped, but this disappointment may have been more the result of wishful thinking rather than in-depth analysis.
In the U.S., we have been achieving slow-but-steady growth. Since the end of the recession, the gross domestic product has been rising about 2% per year. In 2011 and 2012, U.S. manufacturing made up a big part of that GDP growth rate. In the beginning of 2013, this slowed down a bit. The number of thriving companies identified in the McGladrey Monitor fell to 32%, down from 39% in 2012; the Purchasing Managers Index hovered around 51%. By the end of the year, however, the PMI bounced back to nearly 57%, indicating a slow but growing rate of change.
But the executives we’ve spoken to note that their success was achieved through cost cutting and operational efficiencies as much as through business growth. Some of their initiatives include investing in continuous improvement efforts; implementing new information technology applications and systems; diversifying product lines; opening up fresh markets and distribution channels; and making new acquisitions.
Some sectors have done better than others. Building materials companies experienced growth due to rising new home sales and permits as well as increases in home prices. Food and beverage manufacturers are thriving due to growing consumer confidence and more discretionary spending being directed towards dining. The biotech, life sciences, and medical equipment and supplies sector has also been performing well.
But the current economic situation—improving, but slowly—makes it difficult to sustain any optimism executives may have felt about business conditions; not impossible but difficult. This has put some company budgets on hold.
PE: What one thing can manufacturers do in 2014 to sustain their own growth?
Kurek: Management should focus less on congressional gridlock and more on investing in their companies. No one thing is going to work for every company, so each company will have to choose which of the following will work best for them. As we’ve seen over the years in the McGladrey Monitor, successful companies are investing in their futures and are more likely to regularly put a percentage of revenue in a number of areas:
Drive value in client and vendor relationships, including expanding globally. Overseas sales are recognized by thriving companies as a key driver for growth. In addition, strategic sourcing practices allow businesses to manage their vendor relationships by measuring and tracking their procurement delivery and costs.
Introduce new products or product lines; in other words, it’s all about innovation. Invest in process-improvement initiatives. Nearly 87% of organizations with an advanced culture of continuous improvement are thriving.
Invest in new or upgraded information technologies. Management can invest in software to gain access to corporate performance information that they can translate into actionable plans, thereby giving them a competitive advantage over their competitors.
Invest in workforce training. Training the workforce to operate increasingly sophisticated technology helps close the skills gap and increase productivity.
Finally, benchmark yourself against your competitors. Comparing your company to industry peers across the country and, indeed, around the world can be a great way to check your progress as well as to gather best practices.