The resurgence of UK manufacturing

News of the UK manufacturing sector’s death is greatly exaggerated. After output fell by 7.4 percent across the sector between November 2008 and November 2009 – the biggest year-on-year drop since June 1981 – the Purchasing Managers’ Index rose to 57.2 this March (any figure above 50 signals growth), ahead of expectation and proving the best monthly growth in 16 years. This prompted a re-examination of the facts on how important the sector is to the UK economy that has, until recent events, seemed to pivot on the City. While manufacturing has appeared in terminal decline against contenders such as China or India for the last decade, manufacturing still accounts for a large share of the economy, at about 12 percent.

This is a larger share than financial services’ nine percent, economist du jour Roger Bootle said in a column for the Daily Telegraph a fortnight after those statistics were released in April. People find this surprising because they do not come across many UK-manufactured products in their daily lives. But amid the fog rising from the wreckage of recession is the chatter about how to re-engineer the UK economy to produce sustainable growth in the way that, crisis fresh in the mind, the banking and financial services sectors do not appear to have done. And the concept of being a country that makes things of use and purpose may turn out to be more than a nostalgic backlash.

The story behind those November output figures is, in many ways, the usual recessionary tome: companies running down their inventories and hacking cost out of their production wherever possible. By the time the Office for National Statistics (ONS) released them, many plcs with a strong focus in manufacturing had already done everything that could be done and were, in effect, idling their motors, trying to make excess capacity as cost-free as possible while they waited for the upturn. The name of the game has been to try to coax new orders from hesitant customers, while trying not to allow cuts to impair the company’s ability to respond positively to any upturn.

So, perhaps it is precisely because many companies have done this that their economic prospects do not seem that black.

Addressing delegates on the theme of manufacturing confidence at an Economist Intelligence Unit briefing last December, Dick Olver, chairman of BAE Systems – the UK’s largest manufacturer – said that though times were tumultuous, characterised by massive uncertainty and plunging consumer confidence, he remained optimistic about the prospects for UK manufacturing as a whole.

It has been said for some years now that UK manufacturing is on its last legs, because, as Bootle points out, they do not see much of it about compared with TVs from Korea or cars from Japan. But in his speech, BAE’s Olver said that he believes the real competitive struggle in the years ahead lies in winning the ideas battle with clever economies, not in trying to pump up margins through wages arbitrage or shifting manufacturing capacity to countries offering cheaper labour such as China or India.

He noted that the wage arbitrage approach would end up with those economies having a stranglehold on manufacturing while they raced to out-design and out-engineer developed manufacturing nations. That is ultimately the road to ruin for UK manufacturing: put simply, the task for UK manufacturing is not about cornering the market, but in talent and intellectual property, he warned. That echoes sentiment elsewhere that outsourcing has had its day and that upskilling the UK workforce to compete is the next big thing.

That is a critical point, particularly from a finance director’s perspective. Beyond slicing away cost and waste from the production chain, FDs among major plcs must now set the foundation to obtain and retain appropriate technical talent and to leverage the intellectual property that talent generates more smartly, and quickly, than other nimble economies. The manufac­turing base accounts for nearly 15 percent of all employment in the UK, according to the Office for National Statistics and depending on which sector you look at, research and development (R&D) spending varies from between 2.8 percent of turnover – in electrical machinery and apparatus – to 23.2 percent of turnover in pharmaceuticals. R&D in transport, equipment and aerospace average at around six percent of turnover.

Gautam Dalal, head of diversified industrials at KPMG, believes there is a widespread awareness throughout UK manufacturing that a lot more needs to be done in the knowledge and skills arena, if UK companies are to build on recent gains. The government is committed to funding an additional 10,000 places in engineering and related skills in science and technology education – and this is vital, thinks Dalal.

“The UK needs a balanced economy. It cannot run just on services and you need top talent for this,” he says. “In addition, a successful manufacturing base has a multiplying effect; each pound spent in the sector equates to more pounds generated elsewhere in the economy than for any other sector.”

Room for manoeuvre
Dalal draws encouragement from the fact that, while manufacturers have cut their costs, in general, they have not hacked their sales forces to the bone. Historically, when British manufacturing boards cut costs, they sacked sales. But if you want to sell to the rest of the world, you need the expert sales force to get out there and sell for you. This takes languages, people skills and deep product knowledge and it takes companies a long time to build these up. “Companies are doing everything they can to keep their sales base together,” says Dalal.

One big plus in general for the UK is that a weak pound makes UK-manufactured goods vastly more competitive. However, Dalal points out that, while the exchange rate currently favours UK-based manufac­turers, there are many other factors determining whether or not you can take advantage of the favourable exchange rate.

One of the really big issues in manufacturing right now, Dalal thinks, is security of supply – another reason why FDs should not get too fixated on costs in isolation from other factors. The matrix between cost, quality and security of supply is becoming very important and a lot of lessons have been learned – some of them quite sharply through the global downturn – about the difficulties of using suppliers who are on the other side of the planet. Sourcing close to home is starting to look very good.

Of course, where exactly you consider home to be is a moot point for many UK companies. While headquartered in Greater London, Tomkins, one of the UK’s oldest manufacturing companies, does most of its £3bn revenue abroad. Most of its automotive and industrials business is in the US and the Far East, while its air conditioning manufacturing for the building sector is mostly in the US. Liz Lewzey, Tomkins’s vice president for planning and reporting – who reports to group FD John Zimmerman – says that its recent restructuring effort and cost-cutting has paid off, leaving the business ready for an upturn after seeing operating profit for 2009 fall by more than 35 percent.

Tough quotas
Any such green shoots are likely to be tempered by the brand-new pressure on manufacturing: the UK’s Carbon Reduction Commitment, which came into effect this spring and requires companies to reduce their emissions or pay hefty levies. But the flipside is that the green agenda has emerged as a potential saviour of the UK economy, providing manufacturers with the opportunity to cash in on a whole new market in cleaner types of energy.

Siemens UK chief executive Andreas Goss, who was previously its FD, points out that Siemens’s environmental portfolio already represents around a quarter of the company’s total product and services portfolio and is now worth approximately (euro)23bn worldwide. That portfolio includes a whole raft of products, from wind turbines to the components that will go into constructing the London Array offshore wind farm in the Outer Thames Estuary, scheduled to be the UKs first 1GW wind farm, capable of generating enough electricity to supply a quarter of Greater London homes. Siemens, notes Goss, is currently the leading supplier to both onshore and offshore wind farms in the UK, providing about 40 percent of the UK’s wind-generating capacity.

Manufacturing companies would do well to turn their hand to a wide range of industries and to focus R&D on the green agenda for steadier returns. Richard Lowery, FD at SMD, a growing designer and manufacturer of remotely-operated subsea vehicles (ROV) based in Tyne and Wear, owes its health to an ability to swiftly adapt to new market demands, which it learned from the dotcom crash.

At that time, Lowery explains, the company had a single product line in designing and assembling remotely operated subsea ploughs. These were in huge demand due to the race to lay undersea cables for the emerging global internet. But orders dried up once the crash hit and the venture capital-backed company was forced to apply its skills to a new niche market. It switched from being a bespoke manufacturer to running a production line of ROVs to order just in time for the next wave of the oil and gas boom, causing demand for its ROVs to soar.

“Now,” Lowery says, “the current build out of offshore wind farms is generating a fresh wave of orders for the company, since there is a great deal of subsea grid laying to be done with all this new, green power. Renewables are now a very big line for our company.”

Factory jobs
This trend is putting valuable jobs into those areas that were once a hub of manufacturing activity, but have since dwindled. In February, American wind turbine maker Clipper Windpower said it would build a factory to manufacture the world’s largest turbine blades in Newcastle, to furnish its proprietary 10MW Britannia wind turbine, which the company says will supply the annual electricity consumption of 6,500 households. The factory building the blades will be based in Tyneside, creating 500 direct jobs by 2020 and carrying the potential to create 2,500 more by way of the supply chain around it.

Renewable UK, the trade and professional body for the UK wind and marine renewables industries, heralds the news as the start of a regeneration of UK business from the emergence of the onshore and offshore wind supply chain.

“Wind energy presents a significant opportunity for the UK economy, leading to between 60,000 and 70,000 new jobs by 2012,” the trade body’s chief executive Maria McCaffery says. “Clipper’s pioneering example demonstrates that it is possible to attract investment on the back of a world-class research institution [and] co-ordinated action by a number of regional and central government agencies.”

Somerset-based Blackdown Horticultural, a subsidiary of FTSE-listed sustainable building products supplier Alumasc, is an example of a business that has sprung up entirely from the green agenda. Its product is a ‘greenroof’ for commercial buildings – a roof designed to hold a substrate in which plants can be grown. The business is getting a strong kickback from a return to confidence in the construction industry and it is selling off the back of the 2012 Olympics in London.

“Our order book has risen 26 percent since the turn of the year,” says Blackdown’s FD Neil Allan. “Greenroofs are increasingly being specified as part of new school developments due to the government’s continuing investment in its Building Schools for the Future programme. And as a business we are heavily involved with the green roof installations that will help the Olympics to be green.”

Allan adds that the greenroof industry is expected to grow in 2011. “Our challenge is to meet that demand, which is a nice challenge to have. This business is growing and whenever this is the case, working capital comes under pressure – particularly when the greenroof plant material takes 12 months to grow in our UK fields before the finished quality product can be sold,” he says. “Plus, government finances are a key concern for all businesses within the construction industry: how any new government manages and times the expected reduction in capital projects will be a key factor in maintaining the current increased confidence levels.”

The facts about where UK manufac­turing is now headed are plain. But it is perhaps the reputational impasse that is one of the biggest rivers to cross. A recent re-examination of the accepted wisdom about the sector in The Engineer magazine sums it up. “We may never return to the heavily industrialised Britain of the early 20th century,” said editor Jon Excell. “But there are plenty of signs that the skills and expertise on which the UK’s industrial reputation was founded may still have a major role to play.”

Manufacturing and the next government
Source: EEF
Finance directors in manufacturing companies are looking for support from the next government on the cost of research and development (R&D), the way energy use and emissions are taxed and how flexible working rules will affect the bottom line as they seek to get back on track. Examining the manifesto of the party widely believed to be the front runner, UK manufacturing lobby group EEF sees mixed fortunes in the Conservatives.

Taxation versus deficit
Steps to reduce corporation tax, simplify the complex tax system and boost the R &D tax credit are welcome. However, these have to be placed in the context of plans to reduce the deficit overall and include measures to reflect the true costs of modern machinery for capital intensive, high-value manufacturing.

Energy and emissions
Overdue plans to address the lack of gas storage and reforms to base energy taxation on emissions are welcome and will help encourage essential long-term investment in energy infrastructure.

Export support
The improved export performance of manufacturers is now clearly coming through and will be a critical factor in rebalancing the economy. Manufacturers will welcome a clear commitment to match the levels of export support
afforded to competitors.

Flexible working
Both the Conservatives and Labour have committed to extending the right to
request flexible working to more employees. Many employers recognise the business benefits of flexible working, but it creates costs and administrative burdens – and there is a limit to the amount of flexibility working that can be offered by any company.