2018 outlook on manufacturing

This year should be an exciting one for manufacturers. First, we must recognize the long-term trend where large corporations’ productivity gains have been outstripping mid and small-size manufacturing companies (500 employees and less). This year we expect those large manufacturers to continue celebrating those productivity gains. Smaller firms need to find ways to increase productivity without having to make additional capital expenditures.

With that said, 2018 brings risk for any manufacturer, no matter the size, predicated on four inputs that far outweigh any of the other costs within a typical manufacturing environment: 

●      Cost of Energy

●      Cost of Capital

●      Cost of Labor

●      Cost of Direct Materials

Cost of Energy

With a rising global economy there is higher demand for energy, and yet the unit cost of energy isn't necessarily going up, due primarily to pull back on restrictions that have led to a market glut. Alternative solutions continue to encroach upon the market, supported by tax incentives. All manufacturers and those in the supply chain want to keep a close eye on the regulatory political outlook around tax support.

From a political perspective, manufacturers should advocate for increased investment in the smart power grid, which can better insure against disruptions or black swan events. More efficient energy grids also protect against old infrastructure that cannot keep up with increased demand driven by a growing economy and cause potential brownouts. As such, it would be prudent to have continuity backup plans in place that also quantify what kind of investments are required that provide adequate backup and avoid interruptions, should infrastructure fail.

Cost of Capital

The cost of capital remains low, coupled with a 5-year decline in interest rates; however, 2018 shows signs of potential inflation. The recent corporate tax overhaul and its significant corporate tax reduction, including a 100 percent right-off for the year, raises the after-tax return on capital investment.

If the tax cuts create a more robust economy in the U.S., we may see more upward pressure on rates. When the cost of debt capital goes up so does the cost of equity capital and the tax reform has implications for those with huge debt to finance their capital base. Additionally, with inflation coming on and the Fed having to wind down its balance sheet, there will be rate increases like we saw in December. Expect two or three more rate increases this year.

Regardless of these trends, the cost of capital is a huge input for manufacturers that are capital intensive. For the mid-size and smaller manufacturers that are having trouble improving productivity, capital and not labor is the key driver. If these smaller firms can't get more output from previous capital investments they will need to make additional capital investments to meet their product demands. If not, it can be a major disadvantage.

Cost of Labor

The cost of labor far exceeds indirect costs for manufacturers, and, therefore, the key productivity factor is determining how to get more output per unit of input. Manufacturers need to invest in accounting and data systems that provide insight on exactly where costs are; which input costs are being affected, and specifically when looking at labor, how relatively small changes in labor productivity can lead to extensive gains in profitability and return on capital.

Companies focused on using lean disciplines, such as reducing machine cycle times to improve productivity are usually more successful. For example, one manufacturer Stellar worked with freed up nearly $14 million in work-in-process inventory investment, by speeding up throughput by lowering time between machines.

Cost of Direct Materials

New technologies have made the cost of entry for additive manufacturing much more affordable. This year additive should be a focus, especially for large companies that have millions of dollars in spare parts inventory and related costs from distribution centers required to ship the parts. Additive manufacturing can help reduce these expenses; and reduce the amount of capital required to scale up production without making major changes.

When talking about the global economy in 2018, the tax overhaul really makes a difference in the ability of U.S. companies to compete. Over the last 20 years we've seen companies from as large as Boeing to smaller local firms believing that they can purchase parts cheaper offshore, but this model brings inherent risks in supply chain disruptions that can negate any benefits.

Instead the new trend is multinational corporations like 3M accelerating regional manufacturing capabilities in sync with NAFTA markets. The more attractive the regional tax rates, the more attractive reshoring in the U.S. becomes. As manufacturing firms accelerate productivity gains by better understanding major cost inputs; and with the data and the accounting systems to provide better analytics, then they'll know where to go hunting for productivity.