Manufacturing Midyear Outlook: Manufacturers Show Their Resilience
- midyear update
With the vaccine rollout in full swing and a new stimulus package in place, there are plenty of growth opportunities in the manufacturing industry. Despite suffering significant revenue decreases in spring 2020, the industry demonstrated its resilience and creativity.
While the industry faces some significant challenges in both the near and long terms, certain macroeconomic conditions continue to work in their favor, which bodes well for manufacturers through the rest of 2021.
A Disciplined Approach
We saw many manufacturers demonstrate flexibility and innovation in response to the pandemic, allowing them to come into 2021 either with new product lines or new ways of doing business.
A lot of manufacturers also became more fiscally responsible during the pandemic by implementing expense controls. As you’d expect, companies were able to significantly slash their travel and entertainment expenses. Virtual sales meetings, product demonstrations and plant tours turned out to be effective, and I wouldn't be surprised to see many companies continue to sustain their cost discipline compared to pre-pandemic levels.
Furthermore, as more of the country starts to reopen, that should unleash the pent-up demand that’s been building. The combination of expense controls and a rebound in demand should translate into higher gross margins through the rest of 2021. Some of those expense controls, however, will be offset by rising raw material prices and labor costs.
On the downside, several factors are contributing to the disconnect between supply and demand. Whether it’s the situation in the Suez Canal earlier this year, delays at various ports or simply the availability of the raw materials, supply chain delays have been a huge headwind for the industry. It’s causing raw material prices to rise, and many companies have had to implement allocation mechanisms. That combination can create a continuous spiral because when companies are on allocation, they're going to order more than they need, which causes more material shortages leading to inflated prices. We do expect the resulting spike on raw material costs to come down when the supply catches up.
Supply chain issues have led other industries, such as food production and distribution, to reduce the number of SKUs they offer. We’re seeing a similar dynamic in the manufacturing sector with companies implementing the 80-20 rule. That is, if 80% of a company's profits are coming from 20% of its customers, they focused more on that 20%.
On the upside, we’re seeing more price transparency in raw materials. With raw material prices going up, companies have a couple of options. Increase pricing, which will lead customers to demand a decrease in what they pay when material prices come down. Or companies can increase their base prices while including a surcharge to cover the increased raw material prices. That way, when raw material prices come down, companies can get rid of the surcharge while still enhancing long-term profitability with the higher base prices.
In this context, we’re seeing some supplier-customer relationships grow stronger and more trustworthy. What you do now with your clients could define those relationships over the foreseeable future. These are “moments of truth.”
More and more companies are exploring alternative supply chains. Some are considering onshoring their supply chain because they can't afford to have materials sitting in the ocean for 60 days or more. Some are considering alternative countries for supply sources, such as Vietnam and India. Manufacturers realize they need to diversify their supply chains.
The current labor shortage also limits how much a company can produce. Manufacturers are having a tough time finding workers, so they’re deploying the employees they do have to focus on serving their most valued customers. They have also had to get more creative to attract talent. We're seeing some companies offer to pay for employees’ education and paying out signing and production bonuses in addition to increasing base salaries.
Labor will likely continue to be a challenge, which is why manufacturers are looking for ways to innovate using automation. But even this leads to supply chain issues—there's a six-to-nine-month backlog in the equipment needed for automation.
Legislation is the wild card. Another stimulus package could be a boon to manufacturers. On the other hand, too much stimulus money in the system could lead to inflation.
On the mergers and acquisitions front, there's a lot of money sitting on the sidelines. Many manufacturers, private equity firms and family offices are sitting on a ton of cash. For reference, based on our conversations with some of our clients, utilizations have come down 10% to 15% compared to pre-pandemic levels, and companies are looking to do something with all the cash they have on hand.
M&A, generally speaking, falls into two categories. The fixer-upper company, which can be acquired for a good deal, but that type of transaction is not for the weak of heart; and the strong-performing company, which comes with a higher multiple than it would have a few years ago.
We’ll probably see a few cases this year in which companies will overpay for an acquisition. That’s partly because we’re seeing manufacturers considering M&A as a way to acquire talent. Some manufacturers will rationalize overpaying for an acquisition with the theory that you can’t put a value on talent.
Preparing for 2022
Manufacturers have plenty to prepare for through the rest of 2021 and heading into 2022. Addressing supply chain issues will be critical. Adjusting pricing strategies will be a key to long-term profitability. Recruiting new talent while taking care of their key employees is essential as competition for labor will likely continue to be intense. Finally, it’s important for manufacturers to continue the discipline they exhibited during the pandemic and look for greater efficiencies to maintain efficient cost structures.
Overall, we’re bullish on the manufacturing industry. The macroeconomic conditions are favorable, pent-up demand is strong and firms are continuing to exhibit the creativity and agility they showed in 2020.
Market Executive, Head of Diversified Industries Group - Wisconsin
Jeff Ticknor is a Senior Vice President and Group Managing Director of Wisconsin Commercial Banking. This group primarily focuses on the banking n...(..)View Full Profile >
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