Twelve months ago, the biggest concern manufacturing businesses had was high inflation. Today, it is weakening demand caused by central banks successively increasing base rates to keep inflation down.
With interest rates at a 15-year high, demand weakening, labour markets running hot, and energy costs high, manufacturers are, understandably, worried about declining productivity and how to keep investing for growth. If manufacturing growth slows whilst inflation remains high, stagflation becomes more likely, and so too does the prospect of recession. But with a little resilience planning, manufacturers can successfully navigate these challenging times.
The manufacturing industry relies on high capital investment for growth, which over the past few decades has been fuelled by cheap borrowing, with interest rates at just 0.25%. Now, base rates have risen to 5.25%, making it harder to justify the high cost of borrowing needed to remain innovative and fuel growth.
Invariably, there are signs that manufacturers are starting to postpone or cancel investments for the future. But these challenging times are not unprecedented. In 1988, the base rate was almost 15%, and just before the great financial crisis of 2007-08, it was 5.5%. Now, manufacturers need to plan for base rates to remain somewhere between 2-4% in the longer term. SMEs have overcome similarly tumultuous times before, and can do so again.
The three pillars of resilience
To adapt to this increasingly volatile and uncertain environment, businesses need to build financial, operational and leadership resilience.
Financial resilience enables companies to withstand events which will affect capital, liquidity, revenues and assets. Access to cash and capital is critical. Many companies find cash gets tied up in very elongated supply chain cycles, so stock can be held for six months before receiving an order. If supplying a very large company, the manufacturer can wait another 90 to 120 days, some up to 250 days, before being paid.
So, what cash strategies can help? One approach might be adopt a policy to protect six months’ wages. Another is to protect against a rise in core operational costs by shifting the company’s dependency on fixed costs towards variable costs, i.e. costs that change as sales volumes rise and fall. This creates a nimble, adaptable business.
Building operational resilience relies on using four elements – suppliers, people, technology and strategy – to help a company pivot when needed. During the pandemic, several businesses pivoted to produce hand sanitisation units, respirators or PPE. One manufacturer of gym lockers pivoted and, within four months, began making coffins. Today, it is one of the largest suppliers of wooden coffins in the country. Not all businesses can pivot so quickly because their supply chains are hard-wired, inflexible and intertwined. For them, flexibility can be created by having multiple product lines, being less reliant on fixed costs and buying plant and machinery which is multipurpose or multifunctional. When investing in plant and machinery, manufacturers typically focus only on their current product lines because it is less costly than ‘buying’ flexibility. Manufacturers may require a new mindset when they are planning for change. Spending a little more and utilising financing options strategically would increase the company’s ability to adapt.
The supply chain is another potential source of resilience. During the pandemic, the fragility of the supply chain was one of the biggest shocks for manufacturers. It highlighted the importance of identifying supplier vulnerabilities, and finding alternative partners for all critical inputs into the business. If all goods are typically distributed by boat, some deliveries could be made by air freight to move products out the factory door and cash into the bank faster. All these changes create an operating model which can quickly be scaled up and down when needed.
Creating resilience is also about creating a workforce with the skills to pivot with the company when required. Often, workers on production lines only operate one particular machine or understand one small part of the production process, such as quality control. The most successful businesses tend to rotate the workforce to increase their skills and understanding, readying them to adapt quickly if and when the firm needs to change direction.
Leadership and personal resilience are common skills to most SMEs, as demonstrated by their desire to start up, scale up and stay ahead in business. To strengthen their business resilience, they also need vision and the ability to learn quickly from setbacks.
A compelling vision of the future, communicated well internally, will enthuse employees by explaining what and how the business is trying to achieve and their role in delivering that vision. Manufacturing timelines are long. A decision made today can take many years to have an impact, but if there are setbacks, the experience can help to build a more resilient company in the future. The most resilient manufacturers deliberately keep short-term and medium-term actions aligned with their long-term vision.
Managing working capital and cash flow
Managing working capital and cash flow should be an ongoing process, especially during challenging times. Revenues will always be at risk, but knowing your customers and making it hard for them to leave reduces that risk. Understanding a customer’s financials, cash flow, and pain points can help to improve customer service and ensure your business is not a pain point in its own supply chain.
Minimising discretionary spending is a must, but is not the same for every business. A well-established company could potentially afford to cut its advertising budget, but for a new business establishing its name, the exposure and visibility that advertising provides might be keeping it afloat.
Stock control is often a hidden source of cash flow and working capital. Many manufacturers hold stock to meet future demand, but it consumes cash. If just-in-time manufacturing does not suit the business, an accurate sales forecast can help reduce inventory from 12 to six months and release cash into the business.
Reviewing payment terms with clients and suppliers can also increase working capital. One manufacturer traditionally paid all its suppliers within 20 days, whatever the agreement terms, almost as a gesture of honour and nobility. But, it didn’t receive any tangible benefits for doing so, and instead, switching to paying suppliers on time enabled the owner to eliminate his overdraft and earn interest on the surplus cash in the bank.
Underpinning all resilience building is scenario planning. The goal for any business should be to try and turn uncertainty into a manageable risk which can be modelled and mitigated – something banks are very good at doing. Scenario planning isn’t about predicting the future; it’s about preparing for it, by asking all the ‘what-if’ questions.
For example, what if the business lost a key client, material supplier, or member of staff, or there was a significant rise in the cost of borrowing? Having identified the business risks, their impact can be quantified as, for example, a 20% loss of revenues, a 10% loss of profits, or salary costs doubling after losing skilled staff. Mitigating actions such as diversifying the customer base can then be identified. Any such actions need to be carefully thought through and interlinked.
For example, diversifying a customer base may require finding new suppliers because existing suppliers don’t have sufficient capacity. If a clearly defined set of actions is executed, the business should be able to navigate through difficult times successfully.
As part of scenario planning, every business should also consider the impact of megatrends, which will affect us all for the next 50 years. By 2050, for instance, over one in four people will be over the age of 60, drastically changing the demographic of the future workforce. Economic cycles mean manufacturers can expect to face falling demand for their products as more competitors enter their market and undercut prices.
Scheduled events in the business environment are often overlooked when planning. The change in base interest rates was not anticipated by many, for example. If Labour wins the next election, tax breaks, capital allowances or VAT rules could all change.
Even if the Conservatives hang on, change is inevitable. No business can plan for every eventuality, but it can focus on the most critical uncertainties. For example, the Ukraine war pushed up the price of grain, which impacted wholesalers of seeds and pulses but was immaterial to a manufacturer of storage boxes.
Keep investing for growth
Although we are in turbulent times, manufacturers need to keep investing for growth, no matter how small the investment. For most manufacturers, marginal gains add up. Investing in digitisation or automation and upskilling the workforce will increase the company’s innovation capacity, which, in the long term, is the only real source of competitive advantage.
To drive that investment, engage with a bank early, long before it’s needed. No bank likes to be in a position where a business is saying, ‘I can’t pay my suppliers or my staff tomorrow; help me.’ That’s a difficult place for everyone. Use them instead to help plan and build business resilience. Agility is key to survival and success. However, stability and resilience are the hallmarks of sustained high performance.
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About the author
Gareth Anderson, Head of Business Management at Allica Bank
An experienced corporate and commercial banker, Gareth has spent 17 years working in banking and financial services, with much of that time spent working closely with SME’s both as a Relationship Director and in various leadership roles across client facing and product teams.
Having spent years working with companies across sectors from manufacturing, retail & wholesale, technology and healthcare, Gareth’s passion is on supporting the plans and financial ambitions of SME business owners, helping them build resilience into their business models to navigate through times of uncertainty.