Is the UK manufacturing renaissance for real?

Richard Hill, national head of Automotive and Manufacturing at RBS provides a forecast on UK macro issues and explores the key challenges facing UK manufactures in 2015 and beyond.

The UK manufacturing sector has been lucky – and its biggest piece of luck is that it is in the UK. Having demonstrated the strongest, broad-based economic recovery in the EU, coupled with robust government support for high value manufacturing, the UK is now exhibiting the kind of confidence and growth not seen in this sector for some time.

According to Neil Parker, senior economist at RBS, the economic setting for manufacturing will remain strongly positive through 2015. While RBS expects that interest rates will rise perhaps as early as February next year, most companies have priced those rises in to their investment plans, and the expectation is for a gradual return to normal. Inflation is low, job creation is up, and companies are slowly rebuilding their capital expenditure.

Europe needs a new solution

Europe, our main manufacturing trading partner, has not fared nearly as well, and it now appears that the European Central Bank is moving towards the kind of unconventional monetary policy that has worked elsewhere. RBS expects that anything up to E3.5 trillion of ‘quantitative easing’ liquidity could be pumped into European markets, and that means that next year is likely to see the beginning of a demand revival in Europe. In 2014 manufacturing output growth has been driven by domestic UK demand, suffering from a lower than usual demand for exports in Europe.

In emerging markets, RBS forecasts are also positive for the near future. Chinese growth is likely to pick up back to around 8% in 2015, after a weaker 2014. India is also set for revival. After a period when confidence, the currency and the Indian stockmarket all fell markedly, the new government of Narendra Modi seems set to enact business reforms that are sorely needed. RBS expects Indian growth to head towards 7% in 2015, as domestic demand and corporate investment recover.

Overall the key indicators point to a slow but sure recovery in activity and demand from both developed and emerging markets. Manufacturers need to look not only to new markets but also to new business models in order to increase total turnover.  It is a good time to be a strong, innovative manufacturer. But just how strong and how innovative are Britain’s manufacturers?

Technology is the key

Today the issue for companies that want to succeed in high-value, high-margin manufacturing businesses is how to continually innovate their products and processes, and how to finance that innovation. Innovation is the only way that manufacturers can prevent their products from becoming obsolete, it is the only way to defend markets against low-cost competitors, and it is the only way they can command the kind of premiums that make developed world manufacturing profitable.  Across the sector businesses are being transformed by a new generation of technology applications. These include new materials, low carbon processes and propulsion technologies, ‘additive manufacturing’ techniques facilitated by the emerging 3D printing technologies, nanotechnology applications, and the application of ‘Big Data’ analysis to manufacturing and wider business processes. These technologies are building what looks like the factory of the future – only they are building it today.

UK companies are at the forefront of many of these developments, with technology leaders like Sandwell UK in automation (a business that will be worth £200bn worldwide next year), Johnson Matthey in fuel cell and low carbon propulsion, and a host of small development manufacturers working in nanotechnology including applications for the UK-discovered ultra-thin material graphene. But is UK manufacturing investing enough to stay competitive in these fast-evolving sectors?

Investment still lags competitors but solutions are emerging

The current figures suggest that the UK still has a manufacturing investment deficit compared to direct competitors. According to the latest report from EEF and Lombard Asset Finance, capital expenditure as a proportion of UK GDP is still five percentage points below the OECD average of 18%.

If we take for instance the auto sector, for many mid-sized and small component manufacturers the issue is financing, and specifically financing of tooling. Tooling means investing in unique process components that are typically high cost – a single tooling component can range from £30,000 to in excess of £1m to produce. The investment has to be financed upfront, yet it may take more than a year before it produces revenue. In the past lenders have been unwilling to finance such investments due to the unusual ownership structure.

Typically the supplier is expected to fund new tooling components specified by manufacturers, however the tooling and intellectual property is ultimately owned by the car manufacturer – making tangible security for any loan difficult. However, thanks to a deep understanding of the process, RBS has developed a solution – the recently launched bespoke tooling finance proposition.  The proposition utilises the bank’s trade finance expertise and specifically a trade loan structure. The trade finance team will tailor the loan based on the schedule, contract and various stages of the tooling manufacturing process. The team will monitor and control the loan at every stage of the tooling manufacturing process – paying the tooling manufacturer as necessary at key stages, on behalf of the bank’s customer.

Time for lenders to get real

Investment in advanced manufacturing can only be achieved if there is a better understanding of the manufacturing chain from design to final production. Raising awareness means getting out into the real world: it may include joining bodies like the government-industry UK Automotive Council, which supports design, R&D, manufacturing and skills, at which RBS has a seat, but it should also include special initiatives like the ‘immersion day’ meetings recently originated by RBS that allow banking staff, including both customer relationship managers and credit analysts to meet manufacturers on their own ground. Such initiatives help RBS to gain deep insight into exactly how the manufacturing chain works in order to devise new solutions to satisfy what are often complex and long-term financing needs. Banking partners need to understand more than just pure finance; to work effectively with industry; they need to understand industries, policy and processes if they are to meet the financing needs of manufacturing.

The other challenge that UK manufacturers must solve is that of increasing exports, and most likely that means exports to the regions of the world that are growing fastest. The pattern of growth in emerging economies has changed: yesterday it was about rapid industrialisation based on low wages, cheap currencies, and massive inward investment by companies keen to take advantage of the low-cost location. Today it is about the growth of the middle classes – in China, in India, and Africa too – and their demand for luxury goods and sophisticated manufactured goods, largely from Western manufacturers.

Exporting is good for growth

The UK’s larger manufacturers like carmakers understand this. But medium-sized companies (those with a turnover of £10m to £100m) have yet to catch up. For these companies the EU remains the focus of export efforts if they export at all. According to the UK’s Department of Business, Innovation & Skills, only 17% of mid-sized UK businesses generate any sales outside of the EU (for comparison, the figure for Italy is almost double that).

These businesses are cautious about the risks of exporting, and mainly by the risks of not getting paid by trade partners. Figures from the UKTI show that ‘new market’ risks are a deciding factor for 63% of companies already exporting, but the same study shows that companies that do bite the bullet and enter new markets become more productive in their first year (by up to 34%), and that exporting typically ends up driving greater levels of year-on-year growth.

Service is the new paradigm

However, export markets are highly competitive; and success can only come from having the right business model and the right process structures at home. For many businesses this will mean embracing new service models, and rebuilding the integrated supply chain that many neglected in the rush to exploit low-cost manufacturing abroad.

The business benefits of servitisation in manufacturing include a move to a long-term predictable revenue model, a reduction in operational costs, thanks to a stable customer base, and lower inventory costs. A recent study by Aston University suggested the cost savings might be as much as 30% for a company that switches from a product-centred business model to a customer-centred service model.

Servitisation also makes the re-shoring of manufacturing operations close to the customer more compelling. It is compelling for other reasons too: UK manufacturers are waking up to the fact that there are powerful competitive advantages in rebuilding their supply chains close to home, often in collaborative ‘clusters’. This is particularly apparent in the UK auto industry, where an ecosystem of designers, component suppliers and final manufacturers has grown up in and to the north of the M4 corridor. This so-called ‘co-location’ of all the components of the supply chain has been shown to be associated with higher margins in manufacturing. It speeds up design and process improvements which always require intensive two-way traffic between manufacturer and supplier.

Supply chain risks can be managed

Co-location also reduces supply chain risk, something that companies are increasingly aware of in the wake of events like the Japanese tsunami which severely disrupted the supply chains of several global automotive and electronics companies.  To ameliorate those risks, the RBS Customer Solutions Group has recently developed a supply chain model that allows companies to forecast the impact of many risk factors in supply. Changes in material prices, currency fluctuations, and event risks are all capable of being priced in this model, making it possible for companies to make informed supply chain decisions.

RBS expertise

With rising output, rising investment intentions, and export markets growing, UK manufacturing is in a stronger position than for many years. RBS maintains a national specialist automotive and manufacturing team headquartered in Birmingham – the traditional heart of the industry – with a brief to support automotive and manufacturing customers by tackling obstacles to growth head-on. It is a serious investment in banking expertise for the industry, one that is committed to providing customers with a partner that understands their operating environment, and that can help maximise business potential.

It is also a sign that RBS believes that the UK is now on a long-term growth trajectory in manufacturing: with the right investment, and the right support including tools, techniques and industry knowledge, there is no reason why this growth should not continue and even accelerate.