UK business must go large to exploit the recovery

Posted on 7 Dec 2010 by The Manufacturer

Manufacturing is riding the recovery well, according to economic and confidence data. But as all countries try to manufacture and trade their way out of the slump, competition requires UK industry to get in shape for a new set of post-recession challenges. A report by EEF and Royal Bank of Scotland identifies the specific challenges for manufacturers and what the sector needs to do to grow. Roberto Priolo reports.

The last decade brought profound changes to the global economy, to which all industries, including manufacturing, have had to adapt in order to remain competitive.

Early on in the decade the challenge rose from emerging economies like China and India, who exercised a more aggressive approach to accessing markets and have a low cost labour advantage.

Asian competition has been present for decades, but the millenium brought the internet, better access to Asia and more mobile ‘global businessmen’, while relatively cheap oil made distances between countries a less costly supply chain barrier.

Then came the intensified debate on global warming and the deeper acknowledgement by companies that structural changes were needed in order to become more responsible and, simultaneously, more competitive. Finally, one of the biggest recessions in history pushed some economies to the brink of depression.

UK manufacturing was badly hit by the economic meltdown, but it never stopped showing resilience.

It is now experiencing a promising recovery and, provided it effectively tackles some serious issues, the sector will have a chance to participate in, indeed drive, badly needed growth in the economy.

In November EEF, the manufacturers’ organisation, and Royal Bank of Scotland published “The shape of British industry” (SoBI), which examines the main issues threatening manufacturing in Britain.

The report says that UK manufacturing has grown 5.3% in the 12 months since September 2009, its highest growth since 1994. Manufacturing is described as an innovative and diverse sector, that is facing new challenges, from competition coming from developing economies to the rising cost of raw materials and protectionism.

Wanted: More big companies
The central point EEF makes is that the UK needs more large manufacturers, in fact “hundreds of them” in the words of chief executive, Terry Scouler, to be able to fully benefit from the recovery. The report uses the number of employees as the criteria to determine a business’s size – defining large manufacturers as those with more than 250 employees. Large companies have a number of advantages over smaller ones, the main one being that their size allows them to make investments in new market opportunities that can bring benefits to entire industry sectors.

Commenting on the need for the country to support the development of more large manufacturers, Justin Levine, managing director at geared motor manufacturer Parvalux in Bournemouth, says: “From common sense and experience, I say this is the right thing to do. Smaller companies concentrate on making products, as they don’t have enough funds to finance research.

Without this, it is not possible to achieve innovation, which then powers wealth creation.” Levine says there is a pattern in UK manufacturing: once companies grow too much, they go from having opportunities to becoming wasteful and inefficient.

“It’s a balancing act. Companies that reach a certain size and reputation stimulate interest and attract business. A £50m to £100m turnover will allow a company to finance its development, without the risk of inefficiency,” he explains. Before running Parvalux, Levine was the European managing director for Schneider Electric, Compared to some countries like Germany or the US, Britain has fewer large manufacturers. The report identifies that large manufacturers account for half of employment and two thirds of turnover, despite representing a mere 1% of the companies within the sector. Larger companies collaborate more with customers and suppliers, the report claims, in areas of business such as product development and forward planning. This virtuous behaviour has a multiplier effect, generating benefits that will reach all members of the supply chain.

Not everybody agrees with the idea that the UK needs larger manufacturers. Charles Morgan, managing director of Morgan Motor Company, the last British-owned car manufacturer, believes that SMEs can innovate with less effort, provided they receive help from the government.

“Growth areas tend to be in high tech and innovative manufacturing,” he says. “Customers don’t want mass production anymore, they want more diversity – in our case, this means that some want a hybrid car, while others order a traditional vehicle. I see a big opportunity for SMEs to be innovative and responsive. Of course, we need a bit of help from government if they want us to create jobs,” he says.

Xtrac is a motorsport engineering company with operations in the UK and the US, with a turnover of £30m and is growing. The company employs 247 people, so technically it is still an SME, according to the EEF/RBS criteria. Managing director Peter Digby, however, believes that within the motorsport industry Xtrac is already a large manufacturer.

Does he agree with the need for more large companies? “In any industry there is bound to be a hierarchical supply chain whereby a few dominant companies are supported by a myriad of smaller companies.” Digby also maintains that a strong SME base is important for the economy. “Often the smaller companies have the most innovative ideas and the flexibility to respond quickly to new market trends. What we really need is a system whereby large companies help incubate new technology and support innovation by providing real, practical support such as development contracts and by helping to commercialise new ideas through sales contracts,” he adds.

Going abroad, and coming back
Many UK manufacturers devise growth strategies based on developing new products and increasing productivity. Foreign countries are still very appealing to UK companies both for cheaper outsourcing and for export markets. The report, however, highlights how many British companies that were initially attracted overseas by the promise of lower costs are now returning to the UK, having experienced many problems with outsourcing including reliability.

EEF and RBS present the case of laboratory equipment manufacturer Seward. The company is trying to repatriate as much of its production as possible from China, having realized that product quality was suffering and that the true cost of materials was much higher than expected due to supply chain management and logistical problems.

Other companies, less vulnerable to their suppliers’ performance, fully reap the benefits of having production facilities abroad. One such company is construction equipment manufacturer JCB, which has 18 manufacturing facilities worldwide, seven of which are located outside the UK.

John Kavanagh, group communications director at JCB, explains: “We have always successfully opened factories abroad. Each time it is a learning experience, but being a highly vertically integrated company we make a lot of our own key components, through our internal supply chain. This business model works quite well.” Although there will be a shift in the proportion of manufacture and sales worldwide, as demand from emerging markets such as India, China and Brazil grows, JCB will continue to invest in the UK.

“JCB can compete with the best in the world by manufacturing in the UK,” Kavanagh confirms.

Many British manufacturers are now working to keep production in the UK – to hedge against supply chain risk – and export more of their products, as exemplified by a recent spike in exported goods (November’s PMI data). Some companies are building nearly their entire growth strategies on exports.


The role of government
The SoBI report urges the Government to enforce policies that reflect the diversity within UK industry, while creating a stable business environment for manufacturing to grow.

There are so many parallel business models, strategies and types of company that an approach that only promotes a single aspect of industrial activity, like R&D, or only certain sectors, like high tech industries, simply won’t support the crosssectoral growth the economy requires.

EEF says the Government needs to adopt an approach that focuses on infrastructure and innovation. Backing for those manufacturing sectors in which the UK has a global competitive advantage should be accompanied by targeted and wellcoordinated support for small companies with the potential to grow and mid-sized businesses that can become large players in the economy.

JCB’s John Kavanagh says: “The Government should put in place a long term industrial policy, which makes the UK an attractive and easy place to operate a manufacturing business. This needs to be about less bureaucracy, a better tax system and providing appropriate skills.” All sizes of companies surveyed identified the British tax system as an obstacle to growth, creating particular problems for mid-sized companies that face the same challenges of small businesses but the same tax regulation as big ones.


Skills and finance for growth
There is another area in which the Government should intervene: skills remains one of the biggest concerns for manufacturers. Securing appropriate manual, technical and IT skills is more than ever essential to be competitive and to grow a business.

Small companies have trouble funding their training, and often turn to government to find the money necessary to launch skills programmes.

The Morgan Motor Company, for example, used a Knowledge Transfer Partnership, a programme creating relationships between academic institutions and companies, to help them make better use of the knowledge, skills and technology resources that were not yet available to them in-house.

“We train a lot [of people and in rigour] in proportion to our size, and we are given support to do so,” says Charles Morgan. “The Knowledge Transfer Partnership is a great way to get a graduate into a company, giving you the benefits of university knowledge. We took on each of the five people we had in the last three years after the subsidised period.”

Larger manufacturers, are more likely to invest directly in skills development that, given the collaborative nature of many large companies, generate benefits that will ripple down the supply chains. In some cases, big companies even develop large scale training programmes or training infrastructure (like the JCB Academy, a state school sponsored by JBC). BAE Systems has pledged to overtrain staff under an iniative called Apprenticeship Expansion pilots, spearheaded by UKCES, the Employment Commission. The company trains more people to NVQ Level 3 than it needs, so that when employees leave they are adequately trained to secure another job and feed overall industry growth.

JCB’s Kavanagh says: “Every piece of the jigsaw has a role: Government has the responsibility to prepare people for work or further education in areas that support the real economy, while industry has to make manufacturing and engineering as attractive a career option as it can possibly be.

The JCB Academy has been a flagship project that shows what can be achieved by the education world working co-operatively with the industrial world.” Some believe there should be a different system altogether. Power Panels Electrical Systems’ chairman David Fox thinks that the approach to recruitment should be focused on social skills rather than only academic achievement, because teamwork is important to the success of every manufacturing process.

“Especially with workshop operators, it’s likely that each employer will need to teach the necessary skills simply because each factory is unique. It has its own layout, its own selection of equipment and machinery, its own leadership style and its own collection of operators. If people are likeable, possess a ‘good attitude’ and enough selfconfidence to allow communication with their fellow workers, and have had only a good basic education, almost anything can be achieved,” he says.

Accessing funding necessary to start a business or to invest for growth is another serious challenge for UK companies, particularly smaller ones.

The SoBI report says almost 90% of companies surveyed intend to use internal financial resources to fund their growth (see table). Less than half that number plan to use finance from elsewhere within the group, such as bank loans, with larger firms more likely to do so.

External funding is still a frequent choice. Over one in three manufacturers plan to use mediumterm debt to fund their plans and just under a third long-term debt. Small companies will tend to opt for specific products such as overdraft facilities, invoice financing and trade finance, while young businesses are more than twice as likely to use asset-backed finance, because they may lack sufficient trading history to access unsecured lending.

Commenting on the difficulties a company can meet in accessing finance, Parvalux’s Justin Levine says: “Obtaining funding has become increasingly difficult. An SME will go to banks, which are highly reluctant to bet and only finance when it is risk-free.

If this is the status quo we have to live with, then government is the best source to stimulate funding.

We are getting buffeted by countries where access to finance is easier, either through government initiatives or lending.”

So just what is Britain great at?
Stephen Boyle, Head of Group Economics, RBS

”We don’t make anything in Britain nowadays,” is a depressingly familiar refrain. It is also untrue.

Manufacturing is not as big a part of the economy as it was. That’s not unique to Britain, it’s a feature of all rich economies that as we grow, services account for an increasing share of the cake.

Yet we make a great deal in the UK, and much of it is world class.

Britain exports close to £250bn worth of goods each year, more than £4,000 for every person in the country, while services chip in around £160bn of exports each year.

In the drinks industry, the UK claims more than 10% of the world market. So, cheers to warm beer and Scotch whisky! We also score very well in power generation equipment – 8% of world exports – and drugs and medical equipment is more than 7%.

Not bad for a country that accounts for 3% of world output and 1% of the world’s population.

Yet we can’t rest on our laurels. If the UK is to continue its recovery from the worst recession since the 1930s, manufacturers have a central role to play, particularly exporters. The challenge is to keep doing what we do well, but to do it in more places.

We export more to Ireland than we do to fast-growing Brazil, Russia, India and China combined. The first three of those countries had average import growth of more than 10% per year between 2005 and 2009, with China limping behind at an annual rate of 8%. It is in these nations that the prize lies.

The key to success will be leveraging our undoubted quality in sectors like drinks, pharma and power engineering and taking them to more parts of the world. It will not always be easy, but we start with many strengths. We do, after all, still make things in Britain.