Economists predict the U.S. industrial production sector will experience a recession in 2022, but manufacturers are already feeling the effects of a minor downturn expected to last throughout the rest of this year.
COVID-19 economy update: Karen Harris, Bain & Company's head of Global Macro Trends Group, provides a glimpse into how the Coronavirus pandemic has affected the U.S. economy and manufacturers. ITR Economics shares its projections for how the economy will rebound, as well as strategic tips on how to handle black swan events in the economy. Scroll down to the bottom of this article to read both of these updates.
As we enter the tenth cycle of the economy, the U.S. has recorded the largest uninterrupted economic growth in the country’s history, according to the U.S. Chamber of Commerce. But it’s been 10 years since The Great Recession pummeled the manufacturing industry, and manufacturers are anxiously awaiting the inevitable as economists say, “What goes up, must come down.” An impending recession was hinted at during PMMI’s Executive Leadership Conference last year in April, and it’s been the talk of the industry ever since.
“When we hear the word ‘recession,’ we all think of 2008 and 2009,” says Taylor St. Germain, an analyst for ITR Economics, an economic trend reporting firm. “But that is certainly not the case for what manufacturers are about to experience.”
However, the pressure and fears OEMs are experiencing aren’t without warrant. September 2019 marked the first time U.S. manufacturers experienced a contraction as large as the ones toward the end of The Great Recession in 2009. According to The Institute for Supply Management, the manufacturing index fell to 47.8% that September in 2019 from 49.1% the prior month. The report states that machinery manufacturers cited, “Dealer inventories have rebounded, and the overall customer market has softened, resulting in corrections to near-term production schedules and a tentative forecast outlook.” Today, it’s the trade war with China that has wreaked havoc as it causes uncertainty in the economy—a common trigger for a recession. According to the report, many manufacturers cited losing new and existing customers over costs associated with tariffs.
While these numbers indicate that the manufacturing industry may be in trouble, ITR’s St. Germain says the current economic situation is the mildest recession recorded in 100 years for the U.S. industrial production sector. ITR relies on the U.S. gross domestic product (GDP) and U.S. industrial benchmarks to forecast economic events like a recession, and the company found that the pressure U.S. manufacturers are currently experiencing is the result of a minor downturn, which started at the tail end of 2019, and will only last until mid-2020. While ITR says U.S. manufacturers may be feeling tiny contractions throughout 2020, there isn’t a strong case for a recession until 2022.
Aside from gearing up for a recession in two years, global management consulting firm Bain & Company is also predicting that a technology boom will continue and likely accelerate coming out of the next downturn. Bain partner Jeff Katzin says that manufacturers should be doing everything they can to position themselves to be on the right side of the technology boom, which means being open to progressive innovation and concepts.
“We actually think the downturn is going to mark the starting gun of what could be a fundamentally different business cycle with accelerated adoption of emerging technologies and automation,” Katzin says.
For this reason, manufacturers shouldn’t rush to scale down and cut back just yet—despite the uncertainties around trade, tariffs, and the economy. In a recession, many companies may lay off employees, cut down on R&D, and scale back on sales and marketing, but given the unique position manufacturers are in with the upcoming technology boom and current workforce crisis, this isn’t the move.
Plus, Katzin says there is so much to gain from a downturn, especially for manufacturers, because this kind of contraction in the economy can flip the playing field upside down, making it easier to pass competitors.
“While a downturn period could cause some concern, it’s also a period where there is a lot of opportunity if you have a downturn strategy and are getting an early start,” Katzin says. “There can be ‘winners’ in a recession or downturn, you just have to position your company to be one of them.”
Last year, Bain extensively analyzed 3,900 companies and focused on what the successful ones—who gained market share and grew at a 17% compound annual growth rate (CAGR)—did differently than those companies that didn’t grow at all or were worse off after the 2009 Great Recession. In their research, Bain found that the “winners” excelled in four main areas prior to and during the recession, which kept their growth accelerating after the recession at 13% CAGR, while the “losers” only continued to grow at 1% CAGR.
Four ways manufacturers can win in a recession
Here are four things manufacturers can do today to weather the current downturn, as well as prepare for the projected 2022 recession.
Take a hard look at costs. There is a common misconception that in a downturn environment, companies think they need to “burn the furniture,” Katzin says. But the danger with cutting back is that sometimes companies can cut too deeply by ruling out investments and acquisitions, cutting out R&D, and scaling back on sales and marketing. Those companies who came out on top of The Great Recession acted early on costs but did it in a way that analyzed the assets they need to protect, and not scaling back too deeply in those areas.
Put the rest of the financial house in order. It’s critical that OEMs be more mindful of managing liquidity and the balance sheet beyond thinking about profit and loss efficiencies. Winning companies managed the working capital and capital expenditure strategy in an aggressive way to increase cash flow and identify which investments were going to have a higher return in line with their strategic vision. Katzin says this strategy helped one heavy equipment manufacturer see an increase of 40% on its return on investment in 2008, which was up from -5% in 2001.
Play offense with investments. Think about how to drive efficiency and how to reinvest in the business today and tomorrow. With the end of this downturn spurring a different economic cycle and technology boom, companies should invest in important capabilities and technology that they are going to need three to five years down the line. And OEMs need to start making those investments now, which means they need to see how they can free up the resources and capacity as an organization to be able to make those investments and have fast growth on the backend of a difficult economic environment.
Pursue a proactive merger and acquisition (M&A) pipeline. In the midst of the recession environment in 2009, company valuations were lower across all sectors and industries, making some acquisitions very attractive and opportunistic, Katzin says. Acquirers were able to purchase new product lines, customer segments, and capabilities at lower prices. So, if OEMs have the capacity and the financial capability to look aggressively at M&A, it could help them add capabilities and enter into new markets.
On top of these tactics, ITR’s St. Germain says downturns can be a good time for OEMs to evaluate their strategy for the future.
“Take advantage of slower activity during the first half of the year because as we move into the second half and into 2021, we are forecasting a pretty fantastic growth year for the U.S. It’s time to train your people, make capex investments, automate when possible, and have your people and process ready for what’s to come.”
Anytime financial best practices
Track rates of change: ITR’s St. Germain advises OEMs to constantly track their rates of change so that they can better identify when they should expect slow and busy periods. Builders should also be monitoring commodity prices, which are currently relatively low. St. Germain advises buying the commodities in bulk now because the cost will be rising by the end of 2020.
Identify counter cyclical markets: During a downturn, OEMs should also be taking advantage of counter cyclical markets that will be performing well while other main markets will be down.
Build cash: Manufacturers should always be trying to build their cash capital so that they can invest in companies, people, materials, and other strategic items at the bottom of the cycle when everything is cheaper. St. Germain says, “Buy low, sell high.”
Retain talent: Because the manufacturing industry is currently experiencing a workforce crisis, St. Germain advises OEMs to hold onto their talent, as layoffs could come back to hurt a company more than the downturn itself.
“This tight labor market we are feeling right now, it’s here to stay for the next few years,” St. Germain says. “It’s important that we keep those A and B players in our business right now. As things pick up, we are going to need those people in our business because it’s tough to find them as it is right now.”
Your recession defense starts here No matter how much data is kept and analyzed, it can be difficult to predict and pinpoint a recession and its severity, Katzin says. While this may not give many peace of mind as they plan for an uncertain future, there are steps that OEMs can take right now to at least start the dialogue of how they plan to withstand a recession and how they can place their company in a strong position.
“When you talk about the future of your company start with the end in mind. What is the aspiration of an organization three to five years from now?” Katzin says. “Ask yourself where you need to win with your customers versus peers, and where do you need to innovate?”
Secondly, Katzin recommends that OEMs stress test the balance sheet for some different scenarios. Create a plan and strategy for the serious moves, both on the offense and defense, depending on what the world looks like. “I think the challenge is when things happen sometimes the temptation is more of a knee-jerk type of reaction, and you really want to have a series of chess moves planned out across some of those stress test environments as well as profit and loss, cash flow, and a balance sheet through different downturn scenarios. Whether it’s a shallow or deeper recession, I think having these discussions early and seeing where there are ways to make sustainable changes to the business to free up capacity and resources to reinvest is what companies should be thinking about now.”
How the Coronavirus Pandemic Has Affected the Economy and U.S. Manufacturers
Karen Harris is the head of Global Macro Trends Group at Bain & Company, a global management consulting firm. She has co-authored a number of Covid-19 reports and shares her perspective on how the outbreak could impact U.S. Industrial Production sector.
Why has the Coronavirus pandemic upended the economy? The coronavirus pandemic is clearly a once-in-a-hundred years event, combining epidemiological crisis mixed with government policy and the macroeconomy. Because of the big number of uncertainties across these three aspects, it means businesses need to plan for an unusually wide range of possibilities and to date there’s no reasonable way to handicap these possibilities.
How will manufacturers, specifically, be affected? Industrial companies have the unusual situation where as a sector, they were among the earliest to be alerted to potential disruption from the coronavirus—through their supply chains in China—but now, industrial companies are generally not on the front-line of localized disruptions compared to high-touch consumer businesses like hotels and non-essential retail. That said, the impacts of the coronavirus pandemic including the wave of shutdowns to help control its spread are rapidly spreading to affect industrial and manufacturing businesses. We can see some of the data in the Eurozone recently released for a preview of the magnitude of shock spreading into manufacturing. They’re a couple weeks ahead of us on the epidemic curve so looking at their data is a window into our very near future. The Eurozone manufacturing PMI fell to 39.5 in March versus 48.7 from a month prior. Supply chain delays are nearly at all-time record levels and manufacturing job cuts have already hit levels last seen in the Eurozone crisis. Unfortunately, we know from US data that even though we are a little behind Europe on the epidemic curve, manufacturing layoffs have already accelerated to a pace last seen in the 2009 recession.
How will this pandemic shape the future of the industry and business? There’s no question that the industrial economy is facing some serious challenges and risks over the near term. In particular, we’d be concerned that emerging solvency problems broadly spread throughout the service sector could create ripple effects into the industrial sector if not quickly addressed by policy. But we think there’s a real bright spot at the end of what is an unquestionably dark tunnel of unknown length. When we get over this pandemic—as we will—there’s likely to be a broad-based push to rethink the role of industrial and manufacturing capacity, including more diversified and localized capacity. There are some great stories of U.S. manufacturers pivoting on the spot to produce critical supplies needed in the fight against the coronavirus. This is very visibly raising the importance of having flexible surge capacity in-market—at least some share of total capacity—and that is a trend that is likely to sharply accelerate in the years to come and be an important driver of investment growth.
How to Handle Black Swan Events in the Economy
Even before the developments related to the two black swan events—COVID-19 and the international oil price conflict—ITR Economics was expecting a minor downturn in the industrial economy during the first half of 2020. However, the black swan events have exacerbated the downturn. ITR’s new forecast for the U.S. industrial production sector suggests that industrial activity will contract into at least late 2020 and potentially into the first quarter of 2021.
“While we are not forecasting a period of contraction that is comparable to the Great Recession of 2008-2009, we are expecting this to be the most severe decline since then,” says Taylor St. Germain, an ITR analyst. “But there is good news on the horizon. While the recovery is likely to be delayed as a result of the double black swans, we do expect industrial activity to be in business cycle ascent by mid-2021. We expect expansion in U.S. industrial production to characterize the latter half of 2021 and the majority of 2022, with record output by the middle of 2022.”
According to ITR, here are some considerations and actions OEMs should take during this time to position themselves for success.
· As you fortify your supply chain, justify associated costs to customers by highlighting the value proposition of your increased resiliency.
· Proactively communicate your response measures to relieve clients' anxiety, generate goodwill, and establish your brand as a market leader.
· Leverage technology and automation to mitigate risks related to workforce and sales channel vulnerabilities.
· Make sure you are in contact with your banker and that they are aware of your cash position. Liquidity is still there, so it is possible to take on loans at low interest rates.
