2012 Manufacturing Outlook: Are the Shocks to the System Over?

2012 Manufacturing Outlook: Are the Shocks to the System Over?

U.S. manufacturers are bullish about 2012 despite lingering economic problems.

At times, it resembled a global game of "Can you top this?" Economist Chris Kuehl recites a string of "black swan events" in 2011 -- a tsunami and nuclear emergency in Japan, the Arab Spring that sent oil prices spiking, severe floods and tornadoes in the United States, not to mention the European Union awash in debt and on the brink of a meltdown. The United States saw its financial rating downgraded, but that did little to deter Congress and the Executive Branch from engaging in constant political brinkmanship. Yet despite all this, U.S. manufacturing continued to grow last year.

On Jan. 3, the Institute of Supply Management announced manufacturing expanded for the 29th-consecutive month. "Manufacturing is finishing out the year on a positive note, with new orders, production and employment all growing in December at faster rates than in November, and with an optimistic view toward the beginning of 2012," says Bradley Holcomb, chair of ISM's Manufacturing Business Survey Committee.

Most economists expect continued growth in the U.S. economy and in manufacturing, but that growth is likely to be modest. The Manufacturers Alliance for Productivity and Innovation (MAPI) expects manufacturing production to increase 3% in 2012, outstripping U.S. GDP growth which MAPI predicts will be 2.1%. MAPI Chief Economist Daniel Meckstroth says, "Pent-up demand for postponed consumer durable goods continues to exist, particularly in motor vehicles. In addition, firms are profitable and have the need to spend more for both traditional and high-tech business equipment, and reasonably strong growth in emerging economies is still driving U.S. exports."

Barry Misthal, the global leader for PwC's Industrial Manufacturing Practice, also predicts slower growth for the U.S. economy. "My anticipation is we will see a continued slowdown in demand "both in the U.S. and globally, with a few bright spots," he says. "The bright spots are U.S. companies that are aligned to the energy sector, whether it is oil, gas, natural gas or shale gas extraction. U.S. manufacturers that have good exposure to the energy sector will still have very solid demand going into 2012."

Kuehl, who serves as economic analyst for the Fabricators & Manufacturers Association International, says attendees surveyed at the Fabtech show last November were clearly in the mood to buy new machinery. He says some company executives were saying they needed to replace old machines that were wearing out while others need new machines in order to enter new markets.

"But a lot of the responses were, 'I can't wait any longer for people to solve my problems. I have a business to run and I need to get on with it, so I am going to take a more risk-tolerant approach to the coming year,'" says Kuehl.

Opportunities for Growth

Manufacturers that reported they are pursuing exporting were more likely to characterize their business as "thriving and growing," according to a survey by accounting and consulting firm McGladrey.

"Over 70% of the participants are doing some sort of exporting, and it represents about 16% of their sales," notes Karen Kurek, McGladrey's national manufacturing and distribution practice leader. "It debunks the myth that only large companies can export. I often say that you don't have to be General Motors to export. It is something that companies of all sizes, and particularly many smaller companies, are active in."

FMA's Kuehl says one reason small and midsize companies are exporting is that there had been a focus over the last two decades on large markets such as China, Japan and India "where it really takes major multinationals to navigate the complexity of those places." Now, he notes, smaller markets such as Brazil and Turkey are heating up and they present less of a challenge to exporters.

Kurek says the manufacturing sectors most likely to be exporting include industrial equipment, transportation, automotive, computers and medical devices -- "those sectors that have highly engineered products and distinguish themselves from locally produced products."

Reshoring will continue to be driven in 2012 on rising wages in China, increasing costs for ocean and air cargo, and on worries about disruptions of long supply chains. FMA's Kuehl notes that ships passing through the Suez Canal pay 25 times the insurance rate they paid five years ago. Ships are choosing to sail around the Horn of Africa to avoid the charges, he notes, but they then run the risk of piracy so rampant that one in six ships is being seized. "All those things begin to add up and a company says, 'You know, there is just not a lot of piracy in Nebraska,'" Kuehl says.

Meeting the Challenges

While many manufacturers entered 2012 with leaner operations and improved cash reserves, that won't necessarily mean they will be going on a spending spree. PwC's Misthal says manufacturing executives are "very sensitive to uncertainties in demand." He expects them to stick with their broader strategic plans, making cautious investments but not "overinvesting" in any one region or initiative. "Companies will be "significantly challenged to beat their 2011 financial performance," Misthal says.

Misthal does expect merger and acquisition activity to be very strong in 2012. He says companies will be focusing on acquisitions that extend their product lines or fill in gaps, provide service opportunities and that extend their reach into new markets.

"Say you are buying a company in Brazil and they already have a pre-established distribution system where you are now using a third-party distributor," Misthal explains. "Obviously you can make some cost efficiencies and maybe get some margin back by having your own business in there."

One manufacturer demonstrating that trend recently was Materion Corp., an advanced-materials firm based in Cleveland. Last October, the company bought EIS Optics, a Shanghai-based producer of optical thin-film filters and other products. Chairman and CEO Dick Hipple notes that this was the company's fourth acquisition in the coatings business but the first outside the United States. He says EIS will provide Materion with new technology, more presence in the commercial side of that market and a presence in Asia, where EIS does 80% of its business.

Hipple says his company has not been deterred by economic uncertainty. Citing aggressive regulations, health care costs and taxes, he says businesses don't have a problem with uncertainty. "The problem is, it is not uncertain," he says. "It is certain that our costs are high, going higher and the environment to support business is getting worse. That is negative certainty."

McGladrey's Kurek says a continuing test for manufacturers will be finding skilled workers to fill open positions in manufacturing. She notes there have been a couple generations of American parents who have not encouraged their kids to go into manufacturing. Along with that, once-common vocational schools and programs have been disappearing. But she notes that a whole series of initiatives have sprung up to address the shortage, including community colleges slowly beginning to introduce two-year programs modeled on the National Association of Manufacturers' curriculum. "It is a huge issue across the U.S. The skills gap is becoming more acute as most manufacturers and distributors are looking to add skilled workers," she says.

Predicting modest increases in manufacturing employment, FMA's Kuehl says there will be "a lot more enthusiasm for adding machines and adding technology and very little enthusiasm for adding raw numbers of people, unless they are the people who can run these new machines." He observes that small and midsize manufacturers are learning they can appreciably increase their production with "one or two really skilled guys with a sophisticated machine." Going forward, he says, manufacturing will no longer serve as the "fail-safe for the guy that didn't quite make it" through high school. Instead, Kuehl says, manufacturing will provide higher-wage jobs that are more valued and skilled but in fewer numbers.

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