Trouble at t’mill
How will manufacturers fare against inflation and the credit crunch, and how can they defend themselves? Keep the banks at bay and steer clear of the housing sector, advises Peter Hoskin
The media has focused its attention on the financial sector since the credit crisis took hold at the tail end of last year, and rightly so. After all, that’s where the problem started, and that’s where the majority of its effects have been felt. But with the economy so deep in the doldrums, problems must soon spread to other areas.
So what exactly is the state of British manufacturing? It’s hardly a rosy spectacle. By almost any indicator, the sector has been in terminal decline for decades. The number of workers in the manufacturing sector stood at around seven million in 1978, compared to around three million now. In the early 1990s, manufacturing investment represented 22 per cent of all investment in the UK; now that figure is just over 10 per cent. And manufacturing output fell from 23 per cent of GDP to 15 per cent over the same period.
Much of this decline can be attributed to globalisation and trade liberalisation, which have left the UK exposed to the manufactured goods produced in low-wage, low-tax economies, such as China and India. ‘Why pay more, when you get it cheaper from overseas?’ is the sentiment shared by consumers and companies alike, and it has prompted many manufacturers to leave Britain behind altogether. The void has been filled by the rise and rise of the UK services sector, the driving force of economic growth over the past ten years. As Tim Congdon of Lombard Street Research explains: ‘Britain is a rich country – we don’t want to do repetitive things with our hands. We should do unique and specialist tasks requiring the use of our brains.’
If manufacturing was already looking anaemic before the credit crunch swept into town, how is it coping now and what are its prospects? David Frost, director-general of the British Chambers of Commerce, spends much of his time travelling the country speaking to manufacturers – and his dispatches from the front line are surprisingly upbeat. The credit crisis, he says, has thus far had ‘no major impact upon manufacturers’. That is to say, any impact has been slight and indirect. One example – detailed by Bill Jamieson last month – is that banks are becoming far more reluctant to lend money to manufacturing clients. In practice, this means that banks are seeking to renegotiate the terms of the overdrafts that manufacturers hold with them, to make them more stringent. But the banks can’t lean too hard: Frost says that the banks can’t concoct terms that will scare their clients away, or they risk coming out of the crunch with a severely reduced customer base, as well as a damaged reputation. Sensing they have the upper hand in this, many manufacturers are refusing the banks’ stricter terms. Whether banks will roll over so easily if the crunch hardens remains to be seen.
Frost does stress, however, that manufacturers already face a range of problems resulting from the more general global downturn. Yet it is ‘difficult to unpick these issues from the credit crunch’ – there is almost certainly some symbiosis between the two. Among the issues, and perhaps the worst facing manufacturers, is price inflation. In particular, manufacturers are being hit hard by the skyrocketing prices of two of their most important resources: oil and steel. At the time of writing, oil is priced at around $135 per barrel, up from $65 at the same time last year. And steel prices have inflated by over 100 per cent in the last five months alone. These trends pre-date the crunch.
At the moment, says Frost, the situation isn’t so bad that manufacturers ‘can’t pass on most of the extra costs’ to their customers. And his words are supported by a recent CBI survey, which found that 36 per cent of manufacturers expect to put up their prices in the next three months. Nonetheless, the potential remains for a nasty cocktail should inflation worsen while the crunch forces banks to tighten their lending facilities.
These points were echoed when I spoke to Steve Swords, chief executive of Abrasive Technology. This medium-sized British subsidiary of a US parent – which manufactures super-abrasive grinding and cutting tools used in a range of engineering applications – is hardly noticing the crunch. Yes, the banks have been offering less favourable overdraft rates: ‘There’s no justification for it,’ Swords complains, ‘except that banks are struggling’. And, yes, he regards price inflation as the real problem, affecting everything from production costs to the petrol expenses that his travelling reps file each month. However, both of these effects have been limited, and Abrasive Technology remains buoyant.
But what of the future? Swords believes ‘a lot depends on how much house prices come down, because that could really affect economic growth all round.’ A house-price crash would have to be deeper than most current forecasts for the manufacturing sector to take a real hammering – and rising inflation is working to shield the economy from negative movements in the housing market. But prolonged inflation brings its own problems for manufacturers, in relation to labour as well as other costs. Swords believes companies less well-placed than Abrasive Technology may soon struggle to contain upwards pressure on wages, as employees demand settlements to keep pace with food and energy prices.
Much will also depend on what Swords calls ‘exposure’. The more exposed a manufacturer is to the financial and housing sectors, the more likely it is they will be hit by the crunch. Almost every manufacturer has some crossover with the financial sector – hence the concern over renegotiated overdrafts. For those that do direct trade with housebuilding and construction companies such as Persimmon – which recently suspended work on new housing developments – the impact of the crunch could be severe. Abrasive Technology is fortunate in this case – it does most of its business with the aerospace and automotive industries. But Swords does admit to being nervous about future demand from white-goods companies, a sub-sector which is itself exposed to a housing-market fall.
Many of the same pressures apply to larger manufacturers. But at the moment, they appear to be in a better position to weather the storm. After all, inflation costs can be borne easier by companies whose profits run into hundreds of millions. And, while stricter overdraft terms could scupper a small enterprise, they would hardly dent a multinational. All of which may explain why the large manufacturers I spoke to sounded particularly bullish. A spokesman for Ford told me that the automotive firm was ‘bucking the economic trend’, and pointed to improved sales figures over the past few months. And I heard similar stories from other companies with a manufacturing element, including Sony, Apple and General Motors.
This means the manufacturing sector is in a strange position vis-à-vis the credit crunch: at the moment, it remains largely unaffected, but there’s a very real danger that could change. What can the government do to help? Every manufacturer I spoke to said almost exactly the same thing: ‘The Government should maintain a favourable business environment.’ Rather than a raft of special initiatives – which, as Steve Swords points out, could unbalance the market – this means favouring low taxation and unintrusive regulation, and encouraging workforce skills.
One vital element will undoubtedly be fuel duty. The government plans a 2p increase this autumn, a measure that, on top of inflation, will worsen the squeeze felt by manufacturers. The view from the sector is that they already pay enough tax in transporting their wares and employees around the country. Indeed, taxes (fuel duty and VAT) account for 67p of the 110p-plus that most drivers now pay for a litre of petrol. As we go to press, a climbdown on the 2p autumn increase looks possible, but on the wider issue of fuel taxes, ministers’ position is that with government finances already at full stretch, it would be wrong to cut a tax which is believed to have environmental benefits. Frost is cynical about this excuse: ‘Not enough money around? There must be when [the Exchequer] collected £47 billion in [corporation] taxes’. Besides, it won’t be lost on manufacturers that the government recently found £2.7 billion to compensate those who had lost out after the abolition of the 10p tax band.
So what can the sector do? First, it should be stubborn in the face of stricter demands from the banks. Until the crunch gets much, much worse, the banks will not want to alienate their customer base, a fact which gives manufacturers leeway in their negotiations. Second, manufacturers would be well-advised to decrease their exposure to the housing sector, and industries that feed off it – though that’s easier said than done for many companies.
The final piece of advice for manufacturers is perhaps the most crucial: keep shtum. By all means lobby the government over fuel duty, and fight your corner against the banks. But at the same time, play down any grim statistics, and talk up your company’s prospects. When uncertainty is in the air, façade can be everything. As David Frost put it, ‘we don’t want to talk ourselves into a recession’.