On 12 July, the Institute of Chartered Accountants in England and Wales (ICAEW) launched a new report: ‘Audit Insights: Manufacturing’. This is the second in a series of investigations into different economic sectors from the perspective of auditors. Unlike analysts, auditors get right into the detail of every company they look at, meaning they are able to offer observations not always available to others. This report warns that whilst manufacturing is ‘back in fashion’, it cannot be seen as a fad.
From Brunel’s bridges to Wilson’s "white heat", Britain has always been a country proud to make things and make them well. Many have bemoaned the fact that in the last three decades the focus shifted towards financial services, but manufacturing is a bigger sector than many imagine, contributing 11% of Gross Value Added in 2011 and growing by the year. Making things may not come close to size of the overall services sector, but it is a critical element to the UK economy, and the bulk of the output is coming from small and medium sized businesses. The challenge now is not so much the decades of under-investment, but how to manage the recovery.
Although manufacturing is a broad church, the needs of the sector differ from other industries. Firstly, manufacturers are required to ‘hold their nerve’ to a far greater extent. Constantly changing market demands, combined with the need for constant innovation and research and the need for ever-increasing efficiency and productivity mean that the business cycle can be both long and volatile. Things can appear to be going badly, and then suddenly a company can reap the rewards. Under these circumstances, it is unhelpful for commentators to classify businesses as ‘zombie companies’, especially as we are seeing a slow return to growth. Moreover, as Britain is comparatively lacking in some resources – such as metals or rare earths – supply chains can be long and businesses can find themselves exposed to foreign currency risk in order to manage them. Manufacturers need to explain both that manufacturing businesses go through economic cycles, and that different companies can be at different stages at any given time.
Funding is vital for all businesses, but manufacturing stands out because of the huge sums involved. Changes in technology, the need for innovation, and the start-up costs of research, new products, or launching in a new market all mean that the sums involved can be significant. For larger companies in the FTSE 350, access to finance may be less of an issue, but for smaller businesses this could well be the highest challenge they face. There are solutions available, but more could be done; the government, for example, could provide tax incentives to encourage companies to invest and create employment. This would take courage at a time when corporation tax is a political hot potato, but bold leadership is needed in order to help manufacturing grow.
Skills is another area for concern; industries such as engineering require not only high technical skills, but business skills. Although there can be the option to partner with someone with business experience, many are tempted by other economic sectors where the returns are quicker or where there is greater risk but far higher reward. The constant need for innovation means there must be constant investment, otherwise companies end up with a ‘succession problem’ where they have great people at the top, but find it hard to attract young talent. Investing in training and apprenticeships is one way that this could be remedied, but this cannot just be government-led; companies can offer training to motivated employees, and could consider offering more non-graduate routes into the company for bright, hard-working young people who demonstrate the right aptitudes.
There are more areas where companies are struggling, like management information; business decisions are impossible without good information, which means good systems to keep track of data. In some smaller companies, it may be that the use of old IT systems means that the real costs are not accurately tracked. However, new IT systems can cause equal or greater problems when they go down, with potential disruption to production, accounting, or billing. The key factor is to ensure that the system is right for the job, and not any more sophisticated or complex than it needs to be, and is thoroughly understood.
We have heard much about ‘rebalancing’ the economy so that manufacturing becomes a proportionally larger part, and there is much in British manufacturing to be proud of. However, what the Audit Insights series suggests is that the only way to ensure the sector is able to grow safely and sustainably is to recognise where it differs from other areas of the economy. With the right support, and good management, it will be possible to ensure that growth in the sector is back for good.
Michael’s previous blog post