Surviving the financial hurricane

Could it be much worse? Costs were already going through the roof, despite a (temporary) drop in the oil price, when the Lehman-AIGHBOS and whoever's-next idiocies sunk whatever credibility the banking sector had left. Borrowing for investment has long been next to impossible or too expensive. Now these new financial fiascos will give enfeebled and housing-reliant UK demand another kicking. Even before all this, UK manufacturing's August figures showed the fifth month of contraction in a row. Some car sales had already fallen by two-thirds and Land Rover and Toyota had cut production, with untold effects on their supply chains. The Chartered Institute of Purchasing and Supply said industry was working on old orders rather than gathering new ones. And yet and yet. UK industry is leaner and more efficient than ever. EEF senior economist Lee Hopley says the UK has a smaller but, since the 2001-02 recession, more resilient manufacturing sector. It has fought off an uncompetitive exchange rate, poor productivity growth and the emergence of competition from low cost economies (LCEs). There are different messages coming back from different manufacturers, says David Wright, chief executive of the Manufacturing Advisory Service West Midlands (MAS-WM). "It's not comfortable," he says. "You can't ignore the impacts," but, while there is no telling what the future holds, so far West Midlands manufacturers have avoided the worst effects of recession. He mentions MAS-WM's recent straw poll of SMEs for the Advantage West Midlands regional development agency. They are experiencing different effects on their businesses, says Wright, "but every one of them said, 'we are continuing to invest'," either to cope with still-buoyant existing demand or to win new orders. And they're still taking on apprentices. Wright acknowledges the effects on Land Rover and its suppliers. But orders for the firm's Defender are increasing and the effects on suppliers depend on how reliant they are on Land Rover. The Midlands automotive supply chain learned hard lessons from Rover's sale in 2000 and collapse in 2005. Many car industry suppliers diversified, not just among car companies but out of automotive altogether. "They're much smarter in their businesses," says Wright. Ray O'Donoghue, regional director for Barclays in the West Midlands and its national head of manufacturing, says that, while the effects of the downturn vary from one sector to another, manufacturing is doing "far better than most". Manufacturers are used to handling changing circumstances, says O'Donoghue. "Conditions are tough," he emphasises, "but they're conditions manufacturers have become used to." He agrees with Hopley that they've adopted lean, making their processes efficient, and that they have been quick to develop new markets, responding to the challenge from the LCEs as an opportunity rather than a threat. "A lot of manufacturers have taken the right actions a lot earlier than most," says O'Donoghue. "They've looked at their budgets, their forecasts, and adjusted their cost bases accordingly." Now, he adds, sterling's weakness is helping them. Banks no longer need to provide huge amounts of investment capital for manufacturing, says O'Donoghue: "The demand for that has fallen away," he says, because a lot of manufacturing capacity has gone overseas. Hopley notes that few manufacturers are hit directly by restrictions on borrowing since manufacturers invest from retained profits. Those closely tied to particular sectors have been affected by conditions in those sectors - she mentions construction and consumer electronics - "but there are opportunities to be had out there," she says. "Some parts of the global economy are still growing." If investment is not directly affected, however, there is some evidence that manufacturers of all sizes are delaying decisions about the purchase of capital equipment. A prominent machine-tool supplier told Works Management that, though its market share was increasing despite economic woes, customers had delayed projects: "Our order intake has got a bit sluggish." But exports were holding up: "The German market is still very very strong." Hopley adds that companies which are innovating - "adding value through service provision and those serving niche markets" - are likely to be less affected by economic conditions than others. Wright agrees. His remedy against recession and all its ills is innovation - not necessarily R&D, but the application of knowledge: "It's being open minded," he says, "and being prepared to take on a different capability." The automotive and aerospace sectors, for example, have been famously reluctant to learn from each other. That's changing, says Wright: "There are massive [learning] opportunities in aerospace still, but the mystique is being peeled away." Innovation is about services as well as products, and Rolls-Royce's 'power by the hour' idea is a stand-alone example of service innovation in the interests of customers. "It was a shift in thinking," says Wright. New business models like that "can get people thinking about 'what do my customers actually buy from me?'... It's thinking about the holistic nature of your relationship with your customer," says Wright. There might be things that are a pain in the backside to the customer that a manufacturer could do for them and get benefit from. He cites the increasing need for recycling, particularly of electronic waste under the WEEE regulations. Graham Sharpe, CEO of industrial-IT provider In2grate Business Solutions, says: "One area they are worried about is bad debt." That affects cash flow, and the borrowings companies may have to make to overcome it. A recent survey for the Forum of Private Business (FPB) supports this, saying 71% of respondents claim that customers are taking longer to pay them. Research by asset based lender Venture Structured Finance also found that 62% of manufacturers are worried about their cash flow. In other industries the average is 45%. But there are ways round it. Venture's survey also found that over half UK manufacturing businesses already use asset based lending (ABL) compared with 28% across other sectors. ABL uses the value of receivables, inventory or plant and machinery to raise working capital instead of a traditional bank overdraft or loan. Hopley, however, doesn't see any evidence so far that late payments are at higher than normal levels. "So far we're not picking up any serious concerns about that, though again there may be some sector-specific effects." Tom Aldridge of Celerant Consulting's advice to manufacturers in tough times is "to squeeze all the available cash out of their balance sheets." Celerant's clients are Fortune 500 companies among the top 10 truck and car manufacturers, the world's largest energy providers, and food, pharmaceuticals and mechanical engineering companies. He urges them to create a culture in which freeing up working capital becomes both an operational and a finance-department imperative. Budget holders at each level must take responsibility for all of their expenditure, he says, and finance and operations must work more closely to monitor cash flow and related effects on it. You can go into bankruptcy profitably, says Aldridge: "If you can't pay your debts, it doesn't matter what paper profit you're showing, if you haven't got the cash to cover your debts you go into bankruptcy." For O'Donoghue, too, "cash is king, and it is important to take out any bad costs that don't make a contribution... Examine each of your customers and suppliers and carry out some solvency checks on them." The bank will help you do this. "It may also be worth investigating fixed supply and price contracts, buying forward key raw materials and commodity hedging." One important discipline, says O'Donoghue, to keep asking yourself, "What would happen if..." Cash flow If you're worried about cash flow, it's worth looking at a US website called Planware (tinyurl.com/6cqfbr) which suggests more than 30 ways of improving net cash flow. For Aldridge, the greatest risk the current economic picture presents is to the order book: "If you go into an organisation you can drive up efficiencies, that's always interesting. But it doesn't solve the issue." No matter how efficient you are, that won't do you any good if the orders aren't coming in. "A lot of companies will beat their suppliers over the head - there are some wonderful cases of across the board taking 2% off their suppliers' invoices," says Aldridge. "All that does is it turn you into an unfavoured customer for those suppliers. On the other hand you can go to a supplier and say, 'I'm going to share my forward order book with you, that's going to give you a lot more confidence in terms of your future business. In return I want you to work with me to reduce the costs in your supply chain so that I can benefit'. None of it's rocket science." O'Donoghue advises companies to make use of the experience on offer. "A fresh view, an objective view of events is often very helpful. The input of outsiders such as non-executive board members can be really valuable." Non-execs can help you test whether current assumptions about strategic plans are valid. As to the future, in some ways there has never been a better time to be in manufacturing. At least last month's launch of (yet another) manufacturing strategy signals that government has accepted this year's sharp reminder that making solid objects people can take home and use is more worthwhile than selling dodgy financial instruments even the buyers and sellers don't understand. The launch statement even described manufacturing as, "the unsung hero of the UK's economy." O'Donoghue sees the manufacturing strategy's launch as a positive move: "The fact that they're taking manufacturing seriously is encouraging," he says. There are concerns ahead: "The European economies have started to weaken, and that will have an impact on our guys." But the ones that have strong brands and market share will see it through better than most, he predicts. Management counts O'Donoghue has some kind things to say about manufacturing management. Survival, he says, "is a question of management. For us, the quality of management is equally as important as all these other things. Good management can be differentiated between people who have been successful in this sort of climate and those who have not." Bland times, when orders are plentiful, can hide poor management, but manufacturing has seen precious few of those. In manufacturing, he says, "the poor businesses have either been bought up or gone by the wayside." As for the technical effects of the 'credit crunch', the banks are still willing to lend, to manufacturing or anyone else, says O'Donoghue, though he acknowledges that the lack of liquidity in the financial system means that borrowers will find it more expensive to do so than they once did. "There's money available but the cost of that money will be more." And some of the lending criteria might have changed. O'Donoghue's guess is that the current financial crisis "will be around for a while." No improvement until 2010 is his best guess: "Conditions are difficult." _ For management thinking/strategy, go to www.worksmanagement.co.uk/strategy