manufacturing confidence: why manufacturers believe they can defy the downturn

Manufacturing Confidence

Sponsored by

A report from the Economist Intelligence Unit

Manufacturing confidence

© The Economist Intelligence Unit Limited 2009�

Manufacturing confidence is an Economist Intelligence Unit briefing paper, sponsored by Siemens PLM Software. The Economist Intelligence Unit bears sole responsibility for this report. The

Economist Intelligence Unit’s editorial team executed the survey, conducted the interviews and wrote the report. The findings and views expressed here do not necessarily reflect the views of the sponsor.

The research drew on two main initiatives. We conducted a global online survey in February-March 2009. In all, 354 executives took part. To supplement the survey results, we also conducted in-depth interviews with senior executives and independent experts knowledgeable about manufacturing.Our thanks are due to the following for their time and insights:

l Richard Spitzer, managing director for automotive and industrial equipment, Accenture, USA

l Nils Bjorkman, executive vice-president, responsible for worldwide commercial operations, Tetra Pak, Sweden

l Maurice FitzGerald, head of Strategic Initiatives, Europe, the Middle East and Africa, Hewlett-Packard technology solutions group, Switzerland

l ManMohan Sodhi, professor in operations management, City University London’s Cass Business School, UK

l Erin Dobson, director of corporate responsibility communications, Nike, USA

l Tony Maddaluna, vice-president of global manufacturing, Pfizer, USA

l Frank Bamford, senior vice-president of business development and strategy, GKN Aerospace, UK

l Yossi Sheffi, professor at Massachusetts Institute of Technology and director of MIT’s Centre for Transportation and Logistics, USA

l Scott Anthony, president of Innosight, the consultancy, and author of The Silver Lining:

An Innovation Playbook for Uncertain Times, USA

l Brian Krzanich, vice-president and general manager of manufacturing and supply chain, Intel, USA

The author of the report is Sarah Murray and the editor is Iain Scott. Our sincere thanks go to the executives who participated in the survey and interviews for sharing their time and insight.

May 2009

Preface


© The Economist Intelligence Unit Limited 20092

I t is not hard to grasp the difficulties facing manufacturing companies today. Newspaper headlines tell stories of falling orders, plant closings, asset sales and job losses in the thousands. But a global survey of manufacturers conducted by the Economist Intelligence Unit in February

and March found that, although a high proportion are affected by the downturn, a surprisingly large number—given the economic gloom—say they are optimistic about prospects for business over the next 12 months.

Many express confidence in their ability to retain customers and attract new ones, to expand into new markets and secure a resilient supply chain. Others see the slowdown bringing with it opportunities, from hiring talented workers to redesigning products and processes.

Whether this optimism is justified may not become evident for some time. Separate Economist Intelligence Unit research� suggests that, although economic stimulus packages currently under way have a 60% chance of restoring stability by 2010-11, there remains a 20% probability that the world economy will enter a depression.

There is no doubt that on a range of issues, including access to capital, profitability, return on equity and ability to increase output, many respondents to our survey believe that their companies cannot achieve the targets they were reaching a year ago.

What emerges from our survey and from subsequent interviews with senior executives is that manufacturers acknowledge the problems they face and the need to cut costs. But they also have clear ideas about implementing progressive strategies—not just to ride out the storm, but also to emerge in a stronger position once economic recovery is in sight.

Key findings from the survey are highlighted below.

l Companies reveal a surprising level of optimism given the economic gloom. The largest proportion (28%) of respondents say they are affected by the recession and expect their company’s business prospects to deteriorate. By contrast, the second-biggest group (24%) see the outlook as good and expect business prospects to improve in the next 12 months. However, the balance of negative and positive results suggests that our respondents are uncertain about the likely length and depth of the downturn.

lFew companies are anticipating a prolonged downturn in business, although 2009 will be a tough year. Many respondents (39%) expect conditions to improve for their company’s business within 24 months, compared with almost one-half (47%) who see this as applicable to their sector as a whole. Meanwhile, 34% anticipate an upturn in business within the next year, and only 10% believe that an improvement will not be felt within the next two years.

lManufacturers face a wide array of challenges in the current downturn. More than half of the respondents are pessimistic that pressure on prices will have a large negative impact on their

Executive summary

� Economist Intelligence Unit, Manning the Barricades, March 2009.



businesses in the next year. This pressure is also seen as affecting the outlook for manufacturers’ customers, with some 62% citing this as a concern. “We see it clearly in that many of our customers all over the world are becoming very careful with their capital investments,” says Nils Bjorkman, executive vice-president responsible for worldwide commercial operations at Tetra Pak. Strong pessimism was also expressed about availability of credit and exchange-rate movements (both 26%), while supply base stability and energy costs (both 22%) also rank highly as negative factors.

lCost-cutting emerges as the most common means of responding to the economic downturn’s impact on business. Many respondents say staff and benefits cuts (44%) would do most to improve their cash positions, followed by new partnerships with low-cost suppliers (41%) and reduced energy consumption (36%). “Pushing back on costs” was cited by the largest group of respondents (62%) when it came to ensuring the resilience of their supply chains. Lay-offs are a big part of this—Boeing, for example, recently announced cuts from its commercial aircraft unit of 4,500 jobs, or almost 7% of the division’s workforce.

lSupply chain resilience is seen as a critical factor in business survival. The failure of suppliers’ businesses emerges as the greatest concern, with 63% of the manufacturers surveyed citing this as having an immediate impact on their own supply chains and 56% seeing this as hampering their procurement strategy. The problem is acute in the car industry supply chain, where specialisation and extreme interdependency mean that the failure of even one or two small firms can bring vehicle assembly lines to a halt. In addition, more than one-half of respondents cite lack of access to capital (56%) and energy and raw material price volatility (55%) as having an immediate impact on their supply chains.

lMany manufacturers see the downturn as a time to enhance their efficiency. The biggest group of respondents (63%) believe improvements to operational efficiency, both externally by rationalising supply lines and internally by using downtime to work on enhancing process efficiency, will do most to enhance their company’s competitiveness, whereas almost one-half cite changes to their organisational structure (46%). Investing in research and development (R&D) for product and process innovation (45%) also remains important.

lCompanies see a variety of business benefits emerging from the recession. Almost one-half (45%) of respondents see the growing availability of talented workers as helping their business, compared with 42% who point to the advantages of reduced competition as other companies in their sector fail. Meanwhile, merger and acquisition (M&A) possibilities rank highly (39%) as business opportunities, along with lower interest rates (37%). For Hewlett-Packard (HP), a manufacturer and supplier of computers and printers, the acquisition of EDS, a technology services company, in May last year has generated new business in helping clients to cut their costs. “Outsourcing is fabulous,” says Maurice FitzGerald, head of Strategic Initiatives at HP’s technology solutions group for Europe, the Middle East and Africa. “In our EDS business, the outlook for sales has never been in better shape. What that says is more large corporations are considering outsourcing for short- and medium-term cost cutting.”



As manufacturers struggle to survive in one of the toughest economic environments they have seen for decades, they face myriad challenges. These range from currency fluctuations and downward

pressure on consumer product prices to customers’ falling inventories and concerns about the solvency of suppliers.

Up and down the supply chain, manufacturers are tackling a wide range of risks, from consumers’ reluctance to spend to falling sales among corporate buyers, who themselves are experiencing reduced demand for high-end products. Tightening access to credit also constrains supply chain partners, with many of the manufacturers we polled concerned that their suppliers’ businesses will fail altogether.

Accenture, a consultancy, carried out a survey in November 2008 of 40 chief procurement officers or equivalent executives. The results showed that almost 15% of respondents said suppliers had been put out of business or forced to merge with other companies and nearly 20% reported that their suppliers were unable to meet supply levels.

Unsurprisingly, these problems are generating a certain level of pessimism among manufacturers. In our survey, many did not believe their company could achieve the same performance levels as 12 months ago in areas such as access to capital, profitability, return on equity and the ability to increase output.

Last November, for example, Toyota, a leading Japanese carmaker, said that it expected a stronger yen, higher input prices and falling demand worldwide to lead to a 74% drop in net profits in the financial year that began in April.2

Manufacturing output levels are suffering, too. US industrial production fell in March for the fifth consecutive month, by 1.5%, to its lowest level in more than a decade, while in February euro zone output fell by a record 18% from February 2008.

However, in many respects, manufacturers are exhibiting a higher degree of confidence than might be expected. Many believe they are well positioned to retain existing customers and attract new ones, to expand into new markets and to maintain a resilient supply chain.

Moreover, savvy companies are clearly aware of the need to continue to innovate and build their R&D capabilities, not only by investing in technology and forming partnerships with other organisations but also by linking innovation to performance management.

Many are also ready to address operational inefficiencies, to reshape their organisational structures and to rethink and strengthen their supply chains. For some, this means sourcing products and components overseas, particularly in emerging markets, which were identified by more than one-third of the manufacturers we surveyed as presenting the best sourcing opportunities in the next year.

Introduction

2 The Economist, “Japan’s economy: A tunnel, no light”, November 15th 2008.



Many of the challenging circumstances affecting manufacturers can be traced back to one factor: the credit crunch. This is reflected in the results of our survey, in which tightening credit supplies

and lack of access to capital emerge as strong reasons for pessimism. Less than a third of respondents describe themselves as optimistic about the availability of credit, while 40% are pessimistic.

The credit crunch hits manufacturers in a number of ways. Primarily, it has had a dramatic impact on spending, particularly on consumer durables such as washing machines and cars. In 2008, US car sales slumped, with Ford and General Motors (GM) seeing falls of more than 20% each, and Chrysler of 30%3. “The bulk of that sort of demand in the marketplace is provided by credit purchases,” says Richard Spitzer, managing director for automotive and industrial equipment at Accenture. “If you have to have a credit score above 800 to qualify [the scale in the US’s FICO creditworthiness score system ranges from 300 to 850], a lot of people will be falling off the demand tree.”

In Europe, some assistance may come from government stimulus packages. In the UK, the government is offering subsidies of up to £5,000 for purchases of electric cars, while in Germany the

Crunch, crunch, crunch

Overall business confidence

Availability of credit

Energy costs

Transport costs

Cost and availability of raw materials

Ability to retain skilled workers

Pressure on prices

Exchange rate movements

Supply base stability

Other, please specify

Please indicate your level of optimism with regard to the impact of the following factors on your company over the next 12 months. (% respondents)

1731242611

4142626245

352232336

241834357

151624469

2211195115

21740235 14

672639184

262233325

4881214135

Very optimistic Optimistic Neither optimistic nor pessimistic Pessimistic Very pessimistic Don't know/Not applicable

Key points

n Themajorityofmanufacturersarefeelingthesqueezewithregardstocreditavailability

nLackofaccesstocreditisaffectingnotonlythem,butalsotheirsuppliersandcustomers

n CEOsarerespondingbycuttingcostssharply.Joblosseswillcontinue

3 The Economist, “The car industry: The big chill”, January 17th 2009.


© The Economist Intelligence Unit Limited 2009�

government has launched a scheme giving car owners €2,500 for scrapping their old cars to buy new ones, a programme that is also being considered by the UK government.

In the US, vehicle manufacturers have responded by devising deals for wary consumers. To boost sales, US carmakers such as GM and Ford recently announced protection plans for buyers. These range from help with payments for a certain period of time if they lose their jobs to allowing them to walk away from loans or leases without negatively affecting their credit scores.

As domestic markets become tougher places in which to sell products, many manufacturers expect to have to increase their exports in the next 12 months. Of the manufacturers we polled, 46% say that they will increase exports, while 20% say that they will rely more on domestic markets.

However, it is not only consumers for whom restricted lending is causing problems. Corporate customers, too, are squeezed as lack of access to credit compromises their operations, particularly when it comes to larger capital investments.

Tetra Pak, for example, has noted little change in demand for its consumer packaging but is experiencing a slowdown in sales of capital equipment. “We’ve seen a reluctance during 2008 and 2009 to take on new big processing projects and new big packaging machine projects by our customers,” says Nils Bjorkman, executive vice-president for worldwide commercial operations at Tetra Pak. “They are trying to push back their timelines as well.”

For manufacturers in sectors such as electronics, corporate customers’ lack of access to credit has had a knock-on effect. “This is the crunch issue throughout the reseller channel,” says Maurice FitzGerald, head of Strategic Initiatives at Hewlett-Packard’s technology solutions group. “Credit is more expensive so they want to cut back inventory, and if they cut back too much on inventory that plays into the hands of some of our competitors.”

But if consumers and resellers are suffering from lack of credit, so are manufacturers themselves, who rely on it to buy components and raw materials. More than one-half (52%) of respondents to our

Failure of suppliers’ businesses

Lack of access to capital

Increasing volatility in the cost of raw materials and energy

Trade barriers and/or protectionist policies

Increased government regulation

Climate change risks such as prospects for more severe storms or droughts

Threats or interruptions to the power supply

Terrorism threats and geopolitical instability

Growing water scarcity


63

56

55

26

24

9

8

3

1

1

Which of the following factors are likely to have the most immediate impact on the resilience of your company’s supply chains?Please select up to three. (% respondents)

“This is the crunch issue throughout the reseller channel, credit is more expensive so they want to cut back inventory, and if they cut back too much on inventory that plays into the hands of some of our competitors.”Maurice FitzGerald, head of Strategic Initiatives at HP’s technology solutions group



survey cite tighter access to credit as hampering their company’s procurement strategy over the next year. Meanwhile, 56% point to lack of access to capital as having the most immediate negative impact on the resilience of their supply chains.

“Not getting credit is at the top of the list,” says ManMohan Sodhi, professor in operations management at City University London’s Cass Business School. “When you don’t have cash, you can’t buy raw materials; when you can’t get raw materials you can’t produce anything; and if you can’t produce anything, you can’t get any money from customers. So the credit crunch is the number one problem.”

Tighter access to credit also means that manufacturers need to do all they can to free up working capital. In our survey, improving access to working capital ranks fifth among the measures seen as improving companies’ cash positions in the next 12 months.

It is hardly surprising, then, that cost-cutting—particularly through lay-offs—emerges as a strategy that many companies are deploying. In April, for example, Sony-Ericsson, a mobile-phone maker, announced 2,000 job cuts in addition to the 2,000 it made last year. In our survey, 44% of respondents cite cuts in staff and benefits cuts as a means of improving their company’s cash position. Pushing back on costs is seen by 62% of respondents as the best way to secure the resilience of their supply chains, as will be explored in the next section.



While global capitalism is coming under scrutiny, the reality is that manufacturing supply chains are more dispersed than ever, both organisationally and geographically. Few respondents to our

survey (6%) say that their companies produce all their output abroad and most (39%) say that their companies manufacture their entire output locally. A similarly large group (38%) manufacture some of their production overseas, and the same proportion say that emerging markets will present the greatest sourcing opportunities in the next 12 months.

For many companies, these geographically dispersed patterns of procurement and production seem unlikely to change. “The majority of our products are manufactured in Asia—primarily in China, Vietnam and Indonesia,” says Erin Dobson, director of corporate responsibility communications for Nike, a footwear and apparel company, which uses more than 700 contract factories in over 50 countries to make its products. “There are no current plans to alter that focus.”

A number of factors have driven the global approach to manufacturing. For some companies, the desire to tap into lucrative government contracts is behind relocation to facilities abroad. The growth of middle-class populations in emerging markets such as China is also a factor. In our survey, 18% of manufacturers point to China as presenting the best prospects for sales in the next 12 months.

For Pfizer, a pharmaceuticals group, increased reliance on outsourcing also reflects a desire to be able to respond to changes in demand. “One of the major reasons for doing plant network rationalisation is that you remove fixed costs from your base,” says Tony Maddaluna, vice-president of global manufacturing at Pfizer.

Pfizer is currently implementing a plant rationalisation programme that will see the company make greater use of outsourcing. It recently sold its Latina plant in Italy, a transaction bringing the proportion of its outsourced output to 24%. The company expects this share to rise to 30% over the next two years.

As well as the desire to incorporate flexibility, drivers that affect Pfizer’s decisions on internal and external options in its rationalisation process include competitiveness, need for special technology, cost control and site divestitures.

The cost driver is a strong one for UK-based GKN Aerospace. “For us, it’s about how to keep ourselves in a position to deliver the most competitive offering—and that’s a balance of technology as well

Globally dispersed

Key points

nRationalisationofmanufacturingfacilitiesisinvogue

nEnvironmentalconcernsarealsoheightened,butprimarilywherecostsavingscanbeextracted



as price,” says Frank Bamford, the company’s senior vice-president of business development and strategy.

However, Mr Bamford also stresses the importance of looking ahead, to ensure investments in overseas production facilities or relationships with foreign suppliers pay off over the long term. “What we’re looking for is the economic stability around low costs,” he says. “If an economy is no longer low-cost in five years’ time, have you really got the benefit out of the move?”

As recession puts pressure on manufacturers to cut costs, the trend towards outsourcing is likely to gain momentum. “Companies are accelerating decisions that they might [previously] have taken at a more pedestrian pace,” says Mr Spitzer of Accenture. “Saving that amount of money in the near term is an imperative that is far greater than it was a few years ago, when everyone seemed to be riding prosperity.”

External attention on these issues will force us to alter our product range and/or processes

Addressing these issues will help us to reach new customers

Addressing these issues will generate cost savings for us

Addressing these issues will enhance my company's brand

Complying with these issues will drive up my company's process costs

Please state whether you agree or disagree with the following statements regarding the possible impact of climate change and environmentalsustainability issues on your business in the next 12 months. (% respondents)

49

40

55

26

36

51

60

45

74

64

Agree Disagree

Lean and green

If companies are looking to cut costs, one strategy allows them to do so while also addressing another big issue—environmental sustainability. Water conservation, reduced energy consumption and increased recycling can pay dividends in terms of operational cost savings. Envirowise, a UK government-backed environmental consultancy, believes that British companies could save £9m a day through water efficiency measures such as fixing leaks.

There is a growing body of evidence to support the idea that resource efficiency and environmental conservation can contribute to cost savings. In the US, when KKR, a private equity firm, and Environmental Defense Fund worked with Sealy, a bedding manufacturer, improvements in process efficiency generated by the collaboration saved Sealy more than US$4m in material costs. Moreover, reducing scrap per bed by 16% avoided 650 tonnes of solid waste.

“There are enormous opportunities in creating process efficiencies using environmental controls as filters,” says Erin Dobson, director of corporate responsibility communications at Nike, a footwear and apparel company. “Increased energy efficiency and reduced waste outputs, as well as harnessing the innovations that will come from working to solve environmental challenges, will provide unique opportunities for cost savings.”

Our survey indicates that many manufacturers see the benefits of energy efficiency. Energy consumption cuts is cited by 36% of respondents as the best way to improve their company’s cash position in the next year, and around 60% see environmental measures as helping to reach new customers.

However, a perception remains among some manufacturers that addressing climate change and environmental sustainability raises costs. A smaller proportion of respondents (45%) see this as generating cost savings than those who believe it would not deliver those savings (55%), compared with 64% who believe these measures would drive up their company’s process costs.


© The Economist Intelligence Unit Limited 2009�0

I f manufacturers have to keep an eye on their own financial health, they also have to be aware of what is going on in increasingly complex and geographically dispersed supply chains. Both

upstream and downstream, this is where tough economic circumstances may be having an impact. In recent decades, as global manufacturers have embraced just-in-time delivery and looked to

outsource increasing amounts of their production, companies have established extensive and complex supply networks across the globe. Boeing, for example, relied on more than 40 partners worldwide to develop and produce its 787 aircraft, with less than 10% of the responsibility undertaken by Boeing itself.

Prioritising speed of delivery and low inventories, manufacturers shipped goods only when retailers needed them. This approach to manufacturing has led to extremely close relationships between some companies and their suppliers. However, although such relationships enhance cost efficiencies and allow companies to tap into the innovation of their suppliers, they may be left exposed to any breaks in the chain.

More than one-half (56%) of our survey respondents cite failure of their suppliers’ businesses as the factor most likely to hamper their company’s procurement strategy in the next 12 months. A total of 63% say it is their biggest concern when considering the resilience of their supply chains.

Securing the chain

Pushing back on costs

Conducting more thorough due diligence on our suppliers

Increasing the number of our suppliers

Sourcing suppliers closer to home

Reducing the number of our suppliers

We will not be making any changes


62

49

31

29

26

11

4

Which of the following steps will your company take to ensure the robustness of your supply chain over the next 12 months? Please select all that apply. (% respondents)

Key points

n Just-in-timesupplychainshavehelpedcutcostsandboostresponsiveness,butarealsocreatingagreaterexposuretoriskduringthecrunch

n Tosurvive,manufacturersaresqueezingsuppliersoncosts,butalsodiversifying


© The Economist Intelligence Unit Limited 2009��

On the other side of the chain, the financial health of customers is a worry, too. Customers’ solvency was cited as a concern by 38% of respondents. Our survey also asked manufacturers to identify the challenges facing their customers that would have the most immediate impact on their own businesses. Most (72%) selected a slowdown in their customers’ business, with downward pressure on prices ranking second (62%) and reduced demand for high-end products ranking third (40%).

Manufacturers are responding in several ways. First, they are conducting due diligence on business partners more frequently and more thoroughly. In our survey, this was the second most important step manufacturers were likely to take to shore up their supply chain, with 49% of respondents citing this measure.

Pfizer, for example, is conducting an ongoing review of its contract manufacturing to assess the financial situation of all its most important supply partners. “Where there’s a sole supplier, we have to be prepared to work with them closely,” says Mr Maddaluna. “If it’s a situation where we’re multiple-sourced, we can probably shift sourcing of particular products, so we’re pretty well diversified.”

If suppliers are in financial difficulties, companies can to a certain extent fill the gaps with pre-orders. “And now some stronger OEMs [original equipment manufacturers] are not so much extending credit but extending their credit rating to their suppliers when they have a critical supplier that cannot get things done because they don’t have good credit,” says Yossi Sheffi, professor at Massachusetts Institute of Technology and director of MIT’s Centre for Transportation and Logistics. “Naturally, they are taking on some risk, but it does not use cash in the short term.”

In addition, manufacturers are building greater levels of risk management into contracts, with the inclusion of a growing number of conditions. “There are a lot of ifs and buts,” comments Professor Sheffi.

However, building flexibility into the supply chain by identifying other potential suppliers is also seen as important, with 31% of the manufacturers we surveyed indicating that they would be increasing the number of suppliers with whom they do business.

According to Mr Bamford, GKN Aerospace was doing this even before the recession hit. “We’ve been planning our business to smooth the peaks and troughs with strategic supplier partnerships so when the downturn comes we can reduce our capacity,” he says. “And they’re working with more than one customer, which is why we’ve built a portfolio with multiple programmes and multiple customers—so we can shrink too.”

“We’ve been planning our business to smooth the peaks and troughs with strategic supplier partnerships so when the downturn comes we can reduce our capacity”Frank Bamford, senior vice-president of business development and strategy, GKN Aerospace


© The Economist Intelligence Unit Limited 2009�2

One business failure is another business’s opportunity, and manufacturers are seeing a variety of opportunities emerging from the downturn. At an obvious level, interest rates are lower. More

importantly, many rivals may fail, or have already done so, boosting the competitiveness of those who survive. New pools of suppliers and employees are also seen as beneficial by 27% and 30% of respondents respectively, and almost one-half (45%) say that the greater availability of talented workers in the labour market would be to their advantage.

“You can find highly competent talent that’s looking to go elsewhere, especially as in many companies the top executives are held in place by the promise of compensation in terms of stock options,” says Mr Spitzer of Accenture. “When stock options go so far underwater, you don’t have much retention.”

Fully 42% of survey respondents agree that there is an advantage in reduced competition as other companies in their sector fail. “There may be casualties in the process of the recession and there is the opportunity to complement your business with business outfall from those failings,” confirms Mr Bamford of GKN Aerospace.

Others see the downturn as a chance to snap up assets on the cheap. M&A possibilities rank highly

Glass half full

Greater availability of talented workers in the labour market

Less competition as competitors' businesses fail

Merger and/or acquisition opportunities

Lower interest rates

New markets opening up for low-cost products

Availability of new pool of suppliers

Opportunity to reduce debt

No opportunities are emerging


45

42

39

37

27

26

18

6

2

Which of the following factors do you believe will benefit your business in the current downturn?Please select all that apply. (% respondents)

Key points

n Despitethegloom,manufacturershavebeenboostedbyfallingrawmaterialcostsandlowinterestrates.Talented workers are also far easier to find.

n Forthosewithstrongbalancesheets,goodvalueM&Aopportunitieswillabound

n 45%ofexecutivesplantoinvestininnovation,inordertoremaincompetitive



(39%) of survey respondents as business opportunities. “You have to be smart about what you buy, but from an M&A point of view you’re seeing great opportunities,” says Mr Spitzer. In April, for example, Oracle announced it planned to buy Sun Microsystems while PepsiCo offered $6bn to buy its two biggest bottlers. The biggest recent M&A deals have been in the pharmaceuticals sector with Pfizer’s US$68bn acquisition of Wyeth and Merck’s US$41bn purchase of Schering-Plough. Even so, the pharma deals have been driven largely by the competition from generics than the possibility of snapping up cheap assets. At the same time, M&A activity has been hampered by the lack of availability of credit and continued uncertainty in the economy.

Despite this, seeking mergers or acquisitions is ranked fifth by respondents among strategies seen as likely to help their companies become more competitive. “Strong companies are looking at this as an unique opportunity,” says Professor Sheffi. “Sometimes, if two weak companies get together, they can make it because they can take capacity out of the system.”

At the same time, manufacturers are using the breathing space created by a drop in orders to pay some attention to their processes and supply lines. Some 63% of the manufacturers we surveyed identify addressing operational inefficiencies as an important tool for increasing their competitiveness. To achieve this, almost one-half (46%) say they would make changes to management and organisational structure.

However, innovation remains high on the agenda, with 45% citing investments in R&D for product and process innovation as a means of remaining competitive. “Companies that are in a better position to grapple with [the downturn] recognise that they can’t simply focus on operational effectiveness and cost cutting, but must make innovation and change a core part of the company,” says Scott Anthony, president of Innosight, a consultancy, and author of The Silver Lining: An Innovation Playbook for Uncertain Times4. “They recognise that tomorrow’s business will surely be different from today’s.”

Strategies for fostering this innovation range from technology investments (cited by 45% of

Addressing operational inefficiencies

Making changes to management and/or organisational structure

Investing in R&D for product and/or process innovation

Pulling out of less profitable markets

Mergers and/or acquisitions

Diversifying by entering new geographical markets

Increased use of outsourcing

Diversifying our product range

Seeking new partners for product or process development

Acquiring more skilled workers

Investing in manufacturing facilities in emerging markets


63

46

45

32

28

27

26

26

22

21

18

3

What strategies will help your company to improve its competitiveness in the current downturn?Please select all that apply. (% respondents)

“Strong companies are looking at this as an unique opportunity, sometimes, if two weak companies get together, they can make it because they can take capacity out of the system.”Yossi Sheffi, professor at Massachusetts Institute of Technology and director of MIT’s Centre for Transportation and Logistics

4 Scott D Anthony, The Silver Lining: An Innovation Playbook for Uncertain Times, Harvard Business School Publishing, Boston, June 2009



respondents) to linking innovation to performance management (38%) and partnerships with other companies (35%). Only 9% say they would outsource R&D.

A focus on R&D, and on making use of existing assets, can clearly pay off. Rolls-Royce, the British engine manufacturer that 20 years ago was a loss-making company, has over the past few years reinvented itself to become the world’s second-largest maker of jet engines, partly because it is able to sell the services it has developed in business over the years. The company’s after-market revenue now exceeds that for its original equipment.5

A hybrid approach is another option. “We have quite a strong centralisation of our technology development based in Sweden and Northern Italy,” says Mr Bjorkman of Tetra Pak, “but over the years we have also been using satellite R&D centres to make sure we scoop up the good ideas and the local adaptations at an early stage.”

Some companies also see the slower pace of business as a good moment in which to make these investments. Although they may need to lay off workers, manufacturers can retain some key staff and redeploy them. “If anything, this has given us more time for innovation,” says Mr Bamford of GKN Aerospace. “It’s a time when you might be able to get away from the brick wall of operational delivery and start to think more about strategic performance and strategic development.”

This might mean closing unprofitable businesses or moving out of certain markets. In our survey, pulling out of less profitable markets ranks fourth (32% of respondents) in a list of strategies identified as important for increasing competitiveness.

Such moves are essential in a new era of constant turbulence in which the current downturn is simply another element, argues Mr Anthony of Innosight. “Companies should always be on the lookout for businesses that are past their sell-by date,” he says. “But companies are not particularly good at this—it’s easy to say yes, and hard to say no, and it’s even harder to stop.”

Chips with less fat

For Intel, a US semiconductor maker, the economic slowdown is providing valuable breathing space in which to conduct a streamlining of its business. “It’s a window of opportunity,” says Brian Krzanich, the company’s vice-president and general manager of manufacturing and supply chain. “If you were constantly at maximum capacity, you wouldn’t have the ability to make these kinds of choices.”

First, Intel is rationalising its manufacturing operations, closing smaller, older factories and moving into larger, more efficient factories, in some cases in more cost-effective parts of the world. It is soon to open half a million square feet of manufacturing space in Vietnam, while closing smaller plants in Pudong in Shanghai and moving that production to Malaysia and western China. “From a manufacturing standpoint, we will emerge from this with the ability to grow in a more efficient way,” says Mr Krzanich.

When it comes to external supply lines, Intel is cutting some

suppliers and working more closely with those it retains. “This is an opportunity to make more strategic alliances within your supply line,” he explains. “That gives us better costs long term and stronger relationships, and the ones that we stick with will remember us in the good times.”

At the same time, Intel is using the operational slowdown to work on speeding up the rate at which problems can be fixed or new products can be brought to market. “We have more capacity in this area,” says Mr Krzanich. “Rather than have that capacity sit underutilised, we’ve tried to turn that into better throughput times.”

By supplying customers such as Hewlett-Packard or Apple with early production and engineering samples, giving them more time to build their systems around Intel’s chips, those customers can be ready when Intel introduces new products.

“In busy times, it’s not that I can’t spend the money—it’s that I can’t afford to take the system down for 24 hours,” says Mr Krzanich. “So we’re trying to spend smart money now to make investments and to use our engineers to drive those improvements.”

5 The Economist, “Britain’s lonely high-flier”, January 8th 2009.



As our survey reveals, manufacturers are well aware of the risks and challenges presented by the current downturn. Difficulties such as price pressures, tightening credit and faltering supply

chains may well increase before any signs of economic relief start to emerge. However, many realise that simply cutting costs is a blunt instrument which can only go so far

towards strengthening their competitive position. While most may be forced to trim expenditure in some way, leading companies will recognise that taking more strategic steps can enhance their business both now and when the recovery materialises.

Measures include rationalising supply chains and establishing robust relationships, seeking new sources of supplies, walking away from some businesses while embracing others, and viewing operational slowdowns as opportunities to eliminate inefficiencies from their processes.

At the same time, savvy companies know that, to maintain their competitiveness, they must continually invest in innovation and, above all, move to embrace the constant change that is the global business landscape’s new reality.

Conclusion

�� © The Economist Intelligence Unit Limited 2009

AppendixSurvey results


Appendix: Survey resultsThe Economist Intelligence Unit conducted a survey of 354 manufacturing executives during February and

March 2009. Our sincere thanks go to all those who took part in the survey.

Please note that not all answers add up to 100%, because of rounding or because respondents were able to

provide multiple answers to some questions.

Operations

Production

Supply chain management

Procurement

R&D

37

27

21

9

6

In which of the following manufacturing activities are you directly employed? (% respondents)

We manufacture all of our end output locally

We manufacture most of our end output locally, but some abroad

We manufacture some of our end output locally, but most abroad

We manufacture all of our end output abroad

39

38

18

6

Which of the following is most true of your company's manufacturing operations? (% respondents)

Locally — same region as corporate HQ

Abroad — emerging market

Abroad — developed market

58

22

20

From where do you source most of your materials now? (% respondents)

Abroad — emerging market

Locally — same region as corporate HQ

Abroad — developed market

38

37

25

Which presents the best sourcing opportunities in the next 12 months? (% respondents)

Yes, exports will increase significantly (>10%)

Yes, exports will increase slightly (<=10%)

No change

No, we will rely slightly more heavily on domestic markets (<=10%)

No, we will rely far more heavily on domestic markets (>10%)

20

26

35

13

7

Do you expect the proportion of your output (by volume) that is exported to increase in the next 12 months? (% respondents)

17 © The Economist Intelligence Unit Limited 2009



Good, and we expect the outlook for our business to improve

Good, but we expect the outlook for our business to worsen

We are somewhat affected and expect the outlook for our business to worsen

We are badly affected and expect the outlook for our business to worsen

We are badly affected but expect the outlook for our business to improve

24

15

28

15

19

Which of the following statements best describes your business opportunities in the next 12 months for your company?(% respondents)

Good, and we expect the outlook for our business to improve

Good, but we expect the outlook for our business to worsen

We are somewhat affected and expect the outlook for our business to worsen

We are badly affected and expect the outlook for our business to worsen

We are badly affected but expect the outlook for our business to improve

17

15

28

23

17

Which of the following statements best describes business opportunities in the next 12 months for your sector overall? (% respondents)

Within the next 12 months

Between 12 and 24 months


I do not believe that our business will improve

I do not expect business to deteriorate

Don't know

We are not experiencing a downturn in our business

34

39

10

1

5

3

9

If you are experiencing a downturn in your business, when would you expect conditions for your company to begin improving again? (% respondents)

Within the next 12 months



I do not believe that our business will improve

I do not expect business to deteriorate

Don't know

We are not experiencing a downturn in our business

25

47

11

1

6

3

6

If you are experiencing a downturn in your business, when would you expect conditions for your sector to begin improving again? (% respondents)

Overall business confidence

Availability of credit

Energy costs

Transport costs

Cost and availability of raw materials

Ability to retain skilled workers

Pressure on prices

Exchange rate movements

Supply base stability


Please indicate your level of optimism with regard to the impact of the following factors on your company over the next 12 months. (% respondents)

1731242611

4142626245

352232336

241834357

151624469

2211195115

21740235 14

672639184

262233325

4881214135

Very optimistic Optimistic Neither optimistic nor pessimistic Pessimistic Very pessimistic Don't know/Not applicable




Greater profitability

Better return on equity

Access to capital at acceptable cost

Increased output volumes

Expansion into new markets

Supply chain resilience

Appropriate response to climate change risks and legislation

Retain existing customer base

Attract new customers

Compared to this time 12 months ago, what degree of confidence do you have in your company's ability to achieve the following,over the next 12 months? (% respondents)

11232202511

1123123248

21227272210

1133020307

1720263510

241837337

661336317

214234813

1412264412

Highly confident Confident Neither confident nor unconfident Unconfident Highly unconfident Don't know/Not applicable

Slowdown in their own businesses

Downward pressure on their own prices

Reduced demand from their customers for high-end products

Concerns about their own solvency

Demand from their customers for new products and processes

Demand for production and quality control


72

62

40

38

24

21

1

Which of the following of your customers' concerns are most likely to have an impact on your business in the next 12 months? Please select up to three. (% respondents)

Failure of suppliers' businesses due to the downturn

Currency fluctuations

Tighter access to credit

Higher prices for commodities/raw materials

Growing protectionism (export restrictions)

Increased regulation on environment, health and safety

56

55

52

42

29

14

What factors will hamper your company's procurement strategy over the next 12 months?Please select the three most important. (% respondents)

�9 © The Economist Intelligence Unit Limited 2009



Failure of suppliers’ businesses

Lack of access to capital

Increasing volatility in the cost of raw materials and energy

Trade barriers and/or protectionist policies

Increased government regulation

Climate change risks such as prospects for more severe storms or droughts

Threats or interruptions to the power supply

Terrorism threats and geopolitical instability

Growing water scarcity


63

56

55

26

24

9

8

3

1

1

Which of the following factors are likely to have the most immediate impact on the resilience of your company’s supply chains?Please select up to three. (% respondents)

External attention on these issues will force us to alter our product range and/or processes

Addressing these issues will help us to reach new customers

Addressing these issues will generate cost savings for us

Addressing these issues will enhance my company's brand

Complying with these issues will drive up my company's process costs

Please state whether you agree or disagree with the following statements regarding the possible impact of climate change andenvironmental sustainability issues on your business in the next 12 months. (% respondents)

49

40

55

26

36

51

60

45

74

64

Agree Disagree

Yes, they will increase substantially (>10%)

Yes, they will increase slightly (<=10%)

No, there will be no change

No, they will fall slightly (<=10%)

No, they will fall substantially (>10%)

9

38

30

20

3

Do you expect to have to increase your prices in the next 12 months? (% respondents)




Pushing back on costs

Conducting more thorough due diligence on our suppliers

Increasing the number of our suppliers

Sourcing suppliers closer to home

Reducing the number of our suppliers

We will not be making any changes


62

49

31

29

26

11

4

Which of the following steps will your company take to ensure the robustness of your supply chain over the next 12 months? Please select all that apply. (% respondents)

Greater availability of talented workers in the labour market

Less competition as competitors' businesses fail

Merger and/or acquisition opportunities

Lower interest rates

New markets opening up for low-cost products

Availability of new pool of suppliers

Opportunity to reduce debt

No opportunities are emerging


45

42

39

37

27

26

18

6

2

Which of the following factors do you believe will benefit your business in the current downturn?Please select all that apply. (% respondents)

2� © The Economist Intelligence Unit Limited 2009



By shortening or simplifying our supply chain

By reducing staff and/or cutting salaries and benefits

By seeking new partnerships with lower cost suppliers

By reducing energy consumption

By improving access to working capital

By raising product prices

By reducing the company’s product range

By deploying centralised procurement

By closing or mothballing domestic manufacturing facilities

By closing or mothballing manufacturing facilities abroad


46

44

41

36

34

23

23

20

19

12

5

How can your company best improve its cash position in the next 12 months? Please select all that apply. (% respondents)

Addressing operational inefficiencies

Making changes to management and/or organisational structure

Investing in R&D for product and/or process innovation

Pulling out of less profitable markets

Mergers and/or acquisitions

Diversifying by entering new geographical markets

Increased use of outsourcing

Diversifying our product range

Seeking new partners for product or process development

Acquiring more skilled workers

Investing in manufacturing facilities in emerging markets


63

46

45

32

28

27

26

26

22

21

18

3

What strategies will help your company to improve its competitiveness in the current downturn?Please select all that apply. (% respondents)




Cost of raw materials

Spending power

Process efficiency

Pool of suppliers

Pool of talented workers

Research and development capabilities

Regulatory environment

Intellectual property protection

49

38

37

30

27

17

10

9

Which of the following factors in emerging markets will have the largest positive effect on your business in the next 12 months? Please select up to three. (% respondents)

Western Europe

Central and Eastern Europe

North America

Middle East

Africa

South and Central America

China

India

Japan

Australasia

Other Asia-Pacific

15

7

17

7

4

8

18

10

2

3

9

In which regions do prospects for exports/sales look most positive for your company in the next 12 months? (% respondents)

58

11

14

15

2

We expect to increase our focus on innovation for both products and processes

We expect to increase our focus on innovation for products only

We expect to increase our focus on innovation for processes only

We expect no change to our focus on innovation

We expect to decrease our focus on innovation

Which of the following best describes your company's focus on innovation in the next 12 months? (% respondents)

49

45

38

35

23

21

17

9

12

3

Performance management

Investment in technology

Changes in organisational structure to reward innovation

Partnerships with other companies

Recruitment of increased numbers of skilled workers

Partnerships with universities

Establishing R&D centres

Outsourcing research and development

We do not intend to implement any strategies directly aimed at boosting innovation


What strategies will your company implement to increase its innovation capabilities? Please select all that apply. (% respondents)

Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this white paper or any of the information, opinions or conclusions set out in the white paper.

Cover image - © Stockbyte/Getty Images

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