EEF blog

Just under a month a go I blogged about our forecasts for growth in manufacturing sectors in the year ahead. At the time I pointed out that Other Transport – which includes civil aviation – was likely to be one of the strongest performing sectors this year.

Civil aviation has benefited from strong demand from the Middle East in particular, and an article in today’s FT points out that there are sizeable orders backlogs which should keep production growing for some time to come.

However, the article goes on to mention concerns about the strength of supply chains in the sector, though this is a broader issue affecting several manufacturing sectors. Many suppliers were badly hit by the previous recession, and some have since struggled to ramp up production in response to stronger demand. There is also renewed caution related to the ongoing crisis in the Eurozone.

The government’s Advanced Manufacturing Supply Chain Initiative (AMSCI) is taking steps to help build supply chains and last week Vince Cable announced £90mn worth of funding for 32 manufacturers to help build domestic supply chains.

On Monday we published Economic Prospects, 2011: detailing our views on what the year ahead is likely to hold for manufacturing. Over the last few days we’ve set out what we think are likely to be the biggest challenges for manufacturing in the coming year. These include: Eurozone instability; commodity price inflation; and access to finance. The fourth challenge is the likely impact of government spending cuts.

In 2011 government spending will fall substantially and manufacturers are concerned about the impact of this. Nearly one fifth of manufacturers expect to see a direct loss of orders. In addition, 40% of companies expect to see a loss of orders through their supply chains. It is not only lost orders that are a concern: a quarter of manufacturers surveyed were worried about cuts to business support programmes.

There is some good news too: one in six companies expect that the government’s spending cuts will make the business environment clearer, and a few saw new market opportunities arising from a change in spending focus. What is more, 45% of manufacturers thought that reducing the deficit would improve market confidence in the UK economy.

I recently came across this diagram, which will be familiar to most economists, of the standard boom/bust cycle.

What struck a chord is that some of manufacturers’ biggest concerns at the moment are:
- shortages of commodities;
- supply chain problems; and
- difficulties recruiting skilled workers.

So it looks like what we’re experiencing is “growing pains”.

No-one said that economic growth was easy!

Supply chains suffered in the recession. As demand waned many suppliers cut back sharply and decisively. Whilst this enabled many firms to stay in business, it is now hampering their responsiveness to the dramatic increase in demand since the recession ended.

Yesterday the FT reported that electronic component makers are now operating at 94% capacity, up from 56% last year, and many are struggling to keep up with orders. This, in turn, is reducing the ability of large multinational companies to respond to increased demand.

In the UK one sector that is particularly reliant on its supply chain is Aerospace and Defence. According to ADS there are over 9000 defence SMEs in the UK. These SMEs often supply niche or high-tech components for the large defence multinationals.

The problem for the UK defence industry is that these SMEs are now facing a “double whammy”. Having cut back during the recession, these businesses are about to be hit by large cuts in government spending.

Whilst the multinationals will undoubtedly be hit by spending cuts these businesses are much less vulnerable than their suppliers because they have many markets; BAE, for example, generates just 20% of its revenue in the UK.

This matters for the large multinationals and it matters for the UK’s future defence capabilities. If the UK’s supply chain suffers in the short term, the UK’s ability to compete in this sector could be permanently diminished. This has political implications, too. If the UK’s capacity to manufacture defence equipment is reduced then so too is our ability to respond to a changing defence situation.

Whilst there may well be a role for government in supporting the defence supply chain, businesses are also looking at ways to help themselves. Larger defence companies are aware that their suppliers are struggling, and recently there have been some examples of firms buying out suppliers rather than see them go under.

Suppliers themselves are also diversifying by moving into new markets where demand for defence is growing; and moving into adjacent sectors such as security and intelligence.

These strategies are not without risk, UK businesses are not the only ones seeking to increase defence exports in those countries where defence spend is growing, however, it is this kind of adaptability that should stand UK manufacturers in good stead even in a tougher economic climate.