Supply Chain Mastery is Critical in 2019

In the near term, manufacturers who develop a mastery understanding of their supply chains—which in many cases have and will continue to be shocked by regulatory changes—may be able to convert this into a competitive advantage, and thus an opportunity to capture new business.

Based on aggregated figures, 2018 is likely to conclude as one of the best years for U.S. economic growth in recent history. This growth, combined with that anticipated in 2019, however, comes at a time during which the business environment is being affected by a growing list of both domestic and global economic and political factors. As such, the vision of the path forward for virtually all manufacturing leaders has become opaque. In the near term, manufacturers who develop a mastery understanding of their supply chains—which in many cases have and will continue to be shocked by regulatory changes—may be able to convert this into a competitive advantage, and thus an opportunity to capture new business. Also, based on the lessons learned from the Great Recession, manufacturers must think strategically about the types of new business they should seek and make customer diversification a significant part of their growth strategy.

Automotive. The automotive industry continues to track along the same trends as reported at the end of 2017 and throughout the year in Gardner Intelligence’s end-market reports. Unit sales continue to show a growing preference for SUVs and light trucks over cars. This trend is not new, as unit car sales, which peaked in June 2014, have experienced an average 7.5 percent rate of annualized contraction in the 17 quarters since then. Truck and SUV sales continue to offset the weakness in car sales, which has kept total vehicle sales since mid-2015 at a monthly average of 1.4 million vehicles or 17.3 million units on an annual basis.

Vehicle financing plays a critical role in this market. Recent years of historically low interest rates and lengthening financing terms—allowing for smaller monthly payments—supported by an improving jobs market have significantly helped the industry. By mid-2018, the average amount financed for a new vehicle stood at $30,262. Adjusting for inflation, consumers spent almost 9 percent more on a new vehicle in mid-2018 than they did in mid-2012; however, most of this increase occurred after reaching the 2015 peak.

Based on the Energy Information Administration’s short-term energy outlook, West Texas Intermediate oil prices are projected to remain at their present level of around $70 per barrel, leaving fuel prices through 2019 relatively unchanged if all other things remain constant.

The creation and increasing availability of new engine and drivetrain types and technologies to the market has and will continue to create a need for expanding supply chains and supply networks. At the same time, providing an abundance of such new technological options reduces the total number of units produced of any single product, leaving fewer units of production to cover the fixed costs of development and production. This explains the rising cost of automotive manufacturing, which has steadily accelerated since the beginning of 2017. Making the matter more challenging will be the number of new North American launches in 2019 (40) and 2020 (38).

The result of all these factors in the coming year will put an emphasis on cost controls for manufacturers. Regulatory changes, consumer changes, more competition among brands and their growing array of models will cause supply chains to find ways to further cut costs in order to find profitability without the benefit of higher volumes. For many manufacturers, this may mean that keeping a technological advantage over the competition may be one of the best ways to stay competitive and profitable.

Medical. The medical industry continues to be a bright spot in manufacturing as Gardner’s latest financial review indicates on-going growth in revenues, earnings, free cash flow and capital expenditures. The latest results signaled a slight increase in the growth rate of capital expenditures. The most significant financial improvement in the industry was in earnings growth, which turned positive during the second quarter after contracting during the prior two quarters.

Capital expenditures, which includes spending on manufacturing and equipment, grew from 2.8 percent in the 12-month period ending in the first quarter of 2018 compared with 3.7 percent at the end of the second quarter of 2018. This reverses the slowing growth trend in capital expenditures, which began after capital spending growth reached a peak of more than 17 percent in the first half of 2017. An analysis of quarterly data between the fourth quarter of 2014 and the second quarter of 2018 indicates a statistically significant relationship between revenue change during a given quarter and a subsequent change in capital expenditure change two quarters later. From this simple linear regression analysis—which considers no other factors—and assuming an accurate forecast of revenues based on a composite Wall Street forecast, this model predicts total capital spending growth of 11.3 percent during calendar year 2018 followed by slowing growth of 6.6 percent in 2019.

Gardner’s business index data of manufacturers supplying the medical industry is copacetic with Wall Street’s near-term optimism. According to Gardner’s survey data in the year-to-date period, medical industry manufacturers have experienced strong growth in new orders, production and more recently, supplier deliveries.

Aerospace. The aerospace market is and will continue to be a bulwark of the manufacturing space over the coming years with annual growth in the aircraft market from 2018 through 2022 expected to be 5.8 percent. The largest growing segments, in dollars, will include commercial air transportation followed by business jets and military aircraft.

Of the many positive factors that will expand the demand for air transportation services in the coming years, International Air Transportation Association’s (IATA) model for passenger growth in a contracting globalization scenario would cut air traveler growth by almost 30 percent from 8.2 billion to approximately 5.7 billion. The Association’s October survey of airline CEOs indicates that 60 percent of them expect higher passenger demand and 52 percent expect higher freight demand over the next 12 months. While these results are good, they are lower than survey results from the prior two quarters. This may suggest that near-term growth may experience more headwinds, the report indicated that a significant cause for concern involves the growth trade tensions between the U.S and China.

Outside of commercial markets, the demand for military aerospace products cannot be understated. Military demand is often driven by programs, which in the near future will be robust. The U.S. Air Force’s requested budget for 2019 at $156.3 billion is a 6.6 percent increase over the prior year’s. Specific and significant aircraft programs recognized in the budget include the procurement of new fighter jets and aerial refueling tankers.

The combined outlook for the industry generally points to long-term growth based on solid fundamentals. Growing global demand for air transportation services combined with muted expectations of oil price volatility as previously discussed should provide many carriers with the confidence necessary to grow their businesses in the coming years.

Tariffs. Tariffs have played a significant role in affecting business during the second half of 2018. The U.S. has been adjusting its trade position not only with China during 2018, but also many other nations. The latest tri-lateral agreement between the U.S., Canada and Mexico may see NAFTA replaced by a new tri-lateral agreement. In addition, Britain’s exit (“Brexit”) from the European Union is due to occur in late March 2019.

In short, U.S. manufacturing will see significant impacts to the agriculture, aerospace and software industries because of the changing trade stance between American and China, Canada and Mexico. While China is the largest trading partner with America, almost 80 percent of that trade is imports from China. Conversely, when examining exports, America’s exports to Canada, at almost 49 percent of total U.S.-Canada trade, represents a value that is 220 percent higher than America’s exports to China. The situation is similar with Mexico. In total, U.S. exports to Mexico and Canada are more than four times higher than to China. Imports from China equal more than 80 percent of total imports from Canada and Mexico to the U.S.

Manufacturing executives who take a nuanced approach to navigating the current and pending trade volatility should consider if their greatest exposure(s) is on the supply side or on the sales side of their business. For example, are most of your firm’s customers domestic while your supplies are imported? Or are your supplies domestically produced, while your most significant consumers are foreign-based? Correctly answering this question will likely require learning more about your supplier’s supplier and your consumer’s consumer. In Gardner Intelligence’s consulting work with clients, we find that a firm must have a strong understanding of their supply chain and revenue risks before determining how to use limited resources to effectively and efficiently maintain and further grow a business.

By diversifying across end-markets, a company may also be able to mitigate the unforeseeable impacts of the latest trade tariffs along with those trade changes that have yet to fully materialize. Doing so will allow manufacturers to take advantage of a broader range of unforeseeable market opportunities while also hedging against being overly exposed to a single unforeseeable market event.

Throughout 2018, there have been several rounds of tariffs put into place that have affected the price and volumes of aluminum, steel and machine tools of various kinds. In late September, the third and most significant round of Section 301 tariffs took effect, impacting $200 billion of imports across more than 5,700 tariff lines. Gardner’s material prices reading indicates that almost every production machinist experienced material price increases, resulting from either the on-going economic expansion, tariffs or most likely both influences.  

Of the thousands of products which have been affected in 2018 due to tariffs, production machinists will find that their input costs for aluminum and metal barstock may be most susceptible to price rises in 2019.