February 2010 The RMA Journal

Economic Environment

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Metal Manufacturing Significant Risks and Hidden Opportunities

The RMA Journal February 2010 27

a significant challenge for lenders and operators alike.This article reviews manufacturing’s position within the

U.S. economy, focusing specifically on metal manufacturing industries—a sector that is representative of the declining fortunes of heavy industry. The unique characteristics of these industries are outlined with the aim of providing a workable framework for separating opportunities from risks.

Manufacturing’s Declining Share of the U.S. Economy The manufacturing sector’s contribution to overall GDP has been declining steadily since the early 1950s. The perma-nency and consistency of the decline are testament to the powerful and increasingly global competitive pressures that allocate productive resources (land, labor, and capital) to the most efficient producers. U.S. manufacturers have failed to gain resources, and the result has been a rise in the propor-tion of imports necessary to meet domestic demand.

The metal manufacturing sector is composed of 23 [de-leted “around”] industries as defined by NAICS. These industries generate 10.2% of U.S. manufacturing revenue and about 9% of U.S. manufacturing GDP. They supply an additional 91 industries with key inputs for their own businesses, and they purchase materials and parts from 36 [deleted “about”] industries for their own production processes. In total, metal manufacturing has a direct impact on the activities of more than 21% of U.S. industries.

Slower industry growth rates translate directly into more

by GeorGe Van Horn

While U.S. manUfactUring has been under siege from for-eign competition for decades, it remains the single largest industry contributing to American GDP. Employing more than 16.7 million workers, manufacturing is still a signifi-cant source for suppliers of materials, parts, transportation, and financial services. But navigating the slow-growth phase of manufacturing’s declining industry life cycle will remain

U.S. manufacturers

have failed to gain resources, and the result has been a rise in the

proportion of imports necessary to meet domestic demand.

February 2010 The RMA Journal28

difficult internal operating conditions. Relative declines in real revenue growth have the effect of 1) reducing operating flexibility; 2) increasing pressure on profit margins, sourc-ing, and investment; and 3) highlighting the urgency of

diversifying products and markets. The more urgent these changes become, the more limited is a company’s ability to adapt. By striving constantly to meet complex client requirements at thin margins, declining industries often are

Figure 2

Changing Importance of IndustriesShare of GDP by Industry Division

Source: IBISWorld

15.8% 17.0% 15.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2009 2013

Agriculture

Mining

Manufacturing

Utilities

Construction

Wholesaling

Retailing

Transportation

Communications

Finance & Insurance

Prop. & Bus. Services

Govt. Administration

Education

Hospitality

Health

Cultural and Recreational Services

Personal Services

Figure 1

Metal Manufacturing: Imports and Exports

Source: IBISWorld

60%

50%

40%

30%

20%

10%

0%

Exports as a percentage of revenue Imports as a percentage of domestic demand

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

The RMA Journal February 2010 29

highly concentrated in terms of the number of firms and, perhaps more importantly, are highly focused on specific end markets.

Despite the diversity of business characteristics across the 23 industries that make up metal manufacturing, 13 industries in this group sell more than 75% of their output to only three key end markets. For any single operator, such highly concentrated end markets produce significant business risks. Not only does the industry itself take on higher levels of risk, but it assumes a significant propor-tion of risk attributed to its key client. Moreover, despite the tendency for declining industries to produce large companies, these same industries tend to face reduced bargaining power as clients exploit lack of end-market diversity and the existence of overseas competition. Import competition brings greater risks for companies as foreign producers satisfy domestic demand that local firms would supply otherwise.

Industry Life CyclesDespite the long-term global trends affecting U.S. manufac-turing, every major manufacturing division is made up of a distinct collection of industries, products, and operators. In contrast to the trend in total manufacturing, the paths of individual industries can and do vary.

Within metal manufacturing industries, nearly all of the 23 industries have suffered declines in establishment counts and value added (the industry’s contribution to GDP) over the past five years. As such, nine “metal” industries are in the mature phase of their life cycles, and one industry is in its growth stage. However, some 53% of total revenue is earned within declining industries. Mature industries generate 41% and growth industries 6%.

Metal stamping and forging is the lone metal manufactur-ing industry in the growth stage of its life cycle. This segment has maintained its contribution to GDP during the past five years and also benefits from a low globalization rating. Imports make up only 1.2% of total domestic demand. The industry is shifting increasingly into the supply of high-value, high-growth products. Operators are manufacturing complex stamped and forged products, incorporating new metals and alloys, and taking advantage of technological engineering advancements.

A second (and mature-stage) industry example that gets high marks for adapting to new technology is the U.S. metal coating, engraving, and heat treating industry. This industry is mature in the sense that value added generally tracks the broader economy and there is an established repeat-customer base. That is, the product enjoys wholehearted market acceptance and market saturation. At the same time, the industry boasts a strong track record in productivity growth, and its service-based nature means that it is largely immune to import competition. The need to work closely

with specific customer specifications and turnaround times generally prohibits foreign sourcing options. Given its good productivity growth, technology smarts, and limited expo-sure to imports, this industry has the right combination of attributes to be a predictable performer.

Globalization It’s not a coincidence that the two industries with the best life-cycle characteristics also benefit from being di-vorced from the global economy. Globalization is likely the single most significant challenge to domestic manufactur-ers, their suppliers, and lenders. Our definition of globalization forces is based on the propor-tion of imports relative to domestic demand and exports relative to industry revenue. While foreign ownership of companies also is a contributing factor to IBISWorld’s globalization ratings, ownership structure has a less measurable impact on total industry performance.

Figure 4 documents metal manufacturing trade—in terms of the significance of industry trade dependence as well as the speed and direction of change. The graphic illustrates that all industries have experienced increasing levels of globalization throughout the past nine years as trade (both imports and exports) has increased. However, the speed and balance of globalization vary significantly.

Representing the primary stage of metal production, iron and steel manufacturing and copper refining are at opposite ends of the local-versus-global spectrum. While import dependency levels are widely different, both industries have shown only modest changes in import trends over the recent

Figure 3

Metal Manufacturing by Life-Cycle Stage(Millions of dollars in real revenue, 2009)

Source: IBISWorld

$260,059

$31,331

$202,172

Decline (13) Mature (9) Growth (1)

Import competition brings greater risks for companies as foreign producers satisfy domestic demand that local firms would supply otherwise.

February 2010 The RMA Journal

nine-year performance period. This result is in stark con-trast to the performances turned in by metal manufacturers further down the processing/fabrication chain.

Trade in processed metal industries shows different move-ments across two dimensions. Wire and spring manufactur-ing documents the sharpest increase in import dependency, whereas screw, nut, and bolt manufacturing follows a similar (though less abrupt) path. At the same time, valve, power boiler, and hardware manufacturing shows more balanced

trade growth. Nonetheless, even for these last three sectors, imports continued to increase their relative significance.

The speed at which change is occurring can be a signifi-cant business risk. Rapid change creates operating pres-sures that affect more than just financial performance. Lost clients are difficult to replace, and industry supply sources feel the impact as well. Increased pressure to make changes can lead to missteps, and the margins for error can be very small.

Figure 4

Source: IBISWorld

Impo

rts/D

omes

tic D

eman

d

Exports/Revenue

Import Global80

60

40

20

0

0 20 40 60 80

2000 2009

Power Boiler & Heat Exchanger Mfg

Hardware Mfg

Iron & Steel Mfg

Wire & Spring Mfg

Valve Mfg

Screw, Nut & Bolt Mfg

Copper Refining

Local Export

Figure 5

World Metal PricesIncluding IBISWorld Forecasts

Source: IBISWorld

8000

7000

6000

5000

4000

3000

2000

1000

0

Aluminium ($US/tonne) Copper (Dollars) Zinc ($US/tonne) Lead ($US/tonne)

30

The RMA Journal February 2010 31

Figure 4 also shows that, for all industries, exports in-creased as a proportion of revenue. Even declining industries can have dynamic companies that concentrate on growing productivity and investing in higher-value-added products. This approach not only allows those companies to defend their home turf from imports, but also to increase their potential market size by finding foreign buyers. Histori-cally, valve and power boiler operators have been successful innovators in the energy sector, and these advancements provided export opportunities. Indeed, new advancements, such as valves for automotive fuel cells, offer evidence that new products and designs can restore momentum in cur-rently defensive industries.

Another aspect of globalization is the purchase of inputs, and the story here has been fairly grim for metal manufac-turers. Figure 5 shows the change in metal prices over the past two decades. Manufacturers face record-high prices and experienced a significant spike in 2008. While primary metal operators (typically large, vertically integrated companies) benefited from the global economic expansion and rapidly rising metal prices, the good times were significantly diluted further down the processing chain, where operators were more exposed to rapidly changing prices. During periods of escalating prices, metal manufacturers are squeezed by rising input prices and the detrimental effect of higher prices on customer demand. Hedging and inventory control manage-ment offer companies the tools to moderate price shocks, but no risk management system offers complete protection.

The business “demographics” of the supply chain also

can add to downstream pressures. Since metal fabricator industries have thousands of operators, a single business has less negotiating strength than either the client (due to the concentration of end users mentioned above) or the supplier. During the next decade, it is highly likely that ad-ditional consolidation and increased merger-and-acquisition activ-ity within the fabricator sector will create fewer, but stronger, operators.

As illustrated in Figure 5, the outlook for metals prices and the associated risks for integrated primary metal pro-ducers and independent downstream fabricators is likely to follow a similar path to that of recent years. Overseas emerging-market growth will lead the demand for materials and moderately higher prices. While moderately higher prices will still benefit primary metal producers more than downstream fabricators, the disparity will likely be less than what it was during the 2005–08 period.

The Business Demographic Dilemma For companies doing business with metal manufacturing industries, globalization pressures present several business challenges:

Table 1

Best Performers 2000-2009 2009 Worst Performers 2000-2009 2009

< 1000 Enterprises Productivity Enterprises < 1000 Enterprises Productivity Enterprises

Industry Growth Units Industry Growth Units

Iron and Steel Mfg. 135.8% 185 Wire Spring Mfg. -7.4% 880

Copper Rolling & Extruding 148.7% 140 Aluminum Mfg. -2.3% 420

Non-Ferrous Rolling & Extruding 80.9% 405 Metal Tank Mfg. 1.3% 572

Copper & Non-Ferrous Refin. 54.0% 140 Hardware Mfg. 4.9% 711

Steel Rolling & Drawing 44.2% 360

> 1000 Enterprises > 1000 Enterprises

Ball Bearing, Ammunition, Other 53.0% 3630 Sheet Metal Window & Door -1.6% 7045

Machine Shop Services 41.0% 20200 Non-Ferrous Foundry Prod. 6.1% 1095

Metal Stamping & Forging 33.4% 2256 Hand Tool & Cutlery 17.3% 1250

Screw Nut & Bolt Mfg. 30.5% 2815 Valve Manufacturing 21.2% 1060

Metal Coating & Engraving 28.3% 5736

Productivity growth = revenue/employment

New advancements, such as valves for automotive fuel cells, offer evidence that new products and designs can restore momentum in currently defensive industries.

February 2010 The RMA Journal32

• Thedomesticindustriessufferingleastfromforeigntradepressures tend to be those dominated by large global players and relatively small U.S. company counts [not clear what this means]. While these large, integrated metal companies have been generally good clients, the limited number of businesses involved in the industry makes it a difficult market for new suppliers to break into.

• Formanufacturersmoreinvolvedwiththefabricationof specific metal products, increasing import penetra-tion raises risk. Since these industries also are more

likely to be composed of many medium-sized to smaller companies, there are lots of targets to pursue in terms of new business; yet iso-lating the potential sur-vivors from those with questionable prospects will take effort. • Askeyendmarketsfor metal manufactur-

ing are affected by globalization and begin moving ca-pacity from the United States to lower-wage countries, domestic suppliers either follow their clients overseas or are left with shrinking sales. Knowing your client’s clients will be a key to understanding what’s around the corner. Table 1 helps illustrate the current disparities between

metal manufacturing industries’ operating performance and company numbers. A broad productivity measure was used here since, in the long run, productivity growth is a meaningful indicator of a business’s ability to overcome a variety of external business obstacles, such as changes in domestic price levels and comparative wage differentials with foreign supply sources.

Productivity growth among the best performers has been aided by large, integrated firms benefiting from rising metal prices. Let’s take a closer look at some other key topics by industry: • Screw,nut, andboltmanufacturinghasperformed

reasonably well. More than 50% of industry revenue is associated with customized, precision-tuned prod-ucts, and these higher value-added products help buffer the declining revenues associated with mass-market products.

• Asaserviceindustry,machineshopsareprotectedfromdirect globalization forces. Key end markets remain closely tied to the equipment demands of major manu-facturers (aerospace, defense, auto, construction, and so on). While medical equipment is also a key end market, it represents only 10% of the overall market. Given the

sheer number of firms in business, technology adoption will be a key determinant of the winners and losers in the next 10 years.

• Ball bearing, ammunition, and other metal productmanufacturing benefits from low revenue volatility and the wide assortment of products included in the industry. Bearing application can be highly technical, yet the ma-jority of products remain tied to a cyclical customer base that includes transportation and machinery equipment, construction, and oil and gas.

• Wirespringmanufacturingisanexcellentexampleofan industry following its clients overseas. Standardized products and intense price competition show little sign of letting up even as the economy recovers. While industry revenue will receive some near-term support from U.S. infrastructure spending associated with the government stimulus package, increasing imports through 2014 will continue to pressure domestic output. Industry revenues through 2014 are expected to contract at an annual rate of 2.8%, in contrast to the annual declines of 6.2% in the preceding five-year period.

• Thefutureperformanceofthehardwaremanufacturingindustry hinges on American ingenuity. While increasing demand for security solutions will give a boost to product development, industry survivors also will need above-average productivity improvements in order to hold their own in the global economy. The industry was in a state of decline prior to the recession and will continue to underperform the U.S. economy as a whole during the outlook period.

ConclusionFor the majority of metal manufacturing operators, more stable input prices will be a welcome development given the experiences of the past five years. This is especially true for downstream fabricators and their customers. And while the likelihood of growing their way out of challeng-ing marketplace conditions is unlikely, a respite from the economic recession will offer surviving firms an opportunity to look ahead.

For lenders and other suppliers to manufacturers, the op-portunities exist beneath the industry headlines. They deal with more narrowly defined product classes that involve ef-fective use of technology, product development, and sound risk management of inventories and supply sources.

Although life cycles are difficult to turn around, they do restore themselves. An industry that reinvents itself can return to growth, but, unfortunately, only rarely does it exceed the heights from which it originally operated. v

••George Van Horn is a senior analyst at IBISWorld. Contact him at georgev@ibisworld.com.

For the majority of metal manufacturing operators, more stable input prices will be a welcome development given the experiences of the past five years.