Supply chains could suffer if they are unable to access finance and credit
The idea that the economy is genuinely beginning to recover is so seductive that it may seem odd to consider the dangers that this improvement presents to engineering firms. But some are now warning that supply chains could suffer if they are unable to access the finance and credit they need to serve growing demand from customers.
Organisations such as the EEF have consistently highlighted access to finance as a key issue for manufacturers during the financial crisis and the recession. Now the worry is that this factor will also bedevil companies as the recovery takes place.
Andrew Churchill, chief executive of JJ Churchill, works in the aerospace and power generation markets. He argues that, although a business may shrink in a recession, its cash position can actually improve in terms of working capital. “I am not a doom-monger,” he says. “I am a glass half-full person and I am really looking forward to a resurgent manufacturing economy, and economy as a whole.
“But this introduces different risks: they are not new, they happen in every recovery, but they are the sort of risks that are a bit counter-intuitive.”
Of prime importance is availability of cash in terms of both working capital and growth capital. Chris Spedding, head of aerospace and defence at Lloyds Bank, says: “What we see as a bank fairly frequently is that there’s as much risk in terms of financial strength in an upturn as there is in a downturn. In fact there’s more because cash flow gets really stretched, and that’s when companies struggle.”
Take, as an example, the aerospace market. The sector is doing well but OEMs are placing pressure on engineering firms in the supply chain to cut costs while also pushing out their payment terms, typically to 75 days.
But since firms at the bottom of the chain, such as suppliers of forgings or castings, operate on a one-month basis, it’s possible for them to become severely squeezed – especially if they haven’t got ready access to credit.
And a sudden need to bring in lots of stock because of soaring demand can be a financial headache. Predicting demand in an upturn can be difficult, if not impossible, for companies at the bottom of the supply chain.
Churchill says: “The cash crunch is getting worse. The OEM customers are demanding ever longer periods of time to pay. Further down the supply chain, if I paid my suppliers at longer than 30 days they’d be out of business.”
OEMs are also looking for signs that suppliers have the financial wherewithal to fulfil long-term contracts. Delays to aircraft projects are sometimes blamed on an inability to get the supply chain in order at the beginning of the manufacturing programme.
With these pressures in mind, the EEF once again highlights availability of credit from the banks as a crucial issue. Andrew Johnson, the organisation’s senior economist, says small firms in the engineering supply chain that rely on the banks for this support are still struggling to access finance.
“Following the financial crisis,” he says, “there was an extended period where credit was more difficult to access for smaller companies than it was prior to the crisis. Some of that was admittedly due to availability being too loose prior to 2008, but nevertheless
we think things have gone too far the other way.
“The cost, terms and conditions for credit and to some extent the availability of credit are less than ideal,” he adds.
Spedding of Lloyds says the bank has a duty to help customers negotiate risks as aircraft programmes move forward. “We understand the risk to our clients and we need to continue to ensure we understand the industry. We need to make sure we’ve got the right products and understanding of the business to have the right conversation when the upturn happens. And then we can try to help where we can.”
He adds that he understands the attractiveness of the aerospace sector to new entrants. “Once you’re on that programme you can be supplying parts for a very long time,” he says. “It’s brilliant if you’re in that space and able to defend it. To know you can have 20 years of replacement orders – it can sustain the company.”
The EEF is expecting the banks to release more credit than they are doing. Johnson claims that access to growth capital is particularly challenging. He adds that the banks are at least working with major manufacturers to try to gain a better understanding of their order books and the impact these will have on the supply chain.
“It may make smaller firms better propositions for lending if the banks understand what their customers are up to,” he says.
Attractive sector: Aerospace programmes can sustain suppliers for decades
Another issue that needs to be considered is that OEMs in the automotive sector sometimes own the tooling used by their suppliers, so it is not available as security when applying for a loan.
If supply chains are not able to cope with increased demand, the result will be that UK plc loses out on orders, warns Johnson. “Will supply chains crumble? I don’t know about that: but if the UK is not ready to take advantage of new orders they will go overseas. That’s a realistic concern.”
Churchill says: “We did see some companies go under in the last upturn and, even if that doesn’t happen, what it will do is reduce working capital, which in turn reduces the amount of capital channelled toward growth.
“Why is that important? Well, in an upswing it’s really important to be anticipating tomorrow’s increased demands, in terms of capacity, people, innovation and technology.
“If we’re anticipating a resurgent economy, manufacturing needs to be prepared for the future.”
Fortunately, he adds, engineering firms protected their skills bases during the financial crisis more than they might have done in the past. “Once you lose people from skilled manufacturing it’s hard to get them back,” he says. “They are lost to the industry. I think that was well anticipated in the supply chain. In the last upturn following a recession I saw suppliers taking more than a year to get skills back into the business. I don’t think we’re going to get the same quanta of problems this time.
“An area that I think is a big problem is our level of capital investment in innovation – levels in the UK are about half that of Germany.”
Johnson concedes that, as well as supply issues, there has been a choke on demand for credit too. “It’s not fair to say there isn’t a demand issue – there is. We’ve had a long period of weakness. People are thinking twice about investing.”
But he believes that “at least two major banks” are still in a position where they need to reduce their overall lending. “That is a big problem in the UK where the market is so concentrated – rightly or wrongly.” He adds that many more loans are declined by banks in the UK than in competitor nations in some parts of Europe.
“I think there have been aspects of the way that relationships have been handled during the financial crisis, recession and afterwards that mean a lot of firms have been turned off even approaching the banks,” he says.
“We have a banking system that’s trying to recover from the worst financial crisis in 80 years, and firms in the UK are particularly reliant on banks. And even though options are emerging, it’s going to take time.
“We need a more dynamic, diverse and competitive banking industry.”