Automation and Lean Manufacturing: Boost Profits, Squeeze Employment
Despite industrial production reaching all-time highs in August of this year,1 employment in the manufacturing sector remains substantially below levels witnessed before the 2008–2009 recession. When looking at longer term employment trends in manufacturing, it becomes clear that companies increasingly boost production without adding incremental labor. Profit margins, while not yet recovered to pre-recession peaks, endure at historically high levels. Several long-term changes in the manufacturing economy contribute to this divergence: outsourcing, automation, and lean manufacturing.
Prior to the 2001 recession, manufacturing employment followed a predictable cyclical pattern: contraction during recessions followed by strong recovery in subsequent years. However, beginning with the March 2001 recession, manufacturing employment has faltered and remains at depressed levels.
Trends in outsourcing have had the largest impact on labor-intensive industries such as apparel and textiles. Textile and fabric mill employment fell from 773,000 in 1987 to 254,000 in 2011, while apparel-related manufacturing period. The comparative labor advantage of low-cost countries, such as China, has proven irresistible for manufacturers of relatively homogeneous, technologically undifferentiated products.
Despite outsourcing fears, however, the US remains a manufacturing powerhouse with record levels of industrial output. Since the government began tracking data in 1992, capital goods shipments per manufacturing employee have been on an inexorable march higher, increasing from an average of $2,800 per month per employee in 1992 to nearly $6,900 in 2012.2
So, how are industrial firms able to generate ever-higher levels of increased automation and the proliferation of lean manufacturing throughout the industrial economy. The answer, we believe, is increased automation and the proliferation of lean manufacturing throughout the industrial economy.
We are still a long way from running the so-called “lights-out”3 factories envisioned in the early 1980s by then General Motors CEO Roger Smith as a competitive response to the rise of Japanese auto manufacturers. There are signs, however, that manufacturers are increasingly using robotics and automation for tasks once accomplished by laborers. In early 2004, the Robotics Institute of America estimated that 137,000 robots toiled tirelessly on the factory floor.4 By the end of the third quarter 2013, that number increased to 230,000, representing a 5.6% annualized growth rate.5 Manufacturers have also improved production efficiency through the use of programmable logic controllers and computer numerical controls to aid production. This partially explains why private, nonresidential investments in equipment and software have increased 29% since 20096 while manufacturing employment growth remains tepid coming out of the 2008–2009 recession.
The rise of automation has been particularly unkind to workers with lower levels
of education. From 2000 to 2012, all workers in manufacturing faced a 23% decline in employment, much of which was concentrated among workers with less than
an associate degree (-18.0%). Workers with bachelor’s degrees (-6.5%) and higher (+19.0%) were much more resilient. The increasing use of ever more sophisticated automation spells doom for those without the requisite skills to implement, maintain, or interpret the machines. 7
Lean manufacturing’s impacts on employment are also widespread, though difficult to quantify. While Toyota’s Taiichi Ohno pioneered lean techniques with his Toyota Business System, industrial companies have adopted lean manufacturing on a broad scale. This has lead to nimbler supply chains, just-in-time inventory and batching, elimination of waste, and constant demand for cost reductions from business units. The effects of lean manufacturing contribute to employers’ reticence to hire, given that they can make their existing labor force more efficient through continuous improvement and by requiring less inventory to generate each dollar of sales. As larger companies adopt lean principles throughout their supply chains, they create a vicious cycle where fewer and fewer employees are needed throughout the production process. This effect is perhaps best illustrated by the declining ratio of manufacturers’ inventories to sales over time. Though the ratio is a bit higher than pre-2009 recession levels, the trend of lower inventories has been fairly consistent since data collection started in 1992.
Doing more with less has kept capacity utilization stubbornly low, reaching only 77.5% in October.8 If the global economy continues to mend itself and production marches higher, companies may have to spend more to increase productive capacity. Trends in automation and lean manufacturing point to a higher likelihood that companies will invest in fixed capital as opposed to more labor.
The effects of employing increasingly sophisticated technologies and supply chain methodologies appear to be driving higher peak- to-trough profitability for industrial companies. As a result, industrial profit margins have been higher in each of the last two recessions.
Implications for Investors
Investors may be adjusting to the new reality of higher “through-the- cycle” profitability. The S&P 500 industrials sub-index is up 105.3% from March 2001 to September 2013 versus the S&P 500’s 85.2% return. Currently companies within the S&P 500 industrials index are trading at 18.5 times trailing twelve month earnings compared to a historical median of 19.3 times. As investors recognize what may be a structural shift in profitability, historical valuations applied to cyclical equities may prove too pessimistic. At current valuations, we do not consider industrial companies expensive. While profitability held up well in the past two recessions, we will look to future cycles of industrial production decline for evidence of a permanent structural change. As businesses increasingly invest their capital to drive efficiencies and profitability, companies with exposure to automation and tightly controlled supply chains should do well. Companies without the foresight to fully implement automation and lean manufacturing are likely to fall behind.
Footnotes
1 FRED Database, series INDPRO
2 FRED Database, series UTCGVS / MANEMP
3 “Lights-out” is terminology used for a fully automated factory with no human presence.
4 Robotic Industries Association.“North American Robot Orders Jump 17% in First Quarter of 2004,” May 4, 2004.
5 Robotic Industries Association.“North American Robotics Shipments Up, Orders Down for First Nine Months of 2013,” October 29, 2013.
6 FRED Database, series NRIPDCA
7 Levinson, Marc.“Job Creation in the Manufacturing Revival,” Congressional Research Office, June 19, 2013.
8 FRED Database, series MCUMFN
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