Industry 4.0: Revenge of the U.S. Manufacturing Economy
Who doesn’t love Star Wars and how its heroes and villains continually battle themes of conflict and harmony. Surrounded by the myth and power of the mysterious Force, where would the Jedi be without Darth Vader? Equally provoking is to consider where would America be without its manufacturing base?
In contemporary industrial history, we are witnessing the transformation of the industrial sector. From technological and digital applications to existing machinery and equipment, speed, efficiency, low cost, customization and maximized profits are at the hands of more companies today than ever.
To move forward, we always need to first look back. The first industrial revolution started with the harnessing of steam whereby our factories and transportation modes were powered beyond the capabilities of man or animal power. Next came the introduction and application of readily available electric current to power business, residences, and the municipal grid. The third industrial revolution involved using computer power to perform complex problem solving, greatly enhancing productivity, with Moore’s law of transistors per square inch doubling every year relating to the improved worker productivity.
The fourth and current industrial revolution is centered on digital connectivity, the Internet of industrial things, artificial intelligence and smart machines. We could be in a “perfect storm” of industrial innovation and increased manufacturing activity in the United States. The following paper will cover manufacturing trends, trending fiscal policy, and forecasted economic environment to support the cusp of the Industrial 4.0 age that has just begun.
Manufacturing Trends
We are seeing more and more machinery that is aided or even fully controlled by computer equipment. Today’s “smart factory” could have some or all of the following features:
Remote operation: Smart steel mills today have robots, sensors and various levels of automation where the manufacturing process to produce steel can be all viewed, controlled and performed by a few highly skilled operators sitting in a protected, environmentally controlled booth eliminating costly labor and workmen’s compensation liability.
Technical assistance: Machines are equipped with sensors and artificial intelligence modules that “learn” how to reduce and eliminate waste in the manufacturing process as well as report real time production to their human operators. Other applications include monitoring equipment depreciation for either routine or preventive maintenance should components be ready for replacement or are on the edge of breakdown.
Design enhancement: Sensors and computer intelligence can use existing data to design new manufacturing processes for new products with little to no prototyping or sampling. The ability to maximize machine time for revenue generation increases productivity and profitability while reducing waste (i.e. cost) of developing new parts and/or products for customers.
Vendor to customer: The full digitization of a company’s operations is becoming more the norm for the middle market versus just for the largest companies (i.e. GE or Siemens). Linking your business vertically and horizontally whereby information flows and updates real time provides powerful tools to maximize work force, raw material inputs, asset utilization, and financing structure.
Manufacturing trends and the smart factory are calling for more expensive capital equipment requiring fewer employees to operate. This shift appears to favor the shareholder, but that would be short term in nature, as employees with experience and required skills will demand higher wages. Creating apprentice and training programs for future generations will be key to the maintaining the proper balance of new equipment investment and the supply of labor.
U.S. Fiscal Policy
You would have to be living in a cave for the past few months to not know that the United States is going under HUGE political and fiscal policy changes. The emergence of President Trump and the Republican majority of both houses of Congress create a recipe of economic and tax reform. The manufacturing community has already seen the impact of the change of party in the White House.
U.S. companies like Carrier and Ford have already announced changes to their previous plans to move some of their manufacturing outside the country, not investing cross border to make consumer durables. The implied potentially serious consequences for companies that do take jobs (and manufacturing) out of the country have potential positive future manufacturing investment implications.
While tax reform can take time and the new administration’s plans still opaque, initial tax reform regarding investment in capital equipment call for a company to be able to do either: a) fully deduct the cost of equipment acquired in the tax year of acquisition or b) deduct interest expense on the financing of the capital equipment over a reasonable period of time. Unlike today’s tax code whereby a company can deduct accelerated asset depreciation AND deduct interest related to financing, the current proposed tax plan calls for only one of the deduction techniques but not both. Another tax reform could come in capital gains tax reductions further spurring corporate development and investment.
Let’s not forget about the over $2 trillion of U.S. corporate cash still sitting offshore. The new administration is talking about a tax “holiday” for these companies to bring cash back on-shore and to re-invest. Even if these companies (i.e. Apple, Microsoft, GE to name a few) just returned the cash to its shareholders, then shareholders can decide if they want to re-invest in other companies that could use the investment – and support jobs.
Whether you are a fan of the new political administration or not, the potential changes on the horizon could be a growth catalyst for U.S. manufacturing and support the continued improvement in U.S. employment.
Economic Landscape
As we enter 2017, U.S. manufacturing is supported by economic tailwinds not felt for some time. The prolonged period of low-to-no economic growth and “zero” short term interest rates made U.S. businesses hesitant to invest in their capital assets. Machinery and equipment depreciated annually and some assets (think technology) become obsolete after a relatively short period of time without replacement or upgrades. Current forecasts call for 2% annual GDP growth and the incoming Secretary of Commerce wants over 3%, providing shareholders more confidence in making capital expenditures.
The Fed is signaling more strongly than ever that they will continue to raise interest rates due to economic strengthening and real inflation in the economy. When real inflation starts to outpace GDP growth, the Fed steps in with rate hikes. Higher interest rates float all interest and return boats making investments in capital equipment may make more sense to business managers.
The U.S. dollar has strengthened to levels not seen in a decade or more (last time Euro-USD parity was in 2002). While a strong U.S. dollar hurts exports, on the flip side, many foreign businesses seek to hold U.S. dollars and invest in the U.S. This benefits numerous U.S. manufacturers selling everything from office equipment to CNC machinery – and creates jobs.
Industry 4.0: The Future Is Now
As presented above, the confluence of technology, pro-business fiscal policy and favorable economic conditions should spur U.S. business investment in manufacturing. Smart machinery with human expertise can stem the migration of manufacturing to low labor cost countries. The psyche of the U.S. shareholder and business manager has gained confidence recently with slow but steady increasing economic growth and more favorable government support for business investment. Financing is abundant from both regulated banks as well as non-bank lenders covering more of the small business and middle market companies that were passed over in the financial crisis of 2007-10. Industry 4.0 today has the chance to make U.S. manufacturing – shall we dare to say – “great again.”
About the Author
Jeffry S. Pfeffer, Managing Partner, CapX Partners
In 1999, Jeff co-founded CapX and is the firm’s Managing Partner. His responsibilities include new business development, fund raising, and portfolio administration. Additionally, he serves as CFO for CapX, and is responsible for the firm’s SBA relationship.
Jeff has 30 years of small to midsize business finance experience focusing on delivering superior risk adjusted returns to CapX’s private investors. He co-founded the firm with Jim Hallene during an investment vintage when alternative secured financing strategies were deemed not “sexy”. To date, he and his partners have raised over $450 million of total capital in four funds and were instrumental in creating a new investment strategy for the SBIC Debenture Program. Jeff’s areas of expertise include equipment lease financing, mezzanine debt capital, and finding solutions to unsolved financing needs.
Prior to CapX, Jeff was a First Vice President/Regional Manager, responsible for a three-state region for Banc One Leasing Corporation. His career in investment management began as a credit analyst and commercial banker. In 1995, he started his equipment leasing career by helping create American National Bank & Trust Company of Chicago's (ANB) equipment leasing business.
Jeff holds a bachelor's degree in economics from Brandeis University and a master's degree in finance from DePaul University's Kellstadt Graduate School of Business. He has served on the Board of the Midwest Regional Association of Small Business Investment Companies (MWRASBIC) from 2006 to 2010 finishing as the region's President. Jeff is a member of the Association of Corporate Growth (ACG) and the Illinois Venture Capital Association (IVCA), and supports Link Unlimited as a member of its Private Equity Council. He is proud to be a member of the Board of Directors and Vice Chariman of the Executive Committee for the Illinois Holocaust Museum and Education Center. A golf and culinary enthusiast, Jeff lives in Deerfield, Illinois with his wife and two children.
About CapX Partners
Founded in 1999, CapX Partners (CapX) is a specialty finance company that focuses on private equity and venture backed portfolio companies looking for debt financing in the $2-$20 million range. CapX provides senior and mezzanine debt including lease lines and favors manufacturing, distribution, technology, energy and healthcare industries with an emphasis on revenue producing fixed assets. For more information on CapX, visit www.capxpartners.com.