Weak export demand is responsible for UK manufacturing sector’s fragile recovery

The UK manufacturing sector is indicating signs of a recovery, driven by increased domestic demand that has boosted output and new orders. Confidence is also supported by normalised inventories which have in turn reduced suppliers’ delivery times. These improvements represent a bright spot amid ongoing challenges including weakened export demand, geopolitical events, and persistent supply chain disruptions. Market position is often an important driver of manufacturers’ resilience to headwinds, although smaller companies tend to struggle more acutely.

The latest S&P Global PMI survey shows a return to growth for UK manufacturing after a year of contraction. In March, the PMI reached a 20-month high of 50.3, which indicates the first expansion (i.e., above 50) for the first time in almost 2 years. This improvement is primarily attributed to a resurgence in domestic orders, according to S&P Global. However, the industry continues to grapple with a significant downturn in export demand – a trend consistent across key European markets including France, the Netherlands, Belgium, and Poland, where orders have declined for more than two years. This export weakness is largely attributed to post-Brexit trade frictions and elevated global transportation costs.

Export Challenges

Exports play a vital role in the UK manufacturing landscape, with overseas sales comprising 35% of total demand, compared to just 16% for the broader economy, as highlighted in a report by Oxford Economics and the Manufacturing Technologies Association. The same report indicates a 25% productivity boost within two years for manufacturers which enter export markets, attributed to exposure to more efficient practices and technologies and highlighting the benefits of international trade exposure. 

Despite the positive signals from the headline PMI data, the UK manufacturing sector faces several significant challenges. Rising freight costs and surging commodity prices fuel inflationary pressures, squeezing profit margins and influencing hiring slowdowns. The ability of manufacturers to withstand these pressures depends heavily on their market position and financial resilience. Larger firms with robust balance sheets are generally better equipped to manage these challenges. However, those operating in export-heavy submarkets face increased vulnerability. Smaller manufacturers, often crucial suppliers to larger companies, are particularly susceptible to fluctuations in customer orders and broader market uncertainties. These vulnerabilities are compounded by the interconnected nature of supply chains, where delays in customer orders can disrupt production schedules and cause ripple effects throughout the network. 

These challenges spill over into domestic demand as well. A stark illustration of these challenges can be seen in the UK train manufacturing industry. Hitachi Rail and Alstom, two industry leaders in the UK, are reportedly facing layoffs of over 2,000 workers due to a shortfall in orders. Their struggles stem from the cancellation of a joint venture contract they were awarded in late 2021 by the UK government worth up to £2.8bn to build 54 trains for the UK’s High Speed Two (HS2) railway. Prime Minister Rishi Sunak cancelled the contract last year to manage escalating costs. Japan’s Hitachi has warned of running out of work within a year, while France’s Alstom has initiated a €2bn balance sheet deleveraging plan and is considering a capital raise to maintain its investment-grade rating. Alstom has faced challenges such as inventory build-up and delays in receiving payment for orders, stemming from project completion delays. 

Geopolitical Risks and Supply Chain Resilience

Geopolitical events pose a significant threat to supply chains, potentially disrupting production schedules and increasing transportation costs. These disruptions are often unpredictable and have cascading effects. For example, earlier this year, Houthi rebel attacks in the Middle East disrupted Red Sea shipping routes, forcing automakers like Tesla and Volvo to temporarily halt production in Europe due to component shortages. In an environment where export demand remains weak, these disruptions underscore the urgency for manufacturers to increase supply chain resilience.

Manufacturers face a challenging trade-off: accepting delays caused by rerouted shipping due to geopolitical events, potentially impacting production schedules and frustrating customers, or absorbing higher costs by sourcing components closer to home, albeit at a premium. The inability to pass on these higher costs erodes profitability, especially for smaller manufacturers with limited financial flexibility. Manufacturers’ exposure to geopolitical risks and strategies for building supply chain resilience is an increasing focus for company boards, which must consider strategic supplier and location diversification.

Resilience to adversity

While signs of improvement in the UK economy provide some optimism, ongoing disruptions from external factors like geopolitical events continue to challenge manufacturers. BTG Advisory is well placed to help manufacturers enhance their financial, operational and supply chain resilience. We work with manufacturers and their stakeholders to assess risk areas, develop mitigation strategies and understand the financial consequences of these.
Please do not hesitate to contact us today to see how we can help.