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Why similar fabricators can have very different financial results

Disparate financial results show why people really matter

Source: Adjusted averages from the 2014 Financial Ratios & Operational Benchmarking Survey; numbers are for fiscal 2013.

Average out the diverse financial results that pervade this industry, and you get a 2013 that wasn’t the worst of times, but not the best of times either. That’s the takeaway from the latest Financial Ratios & Operational Benchmarking Survey, published by the Fabricators & Manufacturers Association International®.

Key metrics like EBITDA (earnings before interest, taxes, depreciation, and amortization) took a dive (8.4 percent average in 2013 versus 10.39 percent in 2012), as did sales growth (1.6 percent versus 8.7 percent). This isn’t surprising, considering the slowdown many experienced in the fourth quarter of last year (and going into the first quarter of this year).

One metric reveals a big misconception about U.S. manufacturing, particularly to those outside this business. Direct labor makes up only a little more than 13 percent of sales, on average, and that average has declined over the past two years. The indirect labor average, which last year was a little more than 8 percent of sales, increased slightly over the past two years, but not dramatically. Meanwhile, one expense continues to take the top spot: material. The direct material expenses average remains at a little more than 35 percent of sales.

Note that labor costs here don’t include health care costs, which for some shops can be high. A few shops reported that they pay more for health care than they do for all of indirect labor. Some of this may have to do with how indirect labor and other overhead costs are calculated. But no one can argue that for many shops, health care is a serious cost. A lot of this depends on company size, and small is the norm. A majority of respondents run small companies, most with fewer than 100 employees.

Small company size is one of several key areas in the survey that reveal a common thread throughout metal fabrication. Company size is growing, and this magazine’s annual FAB 40 report in June is testament to that fact. But these larger companies remain the exception, not the rule.

Another common thread is customer concentration. The adjusted average has remained at a little more than four customers making up 50 percent of company sales, and it’s taken from responses that aren’t all over the map—a majority of responses are on the low end. In fact, nearly a third said that only one or two customers comprise 50 percent of sales, and more than a quarter said that between two and five customers comprise 80 percent.

Combine small companies with small, highly concentrated customer bases, and you build a nightmare for the data analyst. A small company losing one large customer, or even a medium-sized customer, can change a balance sheet dramatically.

But diversifying is easier said than done. Market forces tend to push shops toward having fewer customers, not more. A fabricator gets its foot in the door at a large OEM, and over the years that OEM tries to streamline purchasing by reducing the number of suppliers it has, sending more work to top performers. As time goes on, the OEM sends the fabricator even more work, which pushes the fabricator’s revenue skyward. It also may well reduce the variety of work on the floor, which reduces variation and helps increase efficiency. Now the fabricator can develop “hard” cells dedicated to product families. Overall manufacturing time plummets. The fabricator buys more equipment and hires more people. Sales growth looks great—but still, managers find themselves in a conundrum.

Existing customers continue to parse their supply base and send more work to their best suppliers, their manufacturing partners. But for the fabricator, it’s difficult to hunt for new business, to diversify, when it’s trying its best to accommodate increasing demand from existing customers.

A shop can hunt for customers in different sectors with different business cycles, but it’s still a numbers game. Having only a few major customers means that significantly less business from one of them will probably hurt the income statement.

So what makes a successful fabrication business? Luck certainly enters into it. Say an executive at a customer, far up the chain of command from the purchasing department, is dealing with lower-than-expected sales and decides to make a change to hit a quarterly number, which forces the purchasing department to look for alternative suppliers with lower prices. Even if the overall cost of dealing with those low-cost suppliers is higher, the executive can at least tell the shareholders he’s doing something. Meanwhile, the decision may have forced the fabricator to lay off a dozen employees. Could the fabricator have done anything about it? Or was this just bad luck?

What may make contract fabrication so attractive isn’t average metrics, but their variety. It’s typical to think of manufacturers as having razor-thin margins, and certain respondents in the survey certainly reported some. But the most successful shops reported very healthy profitability, with operating profit margins near 20 percent and EBITDA margins at more than 15 percent.

In one sense, the variety of responses spells opportunity. Most fabricators don’t build or use proprietary equipment. Good equipment is a necessity for productive manufacturing, and buying a new laser cutting machine or robotic bending cell can give a shop a competitive edge. But there’s nothing legally stopping a competitor from buying the same equipment—and yet the financials between two seemingly similar fabricators can be so different.

Some of it may go back to the diversity of customers fabricators serve and the different prices they’re willing to accept. But I think it also points to the potential of change inside a company, be it implementing continuous improvement, improving customer or supplier relationships, or broadening the customer base. All three are easier said than done, but people need to do them; they can’t be automated. Machines and technology are the engine of this business, but smart managers, engineers, and technicians drive it.

About the Author
The Fabricator

Tim Heston

Senior Editor

2135 Point Blvd

Elgin, IL 60123

815-381-1314

Tim Heston, The Fabricator's senior editor, has covered the metal fabrication industry since 1998, starting his career at the American Welding Society's Welding Journal. Since then he has covered the full range of metal fabrication processes, from stamping, bending, and cutting to grinding and polishing. He joined The Fabricator's staff in October 2007.