Building a modernized metal fabrication business strategy

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May you live in interesting times is a proverb attributed to an ancient Chinese curse. As such we are truly cursed in these exhilarating days of worker shortages, inflation, supply chain challenges, high interest rates, and other competitive forces. Many fabricators recovered from the pandemic very well, but with a few holes as key veterans retired from both the shop floor and the office. Customers are back with strong volumes and good pricing, but also with high expectations.

Fabricators seem to have better prospects than they’ve had in recent years, both with current and new customers. Reshoring is a priority for many OEMs across different industries to reduce the supply chain challenges seen over the past few years. They’re valuing local, nimble, and reliable suppliers over low-cost imports with delivery and quality concerns. Also, OEMs and Tier 1s are resuming the outsourcing of internal operations, which provides new opportunities down the supply chain.

Most fabricators are looking to expand capacity either with new capital equipment or the renewed trend of acquisitions, but this needs to be done smartly and in accordance with long-term strategic plans.

Resist Temptation

The abundance of available opportunities is exciting but also very risky. It’s tempting to justify new equipment with the increased quote and order rates, or even to support specific new-customer projects. Building a case to justify a desired new machine is a proper exercise, but equal effort should be given to how to manage existing resources to meet demand. Perhaps a swing shift would suffice for three months, or moving some jobs to older equipment could create the needed capacity. Fabricators need to save as much capital and floor space as possible to support their true strategic opportunities.

Quality investment in new manufacturing equipment is a core competency for many fabricators, with careful consideration of the new capabilities and capacity, targeting ongoing bottlenecks. This is considered maintenance capital for financial valuation, and subtracted from EBITDA (earnings before interest, taxes, depreciation, and amortization) to determine the amount of free cash flow that a company generates each year. Regardless, a healthy amount of capital expenditure should be planned into each year’s budget.

Also, many fabricators grew over the years by acquiring struggling local competitors, which provided some experienced workers and machinery that was pretty experienced as well. These opportunistic acquisitions are fun and relatively easy but rarely advance a company toward its strategic goal. I have seen many wrap up by closing the acquired plant within a few years and absorbing some of the employees, customers, and equipment. Such acquisitions provide a boost to growth, but at a real out-of-pocket cost.

OEMs and even large Tier 2s are teasing suppliers with new programs and increased volumes, often at the cost of extending existing payment terms to force their suppliers to fund more working capital. Several large companies have partnered with banks to help fund these extended payments, but these programs are similar to factoring and require approval of the supplier’s lender. Alongside this are emerging services like c2fo.com, which works with OEMs and retailers to use their excess cash to pay their suppliers directly, but at a discount.

OEMs are also reducing their inventory stock levels and pushing demand volatility onto their suppliers. Some are pushing for consignment inventory, while others manipulate their weekly releases to encourage suppliers to build extra inventory in case the shipping schedule is actually realized. Watch this build-to-customer schedule carefully, as I have seen several companies lately challenged with loads of finished-goods parts built on releases that the customer is not taking.

Save the Powder

Regional banks are suffering from the national banking turmoil caused primarily by risky and mismanaged investments made by a few large banks. This challenge is compounded by the continued concern of a pending recession that will tighten credit, impacting smaller companies the hardest. Even conservative regional banks are having to restrict their credit agreements with established customers, and previously simple extensions and waivers are subject to great scrutiny if allowed at all.

Members of the Fabricators & Manufacturers Association Intl. (FMA) have shown to be financially conservative, as evidenced in the annual “Financial Ratios and Operational Benchmarking Survey.” Interest rates are up 5 to 7 percentage points over the last year and don’t look to come down much through 2024. Many companies have been negatively affected by the interest rate increase, especially if debt levels have increased over the last year on the line of credit. Interest expense grows quickly when the rate is triple on a revolver that has doubled.

2023 is a good year to be extra conservative financially, at least until the banking turmoil settles down. This will require continued balancing of customer expectations with present resources. A quick weekly cash status meeting is helpful in identifying where cash is tied up, what is coming in, and what is going out. A 13-week cash forecast, which includes a debt service installment, is a very useful one-page analysis that lays out the planned activity for the next three months. Also, thoughtful monthly reviews of all inventories will help sharpen purchasing and production planning.

In early summer, I visited a plant overflowing with raw material—copper coil was everywhere. It turned out that the regular supplier had pushed out deliveries, so the plant ordered extra from a second vendor to ensure it would not run out. Well, both suppliers delivered in May, so the plant ultimately purchased about 50% more than it needed. Much of the extra copper will be consumed in the upcoming weeks, but at this writing, it will have too much still on hand at the Q2 quarterly close.

Most FMA members in the annual survey have built a cushion to normal bank covenants, and as a result have capital available not just to survive a possible downturn but also take on a key strategic opportunity.

Invest in the Team

Most fabricators have a wave of retirements coming in over the next five years. A couple a year doesn’t sound too bad, but remember that these key team members took 20 years to get to the productivity level that we savor now. Many new hires do not have the zest for hard work that their parents did, as they have grown up with technology that their parents did not have.

Also, many have not done much physical labor before—I know 30-year-olds who have never mowed a lawn or trimmed a bush in their lives. It is a cold reality for both new hires and the companies that hire them. For many arriving at work for the first day, it’s their first day of real work ever. We can continue griping about it or build a plan to help them grow and succeed.

We see different attitudes and work ethics from generation to generation. “The great trouble with baseball today is that most of the players are in the game for the money and that’s it.” Ty Cobb said that about 98 years ago. If he could only see the players today! Even so, most have a great passion, toil in the minor leagues for years, and take extra batting and fielding practice with physical training just for the chance to make the major leagues.

Welcome your new hires. Make sure they have a good first day and first week. Years ago, new hires were grateful just to get a job, and our new hires are grateful as well—but to most it is like they have been transported to a foreign planet.

A proper orientation softens the shock and helps overcome the inherent fear that comes with a new job. Assigning a mentor is a good practice in addition to the normal supervisors and HR reps. A good plant tour, product introduction, and some general training also are beneficial. Remember, a new hire doesn’t need to generate production from hour one.

Build the Plan

A consistent 5% compounded annual growth rate will allow most companies to continue in a similar state for as long as the owners are fully engaged and active in daily operations. The company won’t grow much in size or value, but it still provides a great benefit to customers, suppliers, and employees. It’s a company to be proud of, for sure, but more dramatic growth rates require something more: a proper strategic plan. Now is the ideal time to build one.

Fabricators need to build a plan with tangible strategic goals that are three years out. Strategic goals leverage existing company strengths against real opportunities that, combined, will add a significant mix of new customers, products, and perhaps geography.

The top one or two goals will lead the company’s evolution and provide meaningful growth, but if pursued properly will consume a significant portion of leadership time and financial resources. That is why 95% of companies do not do strategic planning—the plan is hard work and the goals are even harder. But the only way to grow faster than the market average is by realizing strategic actions. They do not have to be risky, and they actually can improve the company’s long-term risk profile.

Use Powder to Grow Value

Companies need to grow their value continually, not just for potential sale value but to provide long-term health for owners and employees. Stagnant companies are actually declining in value each year, even if profits are stable. The two factors of a company’s real value are profit (usually EBITDA) and a multiplier (known as the multiple) of profit that represents many important factors including present health, growth plans, and earnings potential. Today, average company multiples are around three times EBITDA, down one or two multiples (turns) from a couple of years ago when interest rates were very low. That represents the company value with zero debt, so loans are subtracted from the company value to reflect the net cash value.

Again, the value is not just a consideration for a company sale but is absolutely considered in financing, employee well-being, and eventually even a transaction within the family. While current EBITDA and net income are critical, strategic actions grow the multiple of a company along with the current earnings.

Generally speaking, two strategies can increase the value of a company’s multiple value: (1) new products that are profitable and provide significant revenue, and (2) a process that generates new customers providing sales growth above 10% annually. Each of these strategic actions shows that a company has the ability to grow beyond the market rate, which in turn shows the ability to grow earnings.

Both approaches result in increased revenue, but from different angles. New products may take a few years of R&D, raw material testing, and processing trials. Acquiring new customers usually involves a commitment of additional sales resources to target an underserved region or perhaps a different industry that may have a need for existing products.

Stay the Course

Turbulent times call for steady hands on the wheel, and that is the environment we have been in for the past several years. As things calm down a bit, it is important to keep a keen focus on the company’s goals and not get too content with the good achievements that keep the business healthy. These wins are wonderful and should be celebrated, but do they bring the company closer to its strategic goals in a sustainable way? Looking back, most companies can recognize the turning points that made the current success possible, but they need to focus their attention and resources on the strategic goals that will transform them once again in the future.