Rebuilding Manufacturing after COVID-19

As someone who has had a 30+ year career working in Australian manufacturing, the current renewed interest in manufacturing is one of the few positive aspects of the Coronavirus crisis. The need for Australia to manufacture more products for itself has been a constant focus in the media in recent weeks. This is welcome and represents a tremendous opportunity for an industry that still employs almost one million people, mostly in high paying full time jobs. So how can we rebuild Australian manufacturing?

Avoiding the Mistakes of the Past

Australia’s modern manufacturing base was established after WWII to provide employment for a growing population in our large cities. The approach was “Fortress Australia” with tariffs set at a level that ensured manufacturers had to establish Australian factories if they were to compete. The result of this policy was small scale uncompetitive factories aimed solely at the Australian market. Inflexible industrial relations and rent seeking behaviour by companies and unions lead to excellent profits, but woeful productivity. There was also little incentive for companies to keep their factories up to date with investment. As a result, when the Hawke Labor government brought down tariff walls in the 1980’s many Australian manufacturers were ill equipped to compete. Therefore, trying to boost manufacturing by reimposing tariffs or other forms of protectionism is not the answer to rebuilding manufacturing.

However, the decline in Australian manufacturing was not just due to lower tariffs, cheap Chinese labour or bad Australian unions. In fact there were many other reasons for the loss of production. Some of these included:

• Collapse of upstream and downstream supply chains – Often when key suppliers or customers closed down, other companies in the supply chain could not sustain their operations – even if they themselves were competitive.
• Failure to reinvest – Many Australian factories, particularly in large companies, are old, with equipment that is decades old. Eventually it becomes cheaper to just shutdown than bring the factory up to date.
• The spike in the Australian dollar and in wages driven by the mining boom.
• Corporate incompetence –  The 1980’s and 1990’s financial masterminds behind leveraged buyouts have a lot to answer for. They destroyed many good Australian manufacturers by stripping out too much cost and saddling the businesses with debt.
• The “branch office” mentality – Why keep a factory in Australia going when you can just add an extra production shift on to your factory in Bangkok, Atlanta, Hamburg or Gothenburg? When the chips are down, most corporates will protect their home market and home operation first and sacrifice “branch offices” like Australia.
• Products die – The federal government invested $50 million in Kodak’s factory in Coburg and then digital photography came along. Likewise, it was the advent of the SUV that really killed Australia’s car industry rather than a lack of government support. You can’t stop the product lifecycle, but we can do more to ensure that new products developed here are made here.

We therefore need to consider all these factors as we rebuild manufacturing, not just labour costs.

Building a Competitive Manufacturing Sector Means Globally Competitive

Contrary to the views promoted in the media, Australia already has many of the elements required to build a competitive advanced manufacturing sector. We have a relatively young, highly educated workforce with excellent engineers and scientists, a culture of innovation, big modern cities with excellent infrastructure, plentiful raw materials and strong research institutions. We have two big disadvantages – our location in the South Pacific and the fact that we have a relatively small domestic market.

Therefore, the only way we can build a sustainable medical device industry to make ventilators (for example) is by applying our skills and inventiveness to design and build the best ventilators in the world and exporting them. This is not as fanciful as it would sound. The world leaders in bionic hearing devices and sleep apnoea equipment are located in Sydney’s North Western suburbs and the world leader in high precision metal grinders is based in Melbourne’s outer eastern suburbs. In each of these cases, the companies are global leaders based on the strength of their technology. This enables them to achieve scale in manufacturing and R&D by exporting the majority of their output. Unfortunately too few companies have made this step to world scale and we need to find ways to help more to do so.

Ownership Matters

Australia prides itself on being open for foreign investment. We are a net importer of capital. However, well publicised decisions to block investments have protected critical infrastructure, key resources and farmland from foreign ownership. Similar concern has not been shown for Australian intellectual property. As a result, a pattern has been established. Australian innovators establish a new product, commercialise it and break into global markets. At that point a major global corporation notices the Australian company, buys it out, closes the Australian facility and integrates both the production and the Australian know-how into their overseas operation.

This has been the fate of Tasmanian designed underground mining vehicles (now made in Thailand), Australian (CSIRO) developed chemical analysis equipment (now made in Malaysia). Even the base technology of our polymer banknotes is now foreign owned with the majority of manufacturing located in Canada and the UK. This does not have to happen. When Ford sold Volvo cars to Chinese manufacturer, Geely, the Swedish Government insisted that the company’s head office, research and development and a significant part of production remain in Sweden. This was despite Volvo cars being almost bankrupt at the time of sale. Retention of Australian developed intellectual property and manufacturing capability therefore needs to be considered in the evaluation of the foreign purchase of any Australian technology company.

Research and Development Crucial

Over the past 20 years incentives for research and development have been progressively cut back. While the 150% tax write off for research and development spending was subject to some abuse, it also incentivised a lot of good private sector R&D. If Australia is to create a leading position in key sectors, businesses must invest in innovation, the simplest way to do this is probably through a more generous, but carefully managed tax incentive scheme.

A further issue is the failure to commercialise research in Australia. I believe that part of this problem is the tendency of researchers to look overseas first to find areas of research. So, for example, Australia now has several government and university funded centres around the country focused on Nano technology. It is an exciting field, but there are almost no established applications in Australia and no companies with the capability to uptake the technology. A quick look at the websites of these nanotechnology centres shows that they are largely focused on partnerships with overseas companies who will commercialise their technology outside Australia.

Instead of looking overseas to see “whats new”, researchers and government agencies should take time to understand Australia’s existing core competencies (the things we are already good at) and build on those. For example, we are world leaders in mining, but much of the equipment on our mining sites is German, Japanese, American or Swedish. We have world leading composites expertise but lack a number of links in the composites supply chain to really build a world scale industry. The biggest application for composites, wind turbine blades, are all imported. We have some of the best medical research in the world and good capability in pharmaceutical and medical device manufacturing, but much of our medical research is commercialised offshore by foreign companies.

As well as incentives for doing R&D, there should be incentives for commercialising innovations in Australia. For example, future research funding could be tied to metrics around past commercialisation success. Universities and institutions that demonstrated that their research was commercialised locally could receive additional funding compared to those that just sell or hand their research to foreign companies. Equally governments should be entitled to claw back with interest R&D costs on developments which are taken offshore.

Incentives for Companies to Re-tool for the Fourth Industrial Revolution

A key reason why many Australian manufacturing sectors failed was a lack of investment in new productive technology. A fourth industrial revolution is currently underway driven by “cyber physical systems”, machines that interact seamlessly with the internet and respond automatically to their environment. Manufacturers need incentives such as accelerated depreciation to encourage them to invest in retooling plants with the most advanced technology. Such incentives must be targeted at investments in productive assets and not items like company vehicles and office fit outs that often seems to be the case now. Likewise access to competitively priced finance for such investments needs to be provided to enable businesses to fund investment in technology and growth.

Another relatively simple change would be to outlaw extended payment terms more than 30 days. By demanding payment terms of 60 days and beyond, big companies in Australia deny growing small and medium companies vital capital. This represents billions of dollars of working capital could be used to invest in new technology or market development rather than being used to artificially improve the balance sheets of those big corporates’.

Targeted Government Procurement

The success of the Scandinavian countries in building innovative technology businesses is well known. Less well known is the role of government in this. By strategic use of preferential government purchasing, the Swedes, Danes and Finns have nurtured the development of world leading manufacturing businesses in areas such as mobile telecommunications equipment and wind power. Meanwhile the US has used military spending to build its overall leading position in high technology.

In Australia, we have tended to take the low road, purchasing in technology from overseas rather than patiently nurturing indigenous capability, accepting that there will be failures and allowing time for the local providers to grow. It is a tragedy that some of the best photovoltaic technology was developed in Australia, but we now import all our solar panels. The current crisis provides a window of opportunity to change this approach. It would be very surprising if we do not at least see governments preferring Australian suppliers of pharmaceuticals, medical supplies and devices. However, this lesson needs to extend beyond healthcare into other areas of government procurement.

This does not mean governments have to pay more. On the contrary, we should discourage subsidies. Instead governments need to set challenging performance and competitiveness targets for suppliers to meet and then patiently support them to meet those targets. There is a precedent for this. The car industry, lead by Toyota have done an outstanding job of developing the capability of local suppliers in almost every market they have worked in. There are efforts in this direction already with government supported supplier development programmes in defence and rail production. These can be extended and enhanced in to other sectors such as medical supplies and infrastructure.

Developing our Management Bench Strength

Much has been made of the quality of Australian management over the years. I have spent many hours in factories around the world and believe that when it comes to small and medium enterprise, our businesses are, on average, no better or no worse managed than those in Europe, China or North America. However, there is room to improve. The complacency developed in the protected years of the 50’s, 60’s and 70’s still exists and too many businesses are satisfied to offer mediocre quality and second best service in the belief orders will always come. Manufacturing is a technology business and too many of our leaders in manufacturing companies, both large and small, lack technology qualifications. That said, having more engineers in leadership positions is not the only answer. When I closely observe successful European companies, I see that brilliant marketing is often core to their success. These businesses are fascinated by their customers, not by their own factories.

A lot of management focus is placed on our SMEs, but I think they are less of a problem than the management of Australian big business. Many of our largest manufacturing and service businesses are monopolies or oligopolies. These businesses are focused on retaining their market share rather than innovating and really competing. As a result, their managers are often good cost cutters, but not entrepreneurs or innovators. This explains why these businesses have performed so poorly when they have attempted to compete overseas. In Australia more aggressive anti-trust action to break up some of these oligopolies and opening some of these upstream markets to more competition could benefit the whole manufacturing sector.

A Positive Future

Until the arrival of the pandemic, the past three years have been good for Australian manufacturing. Despite the closure of Automotive assembly, manufacturing was the largest contributor to full time jobs growth of Australia in 2018. All this has been turned upside down in four short weeks with the Covid 19 pandemic. However, on the other side of this disaster, lays a potential world, where manufacturing is once more seen as a growing and essential industry for Australia. The opportunity is here – it will be up to leaders in manufacturing and government to seize that opportunity.

The challenge is to learn from the lessons of the past and ensure that manufacturing in Australia is as good or better than any in the world and can truly compete and thrive on a global stage.