Priorities for manufacturers adapting to the new economic environment

Industrial companies face a shifting economic landscape, with higher costs of capital, long-run inflation, continued risks of supply shocks and globalization evolving into regionalization. The emergence of this new regime, alongside softer demand in certain manufacturing sectors, is forcing businesses to rethink how they create and sustain enterprise value.

Even though conditions may be improving, companies need to adapt to the new norm of higher rates, higher inflation, constrained resources and an overall higher level of economic uncertainty. These factors have led to persistent margin pressures, even as supply chain challenges and materials costs have eased. Strategic planning now requires integrating the higher cost of capital into decision making, emphasizing the need for more disciplined capital allocation, smart investment choices and increased focus on operational strategy and excellence.

Key indicators

The stress manufacturers have experienced in recent years has led to softer sales and production output, rising inventories and contracting margins. Manufacturing activity has been contracting for most months since September 2022, according to the Institute for Supply Management. This changed in March 2024, when the survey registered expansion for the first time in 17 months with improving sentiment on new orders and production output.

This could be an early sign of improving conditions, which is also supported by rising production and sales, moderating input price inflation, improving inventories and a more favorable labor market. If rising productivity continues in the U.S. economy, that will generate conditions for sustained growth without creating unnecessary inflationary pressures. 

Still, as economic pressures persist, operational efficiency has come into the spotlight. Industrial company executives have in recent quarters cited operational efficiency on earnings calls and in their filings, acknowledging that it requires more attention from executive teams.

Company priorities in these new economic conditions include:
 

1. Revenue growth through product and distribution channel diversification: Businesses might adopt product rationalization focusing on a margin-accretive product mix, add-on services, software solutions and aftermarket offerings, as well as pricing optimization. In addition, manufacturers might consider investing in digital advertising and explore alternative distribution channels, such as direct-to-consumer online platforms to cut distribution layers, expand market share and get better access to end consumers.
   
   
2. Digital transformation and technological advancements: Adopting smart manufacturing technologies like data analytics, digital twins, robotics, connected infrastructure, predictive maintenance tools and artificial intelligence can help manufacturers on their digital transformation journey. These technologies can help them streamline operations, optimize resource management, adapt to demand changes, reduce manufacturing defects, innovate product offerings, and enhance customer and employee experiences.
   
   Creating agile and flexible production lines can enable companies to adjust production setups quickly and adapt to changes in demand or product specifications, reducing downtime and increasing throughput. Adoption of new technologies may require upgrading legacy systems and transitioning to cloud-based platforms to enhance scalability, connectivity and operational efficiency across the organization.
   
   
3. Supply chain and production optimization: Manufacturers should explore measures to optimize plant floors, distribution and logistics functions, and back-office processes. This might involve adopting lean manufacturing principles, standardizing systems and processes, identifying and eliminating bottlenecks, implementing closed-loop systems for real-time feedback and course adjustment, minimizing inefficiencies, and optimizing resource allocation.
    

4. Organizational and workforce optimization: Comprehensive organizational transformations can help align business models with market demands and operational goals, focusing on strategic resource allocation and enhancing organizational agility. In recent earnings calls, companies mentioned closing unprofitable operations, reducing the size of corporate centers and rethinking their geographical footprint and distribution models to improve proximity to consumer markets.
   
   Strategic partnerships, vertical integrations and acquisitions can all play a role in expanding companies’ capabilities, product and service offerings, and market reach. Rightsizing the workforce and removing duplicative management layers across the value chain can enable better decision-making.
   
   
5. Sustainability and energy efficiency: Incorporating sustainability and energy efficiency into manufacturing operations is a strategic approach that connects operational efficiencies with long-term sustainability goals, which by itself contributes to the enterprise value. Companies are exploring and adopting decarbonization and energy efficiency strategies, using renewable energy sources and cleaner feedstocks, recycling and reducing waste, and shifting to smart manufacturing and energy-efficient appliances. Tracking and reporting on sustainability efforts will also be critical.
    

In addition to internal operational improvements, market shifts and macroeconomic growth factors also play into the priorities listed above. Businesses need to leverage growth opportunities presented by secular trends, such as:

• The energy transition and growing adoption of green technologies fueled
• Rapid digital transformation, which is not only beneficial for companies to improve their operations but also creates growth opportunities and expands demand for many manufacturing and energy sectors
• A changing trade landscape, including industrial policies aimed at strengthening domestic manufacturing

The takeaway

By identifying and capitalizing on key value drivers and embracing a more disciplined approach to resource allocation and process optimization, businesses can achieve sustainable growth and maintain a long-term competitive advantage. Investing in innovation and productivity-boosting technologies, adopting lean manufacturing principles, optimizing supply chains and creating capacity for strategic investments will be crucial for manufacturers navigating current economic conditions and looking to capitalize on sector opportunities.