Potential headwinds for the manufacturing sector
The UK manufacturing sector is highly exposed to international demand, global supply chains, and trade policies…
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GEOPOLITICAL HEADWINDS, SUPPLY CHAIN RISKS, AND SHIFTING TRADE RELATIONSHIPS
The UK manufacturing sector is highly exposed to international demand, global supply chains, and trade policies. Exports are a much more important source of demand for the manufacturing sector than the overall economy. According to Oxford Economics, overseas sales represent 35% of demand for UK manufacturing output, compared with 16% across the broader economy. This means that shifts in international demand or trade policies can have a disproportionate impact on the manufacturing sector.
Conversely, weak domestic demand does not necessarily lower the outlook for the manufacturing sector. According to recent data (Q3 2024), domestic orders have weakened, but exports are performing well, with external demand appearing more robust than the domestic market.
Supply chains are and will continue evolving. Shifting procurement strategies (such as dual sourcing, or reshoring) may be driven purely by a need to protect order books from supply chain vulnerabilities, but there may be other reasons too. These may be connected to sustainability concerns or ESG reporting requirements. They may also be driven by government legislation and tax incentives. In the US, the introduction of the Inflation Reduction Act provided incentives to US manufacturers to base their supply chains within the country. This led to some instances of US manufacturers relocating their UK-based operations back to the US.
"Manufacturing operations tend to require a larger, more specialised workforce compared with storage and distribution operations (of an equal size)."
However, while the UK manufacturing sector may be somewhat exposed to foreign governments’ policies and other international externalities, shifting geopolitical relations are also producing tailwinds. Indeed, there are examples of companies reshoring operations. In 2023, Oxford Instruments, which designs and manufactures equipment for scientific researchers, decided to move its ‘sensitive products’, including quantum technologies, out of China due to geopolitical worries.
OPERATING COSTS AND ASSOCIATED RISKS
Wages and energy costs comprise a significant proportion of manufacturers’ operational costs. Some manufacturing operations rely heavily on labour, others on high energy consumption, and some on both. This can make businesses vulnerable to fluctuations in energy costs or changes related to their wage bills.
Labour costs
In general, manufacturing operations tend to require a larger, more specialised workforce compared with storage and distribution operations (of an equal size). Average wages in the manufacturing sector are high relative to other sectors and reported to be 10% higher than the economy as a whole. Employment densities also tend to be higher in B2 facilities than in B8.
According to the Employment Density Guide 3rd Edition (2015), B2 Industrial & Manufacturing facilities have an employment capacity of c.36 sq m per employee. For B8, Storage & Distribution employment densities range from 70 sq m per employee in Final Mile Distribution to c.95 sq m per employee in national distribution centres. This means that a manufacturing facility would be likely to have at least double the number of employees that a distribution facility would have and that wages typically account for a higher proportion of operating costs for B2 facilities compared with B8.
These higher operating costs associated with their workforce can mean they seek operational efficiencies in other areas. Manufacturers tend to invest heavily in technology to increase automation and improve operational efficiencies.
Rising National Insurance contributions
In the Autumn Budget, Chancellor Rachel Reeves announced an increase in employers’ national insurance by 1.2% to 15% while also cutting the threshold at which firms have to start paying the levy. Currently set at £9,100 a year, it will be reduced to £5,000 a year. Manufacturing businesses (along with businesses in other sectors) will face a higher tax bill in April as a result. The impact will be felt most by businesses with a greater reliance on labour, while more capitalintensive production will be better protected against this rise. Firms may seek to increase automation as a way to mitigate against these rises and improve productivity.
Energy costs
Compared with other segments of the economy, production industries are heavy users of energy and manufacturing sectors dominate the list of largest business energy consumers (by total usage). However, even within manufacturing, there is great variation in terms of energy usage and costs depending on the type of manufacturing taking place.
Its heavy reliance on energy meant the manufacturing sector was particularly exposed when energy prices surged in 2022. In Q3 2022, average electricity costs for manufacturing firms were 67% higher than a year earlier, while average gas prices rose 95% (y/y). This has a severe impact on production costs and an inflationary impact on producer output (factory gate) prices.
With utility bills hitting record highs, firms across all sectors have had to reassess their gas and electricity usage and exposure to volatile prices. On-site power generation and microgrid solutions are increasingly being explored by manufacturing firms to help mitigate power distribution and pricing volatility vulnerabilities as well as improve the sustainability of their operations.
COMPETITIVENESS OF THE UK GLOBALLY
The UK manufacturing sector is highly exposed to international demand, with overseas sales representing 35% of demand. The UK’s manufacturing sector must, therefore, maintain a competitive edge. This means positioning itself effectively in key, high-value growth sectors as well as maintaining a relative cost advantage within those sector specialisms.
Across the global manufacturing sector, skilled labour is becoming increasingly important relative to low-cost labour. Consequently, education policy will play a crucial role in equipping the UK workforce with the skills needed for manufacturing in the future. To remain globally competitive, the UK must implement an education strategy that prioritises the development of talent in science, technology, engineering, and mathematics (STEM).
Rising global competition underscores the importance of agility, specialisation, and sustained investment in cutting-edge manufacturing sectors. Emerging economies, especially China, are advancing from low-cost manufacturing to sophisticated, high-tech production. This evolution intensifies competition, compelling the UK to focus on industries where it has a competitive edge by fostering innovation, increasing R&D investment, and developing a highly skilled workforce.
A robust industrial strategy is crucial to keep UK manufacturing globally competitive, resilient to disruptions, and attractive for largescale investments. The COVID-19 pandemic and geopolitical tensions have revealed the UK’s dependency on imports for critical items like PPE and semiconductors. Strengthening domestic manufacturing is essential to enhance supply chain resilience and safeguard economic and national security. Notably, 70% of UK manufacturers believe a long-term strategy could accelerate reshoring efforts (Make UK).
GREEN LEASE CLAUSES
Investors are increasingly seeking green lease clauses to form part of their standard commercial lease agreements. A green lease includes clauses to encourage engagement and cooperation between landlord and tenant to improve the environmental performance of the building. For landlords, these clauses are viewed as ways to protect their assets, future-proof against upcoming environmental legislation and issues, and support environmental, social and governance (ESG) commitments and sustainability goals. They may also be obligated to include green clauses due to requirements attached to their planning or lending facility agreements.
Clauses may include obligations around the use, fit-out, management, and monitoring of energy usage, as well as environmental and building performance. Clauses may require tenants to undertake energy-saving initiatives, such as installing energy efficient lighting, heating, and ventilation systems, or to achieve minimum sustainability certifications (such as BREEAM In-Use) or Energy Performance Certificates (EPCs). They may also include policies on waste management or require environmental reporting and performance monitoring.
"Investors are increasingly seeking green lease clause to form part of their standard commercial lease agreements."
Some production and manufacturing firms may view green lease clauses as too intrusive, particularly if they include data sharing obligations. Manufacturing firms often don't wish to share this type of information as they may consider it to be commercially sensitive. They may also be viewed as restrictive if lease clauses seek to restrict tenant energy usage or alterations that might adversely impact energy efficiency (perhaps prescribing tenant’s fitting-out works are within certain BREEAM requirements). They may also prohibit manufacturers from making other changes to operational practices as they would like.
It is likely that we will continue to see a growing number of ‘green lease’ terms being proposed in lease agreements. The onus is on landlords and tenants to develop workable solutions or clauses that can accommodate the unique needs and operational practices within manufacturing sub-divisions while incorporating and promoting sustainable practices and protecting the underlying asset value.
