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By Joseph Bute, Jr., Steel Valley Authority

Manufacturing Jobs: The Trend Toward Decentralization

Since the 1970's large manufacturing corporations have increasingly become trans-national corporations. The low-wage off-shore competition facing American workers is increasingly organized and directed by large U.S. corporations. One result is that the wagesn workers have been declining at the same time corporate profits have been increasing. There is no longer a direct link between the profits of large corporations and the wages and benefits of employees.

But while large trans-national corporations are important, they are providing a declining proportion of total manufacturing employment. Manufacturing employment in the U.S. is increasingly concentrated in smaller firms with sales from $5 to $100 million or fewer than 500 total employees. These firms do not have the resources or organizational capacity to direct or organize production in off shore locations. These firms do not have the capacity to become trans-national corporations.

As a result of new technologies and processes in manufacturing, firms can become world class producers, often as a part of a de-centralized, but highly integrated, manufacturing system. Whether the label is flexible, agile, virtual, it all adds up to a substantial shift for manufacturing. For example, the U.S. is once again becoming the world's low cost producer of steel. New world class steel plants typically employ fewer than 500 total employees.

"Critical Middle" Firms

Based on a preliminary review of the actual distribution of manufacturing concerns in Ohio, Pennsylvania and New York it appears that the center of high skill, high growth manufacturing employment will be in those firms which we will call the "critical middle". These firms have $5 million to $100 million in annual sales. Most of these firms are single plant operations and the overwhelming majority of these firms are held privately.

This middle sized group crosses into every strategic manufacturing process -- from primary metals to machine tools to injection molding to fabrication and die-casting. They are essential components of most systems used by larger manufacturing complexes who now routinely assign component production work to them -- and in growing percentages. The middle is the heart of the system -- and as it goes, so goes the health of the manufacturing sector.

In a three state study (New York, Pennsylvania and Ohio) of manufacturing firms and plants, over 1 million of 3.6 million total manufacturing jobs were located in firms which had sales of between $5 and $100 million. Despite the significant differences between the three states in terms of manufacturing composition and vitality, the difference across states was only 4%. When employment from firms under $5 million was included, the share of manufacturing employment rose to 56% of the overall manufacturing group, including plants and divisions of the largest firms in the country.

According to Dun & Bradstreet, the three state study indicates that firms of $5 to $100 million will account for over 41% of the total sales revenue. Of $1.6 trillion in annual sales, this group accounted for over $650 billion. In a state-to-state comparison, the variation was modest, only 11% from lowest to highest.

When the reported sales of the firms under $5 million was added in, the three-state share of total reported annual sales grew to 68%.

With weighting so directed toward the firms in the middle, it is interesting to note the distribution of locations -- the middle market companies represent a handful of the total quantity of production sites in the region. Less than 11% of all locations in manufacturing go to firms with sales in the $5 - $100 million category.

In another analysis, a review of sixteen states with the highest concentration of industrial union membership yielded similar results. Here we measured the critical middle firms to be in the range of $1 million to $100 million in annual sales, this accounts for smaller firms in apparel and industrial machine areas. Their share of employment and sales revenue remained at significant levels regardless of the location.

There are key differences between these firms and the larger manufacturers. Among some of the most common:

• Closely held, often family based. These firms are often managed by individuals who are children or relatives of the founders of the firm. The firms are overwhelmingly private (over 92% of the study group) and the directors and management is often selected for their affiliation with the family - either by blood or professional association.

• Owner involvement in management. Very often, the controlling stock interest in the company is also the hands-on manager. There is difficulty in separating the management layer of the company from the ownership and control functions.

• Older, often needing modernization. The vast majority of the firms in this group have been in existence for six years or more (over 82%). It is not uncommon to find that the original company was formed in the early half of the century and underwent succession several times. As the ownership interest ages, so often does the useful life of the plant and there is a reluctance to commit to new capital spending.

• Supplier or component relationships. The growth of this sector in sales and importance is due substantially to the shift in production methods from larger conglomerate interests. These companies are often having to meet quality and price standards set by customers in a totally new way. ISO 9000 replaces 'old boy' network purchasing programs.

• They are competing with off-shore plants and firms. These firms seldom relocate to cheaper labor markets outside the United States (they will attempt to do that within the US, however, such as a shift to the Southeast from the Northeast). On the issue of trade imbalance, unfair foreign competition and concern about the stability of the domestic market, these firms are allies with organized labor.

• There is no effective outside equity markets for these firms. The closely-held nature of the firm and the size and rate of growth make these unattractive to most capital pools. Often increased debt burdens are the only way they can get expansion capital during periods when they want to invest. Depending on the age of the business, its liquidation value and strength of its receivables this can prove extremely difficult.

Strategies for Manufacturing Growth

Based on this review, advocates for manufacturing job growth need to focus on several very important approaches to the 'critical middle' market.

• Advanced warning and technical support to companies which are experiencing problems and may be at risk of failing without intervention.

• Union-centered and directed capital should be a central part of the new industrial union movement. Given the 'capital gap' for critical middle firms, unions can play a strategic role at an absolutely essential period of reorganization of manufacturing. This is not unlike the formation of building trade investment strategies during the time when real estate lending had all but disappeared. Unions can -- and have -- vehicles which invest in companies and enable the restructuring and modernization of manufacturing which leads to job stability and growth.

While all these strategies deserve discussion, this paper will focus on the last two -- areas where the Steel Valley Authority's program experience has provided us with the greatest amount of insights.

Advanced Warning and Technical Support: SEWN

The first strategy which grows from our experience is the value of tracking companies and responding to changes which threaten the continuation of the business. The Steel Valley Authority has assisted nearly 100 manufacturing firms in the past three years using this approach. Called the Strategic Early Warning Network (SEWN), the program conducts a quick response to calls for help or assistance from companies. Through a region-wide education program, the SEWN gets referrals and cases from unions, managers, local officials, state agencies and reported changes in media. In turn, professional staff respond to those calls, conduct on-site evaluations and work to solve problems that are facing the company.

SEWN found that most plant closures and the majority of manufacturing job loss occurs from business failures in smaller companies rather than from closures of branch plants by large manufacturers. SEWN also found that the decisions of large corporations have rarely been reserved even in situations where major public, union, and political pressures have been mobilized against the closure decision. In contrast, SEWN found that in the majority of cases the closures of smaller companies have been preventable.

SEWN concluded that advanced warning can provide the time to mobilize technical assistance which will prevent smaller companies from closing. Larger companies have their own in house engineering, legal, and other professional staffs and do not need or usually will not accept technical assistance to prevent a plant from being closed.

The most common problem that the SEWN program has encountered is the capabilities of owners and management of these smaller companies. In some cases companies have grown to a size and complexity that they have outgrown the capacities of the owner/managers. In other cases technologies in the industry have changed and owners/managers have not been able to keep pace. The most common problem is simply the problem of the age of the owner. In Western Pa. over 45% of all owners of privately held companies are over 55 years of age. In many cases these owners have not adequately prepared to transfer ownership to the next generation. All of these problems can cause smaller companies to fail. But all of these problems are correctable.

SEWN observed that local union members are usually very aware of cases where smaller companies are in financial trouble because they are not being managed properly. Unions members usually work closely with the owners/managers and see the waste and inefficiency which occurs in the company. They also experience the problems caused by old equipment and obsolete technologies. However, advanced warning that a company is in trouble is only useful if corrective action is taken. When management is failing, complaining to or about management will not solve the problem.

Unions can respond proactively to problems. By alerting the appropriate agencies such as the SEWN network many of these problems can be corrected before they cause a company to fail. Owners/managers of smaller companies are usually unaware of the technical resources that are available to them through public and non-profit organizations. One of the major functions of the SEWN network is coordinating the delivery of services to companies. These services range from technical services by industrial engineers and computer information specialists to estate planning and ownership transition services by legal professionals. In most cases companies require assistance in several different areas. Failure to solve any major problem can leave a company at risk i.e. it will do no good to provide update technologies in a company where ownership succession issues have not been resolved.

Smaller companies do not have the internal resources to solve these problems on their own. Most outside consultants to smaller companies do not include unions in the process of problem-solving. By contrast, when SEWN was involved, managers and union members were drawn together. The ability of the union to make a contribution to solving company problems moves the union from being viewed as an impediment to change to being a partner.

The cost of the service is carried through a contract with the Pennsylvania Department of Labor and Industry under a program to prevent plant closures. The program serves all of western Pennsylvania and over the past three years has had considerable impact on manufacturing stability in the region. Because it is a state-sponsored program, it is not identified as a union-centered service. But the staff and advisors to the program are able to work within union companies and plants at a high level of effectiveness because of strong informal relations with area industrial unions. The program recently added a service component which focuses specifically on resolving production and operations problems in union plants.

What the three year history of the program has taught us is that many of the internal issues of union companies are not being addressed as joint union/management issues. The lack of technical resources which approaches the company with a bias toward inclusivity means most outside consultants and technical help will not integrate the union in the process of problem-solving. By contrast, when SEWN was involved, managers and union members were drawn together. The ability of the union to make a contribution to solving company problems moves the union from being viewed as an impediment to change to being a partner.

Retention centers could be developing training curriculum for union leaders in small companies to become effective advocates for change and redirection of work and technology -- moving Labor into a proactive position in this field rather than as a reactor to proposals from management.

Investment Strategies

In the past year, considerable discussion has taken place over the potential of labor-directed capital as a strategy for organized labor. The possibilities are great given the size of invested capital by largely union-dominated pension and retirement funds as well as the leverage of funds invested by unions in other instruments (e.g. health and welfare funds, strike and defense funds). In addition, state employee funds with geographic targeting provide another dimension. Models such as the 'labor-sponsored investment funds' in Canada raise even greater possibilities of direct investment from individual workers with tax-incentives for increasing the investment's return to individual investors.

Up until now, most of these funds have been targeting fixed asset investments such as commercial and residential real estate. This reflect both the sense that such investing and lending is 'secure' and can provide a long-term predictable return on investment. What has not occurred, except through the Canadian funds, is direct investment into businesses, with the exception of publicly traded equities and commercial paper.

If our analysis is correct, then capital formation should be targeted to the 'critical middle'. We have already established that this group is facing problems in accessing capital due to the restructuring of the banking and financial services industry. We also know that there are considerable opportunities to grow these companies, that relatively smaller investments can produce substantial improvements in profitability and long-term growth within this group. Further, the introduction of changes in technology, management practice, work strategies and control can be greatly enhanced by the presence of an active investor who supports those types of changes.

Targeting is one thing, successful investing is another. Based on our survey of investor groups and practice, it would seem that the most effective investors in the target market appreciate the need to be close to their investments, monitor the company performance on a routine basis and be familiar with the individuals involved in the management of the company prior to making the investment. A rule of thumb for investors in this market is often to be within a three hour driving distance of their investments (200 miles).

When funds fail to perform, it is often because they are not in touch with their investments, fail to appreciate changes or are unfamiliar with the business climate that surrounds the investment. Distance and lack of knowledge about the investing environment can greatly increase the cost of investing and also increase losses to the fund.

Our conclusion is that the development of a union-centered investment strategy should proceed on two tracks.

• International unions should seek to work together to develop pools of capital. Capital can be derived from pensions, internal union funds, time deposited funds, leveraged investments from co-operating institutions, individual retirement pools (such as 401(k) plans). These pools would allow capital to be aggregated and then redeployed around the investment goal of each aggregated fund (e.g. high yield/high risk, low yield/moderate risk). Size of funds have certain advantages on a cost of management basis.

• Regional or targeted investment programs should developed which permit geographically based or industry-based investing. The advantages of such targeting are greater effectiveness, higher likelihood of success in investing, greatest political and economic value to organized labor in conjunction with raising their profile in the 'critical middle' group of firms.

The Steel Valley Authority has designed a business plan for just such a delivery vehicle. The fund, Industrial Valleys Investment Fund, is set up as a limited partnership and a licensed Small Business Investment Company. It requires an initial capital investment of $5 million which can in turn leverage another $15 million in federally-guaranteed debentures. It selects companies that fall within the middle market size category, makes investments for long-term growth and improved profitability and projects a minimum annual return of over 20% to the investors. Given its location, the fund would be able to make investments in eastern Ohio, western Pennsylvania, western New York, northern West Virginia and western Maryland. Given its size, it would invest in about 20 middle market companies in five years or less, affect over 2,000 manufacturing jobs. The Fund's board of directors reflects both investing and management experience as well as individuals who actively seek to support union companies. While the fund is not yet capitalized, the model is based on conservative assumptions and constructed around industry experience.

Other vehicles could be developed over time. Funds could be set up on a leverage basis -- such as the IVIC -- or on a non-leverage basis. Funds could be targeted through union-owned banks. Funds could be leveraged through a national development bank (one model for this would be the National Co-operative Bank which is depositor owned by producer and consumer co-operatives). Regardless of the alternative investment vehicles, it is essential for the investing unions to ensure that the program achieves both an investment return objective and a political objective -- namely a clear signal that the unions are investing in American companies to strengthen American job opportunities.

Summary:

• Manufacturing employment in the U.S. is increasingly concentrated in middle-market firms (sales from $5 million to $100 million or fewer than 500 employees). These are closely-held firms with a significant degree of owner-involvement in management. Because of their size, these firms are intrinsically domestic and not prone to move production overseas.

• A study of manufacturing in Ohio, Pennsylvania, and New York show that the center of high-skill, high-growth manufacturing employment will be in these "critical middle" firms.

• These "critical middle" firms are often older, in need of modernization, and often compete with off-shore firms. These firms have trouble accessing the debt and equity markets to allow for growth. With appropriate planning, technology, and capital investment, many of these companies can become world-class producers, often as part of a decentralized, but highly integrated manufacturing system.

• The Steel Valley Authority's Strategic Early Warning Network (SEWN), which provides assistance to companies responding to changes which threaten the continuation of their business, is a model for how unions and communities can actively support local job retention.

• Unions can play a central role in assisting "critical middle"firms to prosper and provide employment through early warning networks, enhancing firm productivity through joint-labor management cooperation, and through investing their own retirement capital in this sector of the market.

Recommendations:

• Unions and communities should create advanced warning and technical assistance to support "critical middle" firms through the provision of technical assistance, labor-management cooperation within the firms, and capital resources necessary for growth.

• International unions should work together to develop pools of capital that can be invested in job-creating ventures that are in the interest of plan participants and beneficiaries, and that particularly target "critical middle" companies.

• Regional or targeted investment programs should be developed to permit geographically-based or industry-based investing that creates jobs in communities.