The Wrap Podcast | Episode 058: Unlocking Success in the Manufacturing Industry | Warren Averett

Commentators (0:03): Hey, I’m Paul Perry, and I’m Kim Hartsock. You’re listening to The Wrap, A Warren Averett podcast for businesses designed to help you access vital business information and trends when you need it. So, you can listen, learn and then get on with your day. Now, let’s get down to business.

Kim Hartsock (0:21): Hi, everyone, and welcome to The Wrap. We’re excited to welcome today, Stephen Schaaf, the leader of our Manufacturing & Distribution Industry Group. So welcome, Stephen.

Stephen Schaaf (0:32): Well, thank you. I appreciate you guys having me, Kim and Paul. It’s a great topic, I think, of diving down into some industry specifics, or it’s a great series here to dive into some industry specifics, because it’s a complex world out there. And you really need to be an expert in your industry to truly add value and understand what’s going on. I’ve been with Warren Averett for a little over 30 years, and from day one, I’ve always worked with manufacturers and distributors. I like what they do. I like how they contribute to our economy. And it’s something that we at Warren Averett pride ourselves in as one of our larger industry segments.

Paul Perry (1:04): Absolutely, glad to have you with us. Now, Stephen, this is somewhat of a continuation of a discussion you and I had last week when we were having our Manufacturing & Distribution Roundtable. You know, lots of conversation in the room. Lots of discussion, lots of opportunities that they had and challenges. What were—you know, as you recap that that roundtable—what were the things that stuck out to you as major challenges for this industry?

Stephen Schaaf (1:28): Yeah, well, it was a great opportunity, that roundtable, to get some other CFOs together. Because one thing with manufacturing is that it is a fragmented industry. So, you’ve got your food and beverage group, you’ve got your plastics group, you’ve got your steel fabricator group. So, one thing we like to do is get those CFOs together from the different industry segments and share some of their pain points, their challenges and their issues. I’ll tell you right now that the number one challenge that came out of that roundtable—which a lot of other industries are having too—is workforce development and finding reliable and capable, qualified individuals who want to work. It’s not just a problem in the Southeast, or really in the United States.

I happened to be on a call earlier this week with an Italian manufacturer. One of our U.S. clients is looking at partnering with them. When we were talking about some of their challenges, the Italians said their number one issue was workforce development as well. They can’t find people. So, it’s on everyone’s mind, and it’s the biggest challenge. We’ve done it to ourselves as a society. I mean, manufacturing has its perception of being a dirty, blue-collar job, and everyone wants their children to grow up and be doctors and lawyers. But the facts are we need—and we do need doctors and lawyers—so, there’s nothing wrong with that. But we always need people to work in manufacturing; it’s not been a glorified position historically, but there are a lot of good-paying jobs, and that can lead to a rewarding career. With the advancement of technology, it can be a technical job too in a clean environment.

Kim Hartsock (2:59): Yeah, it’s interesting that you brought up the international impact, because I think for a long time, we’ve looked at this just as a silo of U.S. But as the industries—including manufacturing and distribution—have become global industries—right—then we have global challenges, like global supply chain, but also global labor markets. I don’t think anyone is prepared to come swoop in and solve our labor problems, right? We’re going to have to be a little bit more creative than that.

Stephen Schaaf (3:30): We are. I think the supply chain issue, which everyone was facing last year, seems to pretty much be under control a little bit more. In talking to a lot of our clients, 90-95% of their supply chain is back intact. We were able to work through that logistically. But this workforce development is a bigger problem that’s going to be here a lot longer, I think.

We try to advise our clients to look at it two ways to break it down into: How do you get new hires? Where do you find those people and get them on board? But, then also don’t forget about employee retention and keeping those employees you have because obviously, it takes a lot more time to bring someone on versus winning someone over and keeping them happy in the current job.

Paul Perry (4:15): I can imagine, Stephen, that the way that society and business is going right now with the move to remote work, that’s very difficult in the manufacturing and distribution industry, right? So, it’s to some degree, everybody’s having a problem. But I would argue manufacturing and distribution has it a little bit differently because you really can’t be remote and get the work done. Is that right?

Stephen Schaaf (4:38): Absolutely. I mean, you can’t take your mill equipment home to your house. You can’t take a lay or some other processing equipment. You’ve got to be there on site. We’ve had a lot of a clients too that have changed their administration side to say, “You need to be in the office if our plant people are here working. We want to present a team effort here and show them that you’re here as well.”

Kim Hartsock (5:02): So, Stephen, how are companies getting around that? What are they doing in terms of hiring? Any new ideas?

Stephen Schaaf (5:08): Well, some companies are trying to offer more non-traditional shifts. Some people have gone to 40 hours in four days. But depending on your production schedule, that can be a double-edged sword, because you may have to hire more people to meet these different shift needs. But it’s really trying to get outside the box. If you’re not on tech and if you’re not on social media, you need to be. I mean, everybody is—including the plant workers that are working these manufacturing jobs. It’s just another way to reach them and stay connected.

We’ve had a few clients that have looked at their current workforce and said, “Okay, these have been some great people. Where did we get them? Where did they come from?” They’re trying to use data, technology and what they already have in payroll. They may say that “Okay, our best employees come from this geographic area, and they live in this zip code. Well, let’s go market there and find more people that are like them, since they’ve been good employees.” A lot of other manufacturers are starting to go to career fair days at high schools and go ahead and plant that seed. In fact, we’ve had two clients—hundreds of miles apart in different geographic markets—that actually around the same time said they went to a middle school to go ahead and start planting that idea of if college is not for you, you can have a rewarding career here at XYZ plant, contribute to our local community and be a productive member.

Kim Hartsock (6:41): I think that’s interesting, because I do think that the approach is: our kids these days are seeing the cool jobs, right? The tech jobs, the Googles and all the things with AI. That sounds so cool. But if they could see the cool things that are happening within the manufacturing industry, right? Using robots and using AI? That might create a little bit more excitement—that it’s an exciting field for them to be interested in.

Stephen Schaaf (7:12): Absolutely. It makes them feel more valued and there’s the fact that they can learn to operate that equipment. I mean, there’s training that we obviously need to invest in the workforce, and it makes them feel a bigger part of it.

Paul Perry (7:27): And that’s bringing in the workforce. You talked also about, you know, retaining staff. Right? So that probably speaks to the culture of the organization. Would you agree with that?

Stephen Schaaf (7:36): Yeah, absolutely. Having that culture of a family environment where you can let these people know that they’re appreciated and valued and listened to? That’s a big thing. Now we’re hearing too of these multi-generations in the workforce that everyone wants their opinion known. And so there are little things where people have asked for picnic tables outside the outside the facility on a break, and even having one company build a gazebo that puts some shade in there. These are in the big scheme of things low-cost things. But that sense of appreciation and giving these employees a nicer environment really does go a long way. Some companies have brought in food trucks periodically on a Friday and either subsidize part of the lunch for the meal or had it be free for their employees. In that time when even (what I’ll call the administrative side) comes out, shares the lunches with them, gets to know them and has more interaction? That just makes for a more cohesive and friendlier environment that people want to stay in and contribute to.

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Kim Hartsock (8:57): So, Stephen, switching gears just a little bit, what are you seeing in terms of tax strategies? Is there anything new coming up that you’re starting to see more of?

Stephen Schaaf (8:58): Well, taxes have always been a big expense. When you think of that on an income statement as a percentage of revenue, that’s one of your largest items by labor and materials. In 2023, here under the current tax law, there are three areas that manufacturers are going to find an unpleasant surprise. Hopefully, Congress—in the next couple of weeks— may implement a workaround for some of this. But, as of right now, it’s not. That first one is the interest expense limitation. This has kind of slipped under the radar for a lot of companies and a lot of manufacturers because of two factors:

One, we’ve been in such a low interest rate environment for 8 to 10 years now. People have taken it for granted that I can have a loan at 2%, 3% or 3 ½%. But now, here, obviously, the environment pain rates are rising. Many people haven’t experienced that there’s actually a law implemented back from 2017 that limits the tax deductibility of your interest expense. Up until 2023, this was based off of 30% of EBITDA. So, you’ve got to take your earnings, plus your taxes, depreciation and amortization—that depreciation being a big one in manufacturing–that really lets you raise that baseline of then what you took 30% of that, and anything below that you’ve got to deduct as your interest expense. Well, starting in 2023, that baseline becomes EBIT instead of EBITDA. So now all these manufacturers are not going to be able to add that depreciation expense to their baseline amount to determine what is deductible from an interest expense. You couple that limit with now interest rates going north of 6%. There’s going to be an unpleasant surprise, if you’re not planning for it, of having a lot of your interest expense that will not be deductible for tax purposes.

Kim Hartsock (11:05): And if you think about specifically, within this industry, depreciation is a huge item, right? This is a very capital intense industry, where they’re relying on that depreciation deduction every year.

Stephen Schaaf (11:17): Absolutely. Then, you throw in that a lot of these companies are financing their working capital through a line of credit and have term loans. So, you have both of those components. One of them’s going away, and it’s not going in the good way. Then, the second. Another item here that changed recently deals with research and development expense. So, historically, these activities have been freed as a current expense for tax purposes.

But effective in 2022, those research and development activities are now required to be capitalized for tax purposes and amortized or expensed over five years. So now, what a company may have spent—and depending on the size of your company–you may have an engineering department or you may outsource some of these R&D expenditures. So, it can be a variety of level of expenses depending on what you do. But you used to be able to expense those, take them right off your bottom line for tax purposes. But now, you’ll only get 20% of that activity each year for five years. So, you still get it, but it’s just spread out over a much longer time period that you get that tax benefit.

Kim Hartsock (12:07): You alluded to this, Stephen, saying that you’re hoping that, you know, Congress will repeal this, but where is this stuck? And where, if I’m a leader within a manufacturing company, and I’m just hearing about this or I’m not aware that maybe this is a law change, where could you point me to that?

Stephen Schaaf (12:46): Well, you need to reach out to your local Congressperson. We’ve actually helped clients do that. We’ve got a draft of a template letter that you could send to your client, stating some of these three things, how they negatively impact your business and that you would like those things reverted back to how they were. But your question on where they stand? I’ve heard the Ways and Means Committee does have solutions to these. But everything right now is going to be on the debt ceiling. Whether these get worked in there or not is anybody’s guess.

I wish we had a crystal ball that we could look at, but as of current law right now, those two things, the interest expense and the R&D, are going to hit people pretty hard. Then, a third item that has always been on the books, but it starts here in 2023, is that bonus depreciation is now starting to be phased out. This has been going on for quite a few years where Congress allowed you to write off 100% of your capital assets, and it was referred to as bonus depreciation. Because historically, you would take that over a—just like that R&D expense I talked about—you take it over a certain amount each year. But that is finally under current law, down to 80% in 2023. So, anything you buy, whether it’s a new mill or any other capital asset you put in your plant, you’ll only get to write off 80% of that in 2023. It starts phasing down by 20% each year until it’s zero in 2027. So, it’s to be determined if Congress will reverse these and give the manufacturers a little more of a tax break, but hopefully they will.

Paul Perry (14:28): Stephen, it sounds like people in this industry and companies in this industry, there are a lot of dynamic issues that they have to solve, you know. What are some of the higher-arching solutions that companies are putting into place to respond to some of these issues? Are they rethinking what and how they do things? What is the solution for a lot of these issues for companies?

Stephen Schaaf (14:51): Obviously, it’s trying to be more efficient and effective in what they’re doing. Some companies—there’s been a little bit of a trend of more companies bringing services back on shore and not stretching out their supply chain as much to have a little more control over that and to get a quicker turnaround order lead time to be more efficient. Because if taxes are going up, we’ve got to find other ways to be more efficient. Companies need to look to using more technology in their manufacturing process. They need to think outside the box on what they do as well.

One story about a company that was a stamping facility: they had an acceptable defect rate. But they wanted to try to lower that even more. They spent a couple hundred dollars on some temperature sensors, and then lined that up from a data analysis perspective on timing on when those defects were occurring. When looking at the data, they realized that there was a certain time period and a temperature drop that were causing these defects to occur. When they analyzed it further, they realized that was when certain employees went on break, and they were opening a door in the facility that was then changing the temperature. Obviously, this was a time sensitive process or temperature sensitive process, and that was causing the defect. So, they ended up putting up plastic that you’d see in a freezer around that exit door. That ended up maintaining the temperature, dropping their defects and becoming more productive by spending a couple hundred dollars on some temperature sensors and by being able to think outside the box and using data in a different way.

Paul Perry (16:45): It’s interesting. I’ve always liked—I think it was IBM’s slogan—know what your data knows, right? It knew what the issue was, you just have to dive in to figure it out. That’s really interesting.

Stephen Schaaf (17:00): With the technology costs continuing to come down, it’s unlimited on what you really could do. You just need someone to come think outside the box and change a little bit or apply a different thought and data to to the process.

Kim Hartsock (17:16): Yeah, I think my approach is just to really recommend to people to understand that the technology is not going away. Instead of fearing it and thinking, you know, how it could negatively impact your business? Reverse that and think, “How can I use it to make us better and make us more efficient?” You know, we just talked about all these labor challenges. How can we use that to solve our labor problems? So, I think, instead of being afraid of it, let’s embrace it and try to figure out ways to make it work for us.

Stephen Schaaf (17:48): Don’t be afraid of asking your workforce too. They’re the ones that are out there in the plant. Go out and ask them: what do they need? What tools do they need to do this better, faster and more efficient?

Kim Hartsock (17:59): That’s a great idea. Well, Stephen, here on The Wrap, we always ask our guests to wrap it up in 60 seconds or less. So, what’s the one thing you want our listeners to leave with today?

Stephen Schaaf (18:11): Okay, well, we talked about a few issues facing manufacturing. My closing comment or wrapping up would be that—and a little bit what we talked about there—I would challenge each manufacturer to think of themselves as a data processor, not just as the manufacturer of your particular product. If you compare the quantity of your products produced each year to the quantity of data you create and analyze each year, I bet you’d be surprised. So, look for ways to improve that flow of data through your whole facility, looking at new data to collect, analyze and sort this data in different ways to your manufacturing process.

I’ve had a few clients that have looked at themselves as data processors—and not just manufacturers—and it’s led to changes that have made them more efficient, more profitable and ultimately increased the level of their happiness of their workforce too. So, no matter how old your product is, or the process is, you can become a leader in your segment by using that data and analyzing it to your advantage.

Paul Perry (19:10): Alright, well, Stephen, it’s been a pleasure having you with us on The Wrap. Thank you for bringing this information to our listeners, and I look forward to talking with you soon.

Stephen Schaaf (19:18): Well, thank you. I enjoyed it. Good to see you both.

Commentators (19:20): And that’s a wrap! If you’re enjoying the podcast, please leave a review on your streaming platform. To check out more episodes, subscribe to the podcast series or make a suggestion of other topics you want to hear, visit us at warrenaverett.com/thewrap/.