Tuesday, 21 October 2014
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Planning for growth

After years of leaving industry to get on with it, the government finally has a plan. But is it the right one, and can it be maintained long-term?

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Engineering doesn’t take place in a vacuum. Because it is so tied up in the development of products and processes, it’s intimately tangled up with the mechanisms of the economy — contributing to balance of payments; to the import and export of raw materials, equipment, products, information and talent; to national and international finance; and to the country’s place in the world community.

It’s hardly surprising, then, that engineering is the subject of a whole raft of laws, regulations and initiatives which have a major effect on how companies and individual engineers, particularly in the manufacturing and energy sectors, go about their business. Most of these are intended to help: to provide incentives for R&D, to help companies secure intellectual property rights for their inventions, and to help gain investment to grow companies.

This, however, is a relatively new development. For many years, since the late 1970s, industrial policy was almost a dirty word in the British political establishment. Laissez-faire economics was the order of the day: the best way to help industry, it was thought, was to interfere as little as possible and let it develop in its own way.

That, it could be argued, didn’t end well. A decline in manufacturing, allied with growth in service industries, led to the economy being disproportionately exposed to the effects of the finance crisis which began in 2008. The government then in office began to look for ways to rebalance the economy, and the Coalition has carried these on, adopting policies such as the creation of the Catapult Centres to accelerate development in strategic technological areas, intended to help the UK dominate the world in high value-added engineering to offset the relatively high cost of labour compared with emerging economies.

‘Laissez-faire was a pretty weak response to a global competitive world,’ commented Tom Lawton, manufacturing specialist partner at accountancy firm BDO, which has been producing a series of reports on how various stakeholders see the manufacturing sector. ‘You could argue that it had some level of success, in that we attracted some inward investment from large companies. But the problem is that we are competing in a global marketplace, and many of our competitors have long-term strategies in place to support manufacturing and innovation and R&D. If we don’t have anything like that in the UK we are going to lose the fight over the next few years.’

‘Many of our competitors have long-term strategies in place to support manufacturing and innovation and R&D. If we don’t have anything like that in the UK we are going to lose the fight over the next few years

Tom Lawton, BDO

Germany has been an important inspiration for the UK’s developing industrial policy. ‘The Catapult Centres seem to be a direct copy of the Fraunhofer Institutes, which have been running for some time, of course,’ Lawton said. ‘But Germany has more to offer than just those. It’s massively high cost, much higher even than the UK in terms of labour costs. But they’ve really focused on the value-added from engineering. They’re not into semiconductors, electronics and computers; what they’ve managed to focus on very successfully over many years is chemicals, automotive and aerospace.’

Moreover, German industrial policy has a continuity which helps companies considerably. ‘One of the underlying themes that we’ve been talking about for a while is that there needs to be a reasonable agreement between all parties so that a policy framework can be organised to hep manufacturing that lasts longer than one party’s government.’ Lawton said. ‘I think that’s one of the key things that Germany has. They have a long serving coalition there, but whoever gets into power you know that their underlying structure is going to be the same, because they recognise that it’s absolutely fundamental to their economy.’

While the UK is now addressing this problem, Lawton believes that the government might actually be making things more difficult for SMEs, the very companies which need the most support. ‘One of the underlying issues that we’re picking up is that we currently have initiative overload. A lot of SMEs in particular just can’t keep pace with all the initiative which have been put in place — not all of which are effective anyway. Just understanding what’s available to help and tapping into it is a significant task, and most SMEs simply don’t have the resources to do it.’ This might be a factor in the poor take-up of initiatives such as R&D tax credits (see panel), he suggested.

One factor in German industry is the system of local banks, which many believe make it easier for smaller companies to access funding. In BDO’s survey of funding institutions, which spoke to the British Growth Fund, a private equity company, and major banks RBS, Santander and Barclays, it was pointed out that German industry operates according to a different culture than the UK. ‘In Germany, the owners of local businesses see themselves as responsible for the local community,’ the private equity respondent noted. ‘While profitable growth remains the key objective for our companies, blending this with accountability and job creation at a local community level is a positive thing.’

Local banks would, of course, entail breaking up the large banking structures in the UK — something the financiers weren’t keen on. ‘It is more of a case of ‘what are the manufacturers looking for in calling for the banks to be broken up?’ said the British Growth Fund. ‘Having a credit committee closer to the funding opportunity and the local relationship director having greater influence are positive steps to address the concerns of larger remote organisations.’ Overall, it said, the regulation is key — if broken-up, more local banks are operating under the same regulations that apply to the large banks now, then in practical terms, nothing will change.

Speaking to politicians, BDO found that the Conservatives are backing the idea of a ‘Minister for Manufacturing’, who would lead a cross-department approach to manufacturing policy. This is something Lawton supports, but he stresses that the post must be cabinet-level, and backed up by a dedicated department. ‘All the departments have good intentions at heart, but they’re all too separated,’ he said. ‘Somebody sitting on the cabinet with a manufacturing remit might be able to draw together all the strands of finance, education, training and R&D support.’ This would have to work alongside a series of targets for manufacturing’s share of GDP, he added.

Research benefit: R&D tax credits

One of the main ways that the government supports R&D is through tax credits against corporation tax. The terms are particularly advantageous for small companies, which can claim 225 per cent of R&D costs against tax — in simple terms, that means that for every £100 spent on R&D, the company’s income eligible for corporation tax is reduced by £225. Larger companies can claim 130 per cent.

However, it appears that many eligible companies are not claiming credits to which they are entitled. In 2010 — the last year for which figures are available — 7900 SMEs filed claims for R&D credits, of which about a quarter were within the manufacturing sector. However, the number of eligible manufacturing companies could be as high as 65000 — meaning that just 3 per cent of eligible companies were making claims.

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SMEs, for the purposes of this credit, are defined as companies which are liable for corporation tax, which have fewer than 500 employees, and either a maximum turnover of €100million (£86.5million) or a balance sheet not exceeding €86million (£74.4million) — the figures are quoted in Euros because the critera for the credit are derived from an EU scheme.

R&D credits are intended to compensate businesses for their costs incurred in developing new products and manufacturing processes, and can be claimed by companies with in-house R&D, companies which outsource research or product testing, or which employ engineers. Any IP created as a result of R&D that is part of the scheme must be owned by the company claiming. The R&D has to advance overall knowledge or capability in science or technology, not just the claiming companies’ knowledge.

‘R&D tax credits are excellent,’ commented IET president Andy Hopper in his President’s Address speech late last year. ‘You sell an inflated loss of your company for cash; not just a loss, you can inflate it and increase it, and rather than claiming the loss some time in the future toy obtain cash within a few months. That is an excellent system.’

As well as what might be regarded as ‘traditional’ R&D-oriented sectors such as computing and biotechnology, companies within sectors such as architecture and automotive can claim. The scheme also allows the entire cost of equipment used for R&D to be written off against tax.

Driving innovation: breaking into automotive

Companies in the automotive sector can have a particularly difficult time getting their innovations to market, especially if they are trying to launch products in the volume car sector. Outside the remit of the Technology Strategy Board’s Catapult centres, which tend to deal with technologies in emerging sectors, automotive innovation often comes from engineers with a background in the sector, and yet this does not always make their job easier.

This, explained Prof Geoff Callow, managing director of engineering consultancy at specialist merchant bank Turquoise International, stems from a paradox which is specific to the sector: innovative companies, by their nature, tend to work quickly, but the mainstream automotive sector is by comparison glacially slow.

This slowness is partly the nature of very large manufacturing operations, and partially because automotive is constrained by legislation and regulations, Callow explained. ‘It’s not a small thing to change a large assembly line, for one thing,’ he said. ‘But what’s more significant is that everything in the automotive sector has to be exhaustively tested and approved for safety purposes. That makes it very difficult for companies to introduce anything quickly.’

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It can take take to introduce new technology onto an established production line

Turquoise specialises in second-stage funding — both investing directly and helping to identify other investors — for engineering and technology projects; that is, taking companies which have already obtained funding to move a technology or product out of the lab and into an industrial development phase. ‘We typically get involved in helping them to make the transition to becoming a commercial enterprise,’ Callow said.

As a former chief scientist at MIRA, Callow knows his way around engineering R&D. The problem facing the automotive sector is that it isn’t set up to exploit it. Automotive companies are keen to acquire new technologies, he said, but unlike more traditionally R&D-oriented industries, like pharmaceuticals, it isn’t able to simply buy up promising research operations and incorporate them into its own structures.

For a company looking for investment from mainstream automotive, this means that they have to be able to understand how their product can be transformed from a one-off lab prototype to a refined working component which can be produced in volume, with material and working costs reduced as low as possible while still keeping quality high — and they must also understand how to get financial return on their product at a variety of stages on the way.

‘The journey to large scale production can last up to 25 years, if not managed efficiently,’ Callow said. Investors tend to want a return in five to seven years, and because of the constraints on the large automotive sector, it can often take two years from solving a technological problem before the ‘fix’ starts earning money.

One way around this might be to approach niche vehicle manufacturers, Callow said. These won’t offer volume production, but they are more minded to take on unconventional technologies, and this can provide performance data to support refining the technology and taking it to the next stage.

Another possibility is to target an automotive sector which is itself at an early stage, such as personal rapid transport, a class of vehicle where the Department of Transport has not yet decided on regulation. This, Callow says, is likely to be more stringently regulated than quad bikes but, because they are unlikely to be used at speeds above 30mph, less strictly than conventional cars. Because the automotive manufacturers have no more experience in these sectors than anyone else, getting a technology into this sector would allow it to gain a foothold in a low-volume niche market and ramp up volumes and gain testing as the sector itself develops.

One thing that can assist here is an initiative which the automotive sector has itself undertaken — technology roadmaps, which have been produced both by the European Road Transport Research Advisory Council (ERTRAC) and the UK Automotive Council, which produced a roadmap in 2010 setting out five priority R&D areas — internal combustion engines, electric machines and power electronics, lightweight vehicles and powertrain structures, intelligent transport systems, and energy storage and energy management. ‘The great things about these roadmaps for R&D companies is that they set out what sort of technologies the industry is looking for, and when it expects to incorporate them into vehicles,’ Callow said. ‘And that’s a big help for planning how to approach investors.’


Readers' comments (1)

  • I am constantly amazed that our 'leaders' suggest that other nations 'do' manufacture better than we, when there are clear indications from past policies, just why this is. The laws of Nature are the same in Tubingen, Tokyo and Tunbridge Wells. That cannot be a reason!

    In 1945, two nations, the losers in the conflict that had engulfed our worlds, were told by the winners: you have been so disgraceful you may not make any weapons or their means of delivery : so the clever folk set to and made everything else. Made the items needed and bought by billions of individual citizens, not in a few hundred by Governments! they have been doing this ever since. Small wonder their economy -and that is the real ones of wealth (not just money) creation- is so powerful and ours so weak. Powerful enough to be the root (and the route!) to bail out the rest of us.

    There are about 150 UK institutions offering HE and FE Engineering Education and associated research. There are about the same number of designations of manufacture of useable domestic products. Almost exclusively imported at present. Ergo: let each HE &FE institution select/be allocated one, let such be funded appropriately by HMG [I estimate no more than £2 million per annum] for five years [ie a total of £600 million per annum, less than we spend on diplomats, and tasked with creating world-beating designed, Engineered and manufactured and marketed products If they succeed -a share of the profits to further that institution: if they fail, NO further funding for any research. That would concentrate their minds]

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