Stronger dollar, cyber attacks add to worries
BDO Manufacturing Risk Factor Report covers Michigan trends in 2015.
Michigan’s manufacturing industry, fueled by a strengthening economy and increased product development, continues to accelerate. But as Isaac Newton pointed out, for every action, there is an equal and opposite reaction.
The sector’s renewed momentum may be generating more competition across the state, which could cause Michigan manufacturers to more carefully consider the quality and protection of their products.
According to a report issued by BDO USA, 77 percent of Michigan manufacturers cite risks related to product quality or contamination issues this year, including recalls, up from 74 percent in 2014. Faulty products can lead to costly legal proceedings and damage a company’s reputation.
“This is simply the continued concerns over operating in a manufacturing environment with high-quality standards,” said Matthew K. Becker, regional managing partner/tax services at BDO in Grand Rapids.
“As products become more complex, the risk of quality issues in products increases. Manufacturing is consistently becoming more precise, and with this precision comes higher expectations and more risk in the event of quality issues.”
BDO USA LLP is a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of companies for more than 100 years. For several years, BDO has analyzed the risk factors listed in the most recent SEC 10-K filings of more than 30 publicly traded U.S. manufacturers headquartered in Michigan.
The 2015 BDO Manufacturing Risk Factor Report for Michigan finds risks concerning intellectual property violations and copyright challenges are cited by 74 percent of Michigan manufacturers. Intellectual property, which provides manufacturers with considerable competitive advantages, can pose issues both domestically and overseas, where there may be less regulatory oversight regarding such issues.
“As Michigan’s manufacturing industry continues to pick up speed, manufacturers are feeling the pressure to deliver innovative, quality products to their customers in order to stand out from the competition,” said Fred Rozelle, Detroit-based regional managing partner and member of the BDO Manufacturing & Distribution practice. “This environment may foster the opportunity for more manufacturers to develop and market new products; however, they will have to strategically navigate through certain business risks and operational hurdles while forging a path forward.”
Breaches of technology security were listed as a risk by 77 percent of Michigan manufacturers in the latest survey. However, a year ago, the concern was only listed by 53 percent of them.
According to BDO, 86 percent of the largest 100 publicly traded U.S. manufacturers list the same risk. Additionally, 65 percent of Michigan manufacturers note the ability to maintain operational infrastructure as a concern, including IT systems, up from 62 percent the year before. If IT systems are damaged or cease to function properly, manufacturers may experience extensive business interruptions.
“Cyber security and IT risk seems to be a growing concern across the manufacturing world,” noted Becker, adding that “a larger number of companies are falling victim to cyber attack.”
Manufacturers pay particular attention to the risk of hackers breaking into their intellectual property data, for which there would be a market in some parts of the globe where manufacturers are under fewer constraints than those in North America.
Becker noted there are many types of data that can be exploited by sale to competitors, ranging from employee records to customer data and shareholder information. Stolen employee data is obviously in demand by identity theft scammers.
Jeff Williams, COO of Springthrough, a business IT support and development company in Grand Rapids, said the company has seen “ransomware” attacks on local companies.
“This is where someone downloads a Trojan virus on their machine and it happens to encrypt files across a company's network once that computer connects. The companies with good backups and security practice recovered from these with no problems,” said Williams.
But that doesn’t mean everyone is in the clear.
“The concerns over international operations are growing,” said Becker.
Eighty-seven percent of Michigan manufacturers cite threats to international operations and sales as a risk, up from 85 percent last year. One of the factors is the global strength of the U.S. dollar, which reached 12-year highs in the first quarter of 2015.
On April 1, a euro was worth almost 93 U.S. cents. That spiked to 94.5 cents in mid-April but as of the end of June, it was down to about 89.5 cents.
The Chinese yuan has been having a similar rocky ride compared to the dollar. On April 1, there were 6.11 yuan to a dollar. By late June, that was down to about 6.085.
As the dollar becomes more valuable compared to the overseas currency, foreign orders for American goods cost more, often leading to fewer orders.
Becker said the volatility in exchange rates also makes financial planning more difficult to manage for U.S. manufacturers that are buying local labor and raw materials for their plants there.
“It becomes very difficult to manage what the cost structure of a product is going to look like,” said Becker, noting American manufacturers overseas try to use hedging strategies and forward contracts to minimize the risk.
“Some manufacturers … are really concerned right now because of that increased risk of volatility,” he said.
Back in the U.S., the tax and regulatory environment continue to be the top risk factor cited in 10-K filings by Michigan manufacturers studied by BDO. Last year, 94 percent of them listed federal/state or local regulations, but in 2015, it is 100 percent.
Becker noted one example of a driver behind that high-risk fear is the diminishment of the tax incentives offered by the Michigan Economic Growth Authority Board, which has led to “uncertainty around the future of the credit for manufacturers.”
Originally created to aid auto plants and prevent massive layoffs, the MEGA program unexpectedly created $9.4 billion in potential future tax liability for the state. The result was two bills in the Michigan Legislature to limit the programs, according to the Associated Press.
This sentiment by manufacturers is underscored by BDO’s Tax Outlook Survey, which revealed that 75 percent of respondents — tax directors at $1 billion-plus companies — say the cost of compliance within the tax and financial regulatory landscape has risen over the past three years. Additionally, 45 percent note uncertainty around foreign, federal and state tax legislation is the primary tax issue they currently face.
BDO serves clients through 58 offices and more than 400 independent alliance firm locations nationwide. As an independent member firm of BDO International Ltd., BDO serves multi-national clients through a global network of 1,328 offices in 152 countries.
2015Rank Risk Factor Cited in 10-K Filing 2015 2014
1. Federal, State and/or Local Regulations 100% 94%
2. Competition and Consolidation in Manufacturing 97% 100%
3. General Economic Conditions 94% 97%
4. Currency/Foreign Exchange Fluctuation 90% 88%
5. U.S. and Foreign Supplier/Vendor Concerns and Distribution Disruptions 87% 88%
5t. Threats to International Operations 87% 85%
5t. Management of Mergers & Acquisitions 87% 85%
5t. Less Demand for Products 87% 85%
5t. Commodity/Raw Material Prices 87% 76%
10.Failure to Properly Execute Business Strategy 84% 76%
11.Legal Proceedings 81% 85%
12.Restrictive International Trade Policies 77% 79%
12t.* Product Quality Issues/Recalls 77% 74%
12t.* Breaches of Technology Security 77% 53%
15.Intellectual Property Violations/Challenges 74% 74%
16.Labor Concerns; Underfunded Pensions 71% 76%
16t.* Health of the Major Industries They Serve 71% 74%
18.Environmental Laws, Regulations and Liability 68% 76%
18t. Access to Capital 68% 76%
20.Ability to Innovate to Meet Changing Customer Needs 65% 68%
20t.* Loss of Key Management/New Management65% 65%
20t.* Ability to Maintain and Implement New Operational Infrastructure, Including IT Systems 65% 62%
20t.* Natural Disasters, War, Conflicts and Terrorist Attacks 65% 62%
* t indicates a tie in the risk factor ranking.
**2015 and 2014 percentages are out of 32 and 34 companies, respectively.