Service With a Smile

Last Updated Apr 15, 2009 6:54 AM EDT

While the decline of the manufacturing base still raises strategic concerns, it might be a boon to the economic recovery.

I've been writing a lot of articles about working capital over the past 18 months - and for good reason. It's hard to escape the old saying that "revenue is vanity, profit is sanity, but cash is king" when you discuss this kind of operational financial management. But during a downturn, I prefer the line the finance director of a quoted fashion retailer gave me: "You can make losses year after year, but you only run out of cash once." It's life and death stuff.

(A quick primer: working capital is the cash you have tied up in your business, mostly in the form of invoices you've issued that haven't yet been paid and stock. The more credit you give clients, or the more stock you have, either in raw materials or unsold goods, the higher your working capital. If your working capital is high, you have less money available to invest in growing your business by buying new plant, for example. But more importantly, if you're not generating cash (as opposed to sales), you might run into trouble paying wages, rent or taxes, any of which could result in you going bust.)

The reason it comes to mind today is a posting from progressive blogger Matthew Yglesias. (He's pretty left wing for a Yank, although he could happily belong to any UK political party.)

He explained, very succinctly that excess inventory doesn't just eat up working capital - it also delays economic recovery.

The theory is simple, and applies most obviously to car makers. If production is maintained while sales drop, you create excess inventory, a stock of unsold cars. When people get more optimistic about the economy -- and we're already seeing a fair bit of that now -- they start buying again. But even, if sales are picking up, you can't ramp up production because demand is easily satisfied by unsold stock until inventories are exhausted.

That means workers still on short time (and reduced incomes), dampening the effect of the recovery. Annoying.

So where's the good news? Simple: British manufacturing is continuing a long decline as a share of national output. Our service industries have taken up the slack.

Because many services are rendered without inventory (or, at least, minimal stocks of goods required to provide the service to the next month or two's customers), there's a triple benefit to being a low-manufacturing economy. First, service businesses have lower working capital requirements. That means they're less likely to run out of cash - particularly when the banks aren't lending - and more likely to survive.

Second, when demand starts to pick up, there's no stock of finished goods to exhaust before people are working at capacity. An electrician doesn't have a stock of pre-wired office buildings to flog before he's earning real money again. That means our service-heavy economy could recover more quickly than countries where manufacturing still dominates. (Heaven help Detroit...)

And third? Well, look at your own businesses. When sales go down, you might have to lay off front-line staff whose existence relies on the volume of trade. When demand falls, you need fewer salespeople, engineers or labourers. But while you might be able to trim a little fat from the marketing, finance or HR departments, you still need all those functions - whether you're selling 100 widgets a day or just 60.

The British economy now undertakes many more of those service-type roles for the global economy. So while the global recession hurts, our global advertising agencies, architects, accountancy and law firms, software companies and designers can keep things ticking over.

True, there are many excellent reasons for having a robust, diverse manufacturing base in the UK (not least national security and the fact that manufacturing is still our dominant export earner). But it doesn't hurt to look at the positive side of service industry's triumph at times like these.

(Photo: debaird cc2.0)