Outsourcing Means Fewer Jobs in Manufacturing

Barely a week goes by in the USA, the UK and elsewhere, without news of job layoffs in the manufacturing sector.

Caterpillar Inc. (NYSE:CAT), one of the world’s biggest manufacturers of construction and mining equipment, recently announced 5,000 job cuts by the end of 2016. In mid-October Tata Steel (BOM:500470) announced that it was axing 1,200 jobs in the UK. Two weeks later the British engineering firm Meggitt PLC (LON:MGGT) announced that it would have to cut 300 jobs. BP has also hinted at the need for job cuts, given the continuing low oil price.

There is no doubt that prospects have worsened for manufacturers over the last quarter in view of the slowdown in China and sluggish global growth. But there are other reasons why the job count in manufacturing is falling.

In the USA, apparently, in the 65 months from March 2010 to July 2015, the manufacturing sector shed 1.4 million jobs and the number of bar workers rose by exactly the same number[i]. This is not a very inspiring statistic.

But if you assume that our manufacturing sector is shrinking and is of less importance to the economy as a whole, think again. We need to look deeper if we want to understand what is really going on in the world of work.

Look at jobs in the agricultural sector – farming, in plain English. In 1840, 70% of the American labour force worked in farming. By 1900 that had come down to 40%, and then to 20% by the time of The Grapes of Wrath in 1930. And by 1970 it was just 2%. Today it is less than 1%[ii]. The UK figures are parallel, although we started to industrialise before America.

The point is that, as everybody knows, agricultural production has not fallen. In fact, it has grown over the same period by more than the economy as whole. Yet, thanks to mechanisation and new technologies (like genetic modification – the impact of which is only beginning), this can be accomplished by fewer and fewer people.

Now most people don’t regard this as a bad news story. OK, there are a few idealistic pastoralists who would like us all to go back to the land and traipse around in wellies. And I agree, the rise of allotment-keeping amongst the middle classes speaks of a need to get closer to the food we eat. But fundamentally, most of us lead better, more fulfilled lives because we are no longer slaves to the land, as our ancestors were.

Soon we might similarly come to see the decline of jobs in manufacturing as, if not good news, at least not a bad news story.

In America, the proportion of the workforce working in manufacturing stayed steady for decades after WWII. It peaked at 19.5 million workers in 1979, since when the number has fallen to around 12 million for two main reasons. Namely: outsourcing and technologically-driven productivity gains.

In America big firms began to outsource the payroll function back in the 1950s. Then, slowly but surely, they began to outsource accounting, customer support and legal services. With the coming of the internet this trend accelerated. Web design and data entry as well as IT maintenance are all generally managed by third parties. From the 1980s onwards most corporations outsourced staff catering. Then came security and logistics, which are rarely now undertaken in-house.

Nowadays, manufacturers buy in specialist expertise, as required, rather than recruit new staff. Hence the rise of public relations consultants, head-hunters, call centre operators, cyber-security specialists, social media optimisers – the list goes on.

So a lot of jobs apparently shed by manufacturers have not disappeared at all – they have just been transferred to the service sector.

Increasing productivity, as we well know, has also cut a scythe across the job count. Indeed, factories and utilities like power stations are under construction which, thanks to robots and brilliant IT, will require a handful of skilled technicians to operate them. A recently completed US$100 million natural gas processing facility in Cotulla, Texas employs about 20 people. Amazon’s warehouses, I am told, are almost ghostly, so few humans are required.

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All very interesting, I hear you say, but how do I make money? Be alive to the new trends in outsourcing and where most value can be added within the value chain that is our advanced technological economy.

Image consultants? Shopping advisers? Personal Pilates trainers?

Being of a sceptical nature, I like businesses that I understand. Contract catering seems to me a fantastic business with a great product: meals. Everybody needs to eat. Economists, who generally eat badly in my experience, consider contract caterers a service industry, even though caterers do make things. This is apparently because the products in question (breakfasts, lunches and dinners) are consumed as soon as they are produced.

Because this business is not really cyclical, in the technical sense, and because there is still huge growth potential in this sector, shares in contract caterers have been able to command high earnings multiples.

There are three outstanding contract caterers which I have had an eye on for some time. Two of them are French, which in the realm of food is certainly not a disadvantage.

The market leader in the UK is Compass Group (LON:CPG), which serves meals to industrial workers, hospital patients and even members of the armed forces across the UK and beyond. As I write it’s trading at around 1,050 pence on the London market giving a P/E of just under 21. On 30 October the company announced stronger than expected results for Q1 2015-16.

But Compass is dwarfed in size by the French giant Sodexo SA, which trades on Euronext Paris (EPA:SW). At a price this morning of around €79 its P/E comes in at just under 22. Note that the brokers have been a bit sniffy about Sodexo’s performance of late. Goldman Sachs downgraded the stock to SELL on 09 November. Of course, Sodexo does much more than just catering. It sterilises medical equipment, cleans offices, rehabilitates prisoners and cares for children. (I hope that the last two are not connected). So it is an outsourcee (if such a word exists, though it should) par excellence.

Then there is Elior Participations SCA (EPA:ELIOR), which ranks itself as number one in contract catering in France, Italy and Spain and number four worldwide. Millions of school children across France and southern Europe are nourished by its meals. Full year financial results will be released on 11 December but, so far, earnings and margins have been ahead of expectations. The company has been acquiring smaller operators across the English speaking world over the last year. A strategy of global domination, perhaps? This morning the shares are trading at just above €17, giving a whopping P/E of nearly 31.

Contract caterers compete not just on price but on quality. Healthy eating, especially for youngsters, is a major issue right across the advanced world, not just in the UK where Jamie Oliver has declared war on the chip butty. A productive workforce needs to eat well.

Some food for thought, I hope. Outsourcing still has a lot further to go.

[i] See: http://www.zerohedge.com/news/2015-08-07/holy-grail-americas-new-economy-waiter-bartender-jobs-have-increased-64-past-65-mont

[ii] Figures from Where will the New Jobs Come From? by Thomas Tunstall (University of Texas), Wall street Journal, Friday, 06 November 2015.