Competitive Status of the U.S. Machine Tool Industry: A Study of the Influences of Technology in Determining International Industrial Competitive Advantage (1983)

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REFERENCE COPY FOR LIBRARY USE ONLY The Competitive Status of the U.S. Machine Tool Industry: A Study of the Influences of Technology in Determining International Industrial Competitive Advantage Prepared by the Machine Too! Panel, Committee on Technology and International Economic and Trade Issues of the Office of the Foreign Secretary, National Academy of Engineering and the Commission on Engineering and Technical Systems, National Research Council E. Ray McClure, CHAIRMAN Paul R. Schulman, RAPPORTEUR NAS-NAE FEB 1 1 1983 NATIONAL ACADEMY PRESS Washington, D.C. 1983 LIBRARY 



Summary This report examines the comparative international standing of the American machine tool industry. It reflects the deliberation of a panel of industry leaders and analysts assembled under the auspices of the National Academy of Engineering. The historical roots of the American machine tool industry are very deeply set, going back almost to the beginnings of the Republic itself. The present structure of the industry reflects many of these historical antecedents. It is an industry of small companies, more than 65 percent of its firms have fewer than 20 employees. Total industry output in value of shipments in 198] was approximately $5.1 billion. In addition to its small size, the American machine tool industry is extremely fragmented. Indi- vidual companies are predominantly family-owned, and there is little industry concentration through mergers or acquisitions. Indeed, among American machine tool builders there is an intense competitiveness, and the industry is characterized by very little subcontracting and few cooperative ventures. Despite its size and fragmentation, however, the machine tool industry is of great strategic importance to the processes of economic growth and industrial development. Virtually every major manufactured product is produced on machine tools or on machines built by machine tools. Advances in machine tools have been important factors in technological advances in electronics, optics, and aerospace hardware. In the Machine Tool Panel's judgment, economic as well as national defense dependencies are important reasons for the continued maintenance of a strong domestic machine tool industry. Yet the panel was forced to conclude that the American machine tool industry is currently far from healthy. The industry is steadily losing ground to its international competitors, not only in world trade, but also in its own domestic market share. The American industry is beginning to lag behind in technological leadership to the Japanese and West German industries, particu- | 

2 larly in the area of machine software and control units. American machine tool builders are significantly behind, the panel believes, in the organization and technology utilized in their production processes. Many of the American industry's problems can be traced to the severe cyclicality of its domestic market. Market fluctuations contribute to manpower insufficiencies and the undercapitalization in regard to plant modernization with which American machine tool builders are afflicted. These and other problems of the industry are examined in detail in this report. In the judgment of the panel, increased international trade could significantly buffer the cyclicality of the machine tool market. Such trade affords American machine tool builders a significant opportunity to ameliorate many of the problems that they confront. The panel reviewed a variety of policy options related to trade and other industry problems. It attempted to assess these options in terms of both their possible positive and negative effects. In particular, however, there were several policy options that the panel specifically does not endorse for the industry. These include: * any major government subsidies or direct supports to the machine tool industry; * any tariff or protectionist responses to the rising rate of machine tool imports and * major counter-cyclical purchases of machine tools by government agencies, such as the U.S. Department of Defense, to bolster the industry. In addition to assessing options pertaining directly to trade, manpower, recruitment and training, capital formation, and technological development, the panel reviewed the impact of existing regulatory practices upon the machine tool industry. Lastly, the panel analyzed some strategies that the industry itself could adopt in an attempt to address its problems and safeguard its future. 

1 Description of the Industry This report examines the international competitive position in both trade and technology of the American machine tool indus- try. It reflects the deliberations of a panel of industry leaders, researchers, and analysts assembled under the auspices of the National Academy of Engineering. The focus of this report is on the economic, technological, and institutional character of the machine tool industry; its importance to the American economy and national security interests; and its projected future in domes- tic and world trade. The report explores major problems con- fronting the industry and assesses potential policy options for both government and industry that might be appropriate in the face of these difficulties. IDENTIFICATION OF THE INDUSTRY The National Machine Tool Builders Association (NMTBA), a major trade association of machine tool manufacturers, has described a machine tool as "a powered device, not hand-held, which cuts, forms, or shapes metal." Such machines are highly diverse in nature--ranging from boring, grinding, and threading implements to pressing, bending, and die-casting devices. The machine tool building industry is described in the U.S. government's Standard Industrial Classification (SIC) code primarily by items 3541 and 3542: metal-cutting and metal- forming machine tool manufacturers. While the machine tool industry is often defined to include both contract tool and die shops that manufacture special machines on an individual job or order basis and machine tooling companies that employ machine tools on job assignments for specific customers. These additional activities are not the focus of this report. A differentiation of these separate machine tool sectors is shown in Figure |. 

Covered by this report: Agriculture and construction industries “Machine Tooling” establishments (Approx. 11,000) ve . 1% —p Captive shops Machine tool builders _- Aerospace (SIC 3541, 3542) industry _ _Metal cutting metal forming (approx. 1343 companies) , \ Automotive industry Figure 1: The machine tool building industry under study in this report *Captive shops are owned subsidiaries of companies in the aerospace, automotive or agricultural and construction equipment industries. 

d The panel's analysis focuses on the general machine tool build- ing industry, excluding captive shops which build machine tools for single users with whom they are financially integrated, such as in the aerospace, automotive, or agricultural equipment industries. The analysis also excludes the manufacturers of special tools and accessories. ! Many of the issues addressed in this report, however, could apply to such organizations, as well as to the machine tool using job-shops of the metalworking industry. The latest published Census of Manufacturers of the U.S. Department of Commerce (1977) estimated the number of machine tool building companies in the nation at 1343. The NMTBA estimates that of these roughly 60 percent are machine tool manufacturers, as opposed to manufacturers of parts and accessories. (NMTBA membership currently numbers around 400.) Employment estimates for the U.S. machine tool building industry in 1980 were approximately 100,000. Total industry shipments during 1981 were valued at an estimated $5.1 billion. IMPORTANCE OF THE INDUSTRY From these figures it is immediately apparent that the U.S. machine tool building industry is quite small. In addition the average size of individual firms in the industry is small alsos in the 1977 census more than 65 percent of the firms surveyed had fewer than 20 employees. A number of individual corporations in other sectors of the economy have more employees and higher sales than does the entire machine tool industry. Yet despite its size, the machine tool building industry is of great strategic importance to economic growth, and to the nation's comparative international position, both economically and militarily. Virtually every major manufactured product is produced on machine tools or on machines built by machine tools. As Figure 2 illustrates, machine tools are crucial to a great vari- ety of industrial processes and commercial products. General economic growth depends closely upon the availability of machine tools for the manufacture of new products. Advances in machine tools have been an important factor in the development of many new technologies in such areas as electronics, optics, and aero- space. Many major American industries, such as the automobile industry, are closely dependent upon machine tools for the maintenance of their competitiveness in domestic and world markets. As one General Motors executive asserted, "Machine tool builders have produced the equipment that has won one of the greatest battles that humanity has ever fought. I don't mean World War II, I mean America's battle for the abundant life." 

Clothing J Weaving Carpets machines Furniture | — Electronic components Glass-blowing — Containers J | machines 4 Electric bulbs — Scientific instruments —Lee._| Machine Create Drilling Petroleum Pharmaceuticals tools equipment products —— Automated assembly rt. - Toys machines — Automobiles i —Lete._] — Tanks, trucks a Other machine it Airplanes Pe ——— tools —L Ete] Figure 2: An example of the long-linked economic impact of machine tools. 

7 Computer controlled and monitored machine tool systems, most analysts agree, are of critical importance to manufacturing automation along with the advancing technology of robotics. In this regard, machine tools are crucial elements in heightening industrial productivity. The productivity issue, in turn, is an important determinant of the international competitiveness and price stability of modern national economics. In recognition of this, productivity has become a major issue in the revitalization of American industry. Apart from these immediate economic dependencies upon machine tools, national security is also linked to the performance of the industry. The manufacturer of defense weaponry depends in no small measure upon applicable machine tool capacity. Indeed, one of the major advances in machine tool technology-- numerically controlled units--came about as a result of an Air Force contract to develop this militarily important machine tool and manufacturing capability.? These economic and military dependencies upon machine tools are extensive and are important reasons for the maintenance of a vigorous machine tool industry. Some analysts might suggest, however, that even given these dependencies, imported machine tools, manufactured by industries in other nations, could supple- ment or even replace much of our domestic industry. Yet there are strong arguments for the continued importance to the national interest of an internationally competitive and technologically vigorous American machine tool industry. The U.S. Cabinet Council on Commerce and Trade in the final draft (May 19, 1982) of its soon-to-be released report, An Assessment of U.S. Competitiveness in High-Technology Industries, asserts, "a healthy machine tool industry is considered an important element of the U.S. industrial base." Uncertainty in the cost and avail ability of imported raw materials such as petroleum has demon- strated the possible consequences of major import dependencies for critical items. Increased dependence on foreign sources for machine tools could potentially adversely affect the U.S. military effort by disrupting supplies and thereby reducing the U.S. capability to meet increased military production demands in times of national emergencies. It could similarly disrupt major U.S. industries that rely on a dependable supply of machine tools for the maintenance of their world market shares. Although balance-of-payment deficits in any one industry may not be viewed as crucial problems, until 1978 the machine tool industry had a positive balance of payments. Since that date the industry has had a negative balance, having reached more than $500 million in 1980.4 

8 Finally, a great deal of engineering and manufacturing know- how would be squandered should an atrophy of the domestic machine tool industry occur. In an era of high unemployment levels, the U.S. skill base should not be allowed to erode. Such technical skills are perishable. They provide a base for tech- nological innovation that might not be duplicated fully in other countries. In this regard, it is important to stress the multiplier effect that a nation's machine tool leadership can have upon its competi- tive advantages worldwide in other industries. Many domestic manufacturing interdependencies lie behind a nation's internation- al trading success in any one product. Should the American indus- try not take the lead in the development of the newest innovations in machine tooling, the prospects exist that important advances in manufacturing technology for many industries might be signifi- cantly delayed, or escape development at all, in this country rela- tive to its overseas competitors. Such dangers would loom over a number of American industries should advances in machine tool technology be entrusted to other nations. The United States would certainly have had to wait far longer than it did for numerical control machine tool technology and its multi-industry manufac- turing benefits if it had not taken the lead itself in the develop- ment of this major machining innovation. For these reasons, it is the firm contention of this report that the continued health of the American industry, both economically and technologically, is of vital importance to the United States. At the same time, as this report will demonstrate, the future of the industry is distinctly insecure. A number of disquieting prospects confront the industry--some immediate and some long-term. Without question the most pressing problem immediately confronting the American machine tool industry is its sharply declining share of both the international and domestic markets. As Figure 3 indicates, the U.S. industry's share of world exports has declined steadily over the past two decades from approxi- mately 23 percent in 1964 to less than 7 percent in 1980. Indeed the United States has dropped its onetime world leadership in machine tool exports to a far less secure position, trailing West Germany and Japan in world market shares. In the dollar value of world machine tool exports in 1981, the United States (at approximately $1.1 billion) trailed far behind West Germany (at $2.5 billion) and Japan (at $1.7 billion). Further, the U.S. machine tool industry has suffered a significant loss of its own domestic market share. Machine tool imports have increased as a percentage of domestic coopsumption from less than 4 percent in 1964 to 24 percent in 1980.” For the past 3 years the United States has experienced a negative 

Source: American Machinist U.S. Dept. of Commerce, NMTBA Figure 3: Relative national shares of world exports (Machine tool exports as a percentage of total world exports) Source: NMTBA Economic Handbook, 1981-82 trade balance in machine tools--an unprecedented development in the history of the industry. By way of contrast however, Japan, which is now the largest foreign supplier of machine tools to the U.S. market, has seen its imports shrink from 31 percent of total Japanese consumption in 1960 to around 8 percent in 1980. Imports were 24 percent of U.S. consumption in that same year. This declining position in world market share, together with increased foreign penetration of the U.S. market, poses many difficulties for the machine tool industry. It is not simply the lost revenue that threatens the health of the industry. (Even with the decline in world trade, machine tool orders and shipments have risen dramatically in recent years.) What is of particular concern about the declining share of the machine tool export market is that international trade, in the view of many industry analysts, is a major way for domestic machine tool builders to moderate one of their most chronic and burdensome problems: the “boom or bust" cyclical variation of machine tool demand. 

10 As this report will demonstrate, the machine tool industry has been subject to sweeping oscillations in sales, with great demand peaks followed by steep declines in orders. Frequently these oscillations run in 8-to-10-year cycles. This cyclical behavior of the domestic market causes a number of major problems in the industry, ranging from capital-formation difficulties to chronic manpower shortages. Such oscillations are characteristic of metalworking industries in general, and, as Figure 4 illustrates, they are not limited to the United States. Yet significantly, these worldwide oscillations are not in phase, and machine tool demand does not wax and wane in unison throughout the world. The world export market, therefore, represents an important means by which the American industry could buffer the cyclical nature of domestic demand by offsetting sales to a world market in which aggregate demand is relatively stable. It is this potential stabilizing opportunity that is lost to the industry with the decline in its share of world machine tool exports. For reasons such as these, this report concludes that world trade is a major challenge facing the American machine tool industry. Yet additional important challenges confront the industry as well. In order to have a chance to compete success- fully on world markets, the industry must be a world leader technologically in both the design and manufacture of its products. This report will review in some detail the relative technological standing of the industry, but its general conclusion is that at present its manufacturing and production technology is significantly below the state of the art attained by leading international competitors. While the technology of American machine tools as products is at present roughly comparable to those of other nations, the prospects are uncertain that the domestic industry will exploit the latest technological develop- ments to the degree necessary to attain over the next 3 to 5 years a competitive edge for its products. Apart from technological uncertainties, the American machine tool industry at present and for the foreseeable future faces serious skilled manpower shortages as well. Chronic skill deficiencies exist in a variety of areas, ranging from the managerial to the shop level. Manpower problems loom as perhaps the most pressing internal dilemma confronting the industry. This report will explore these and other challenges in detail. A number of public policy questions arise in connection with the industry and its problems, and these will be analyzed as well. First, however, some historical background on the development of the American machine tool industry is necessary in order to understand its present condition. 

11 32 Current $ X 10° a tN 16 12 Figure 4: Machine tool consumption among selected industrial nations (Consumption = production + imports - exports) 

12 NOTES l. These restrictions on the scope of the study were agreed to unanimously by the panel given the limited available data and the need to facilitate international comparisons. The exclusion of Captive shops and special tool and accessory manufacturers is not meant to imply that these organizations should not be the subject of additional intensive study. 2. See "The Reindustrialization of America," Special Issue, Business Week (June 30, 1980). Also, "“Microsolutions to Manufacturing Productivity Problems," Machine Tool Bluebook (May 1980), pp. 108-119. 3. R. Watson, Numerical Control in Manufacturing (New York: McGraw-Hill, 1963). See also, E. Mansfield et al., "The Diffusion of Numerically Controlled Machine Tools in Ten Manufacturing Industries," in Mansfield et al. (eds.), The Production and Application of New Industrial Technology (New York: W. W. Norton, 1977). 4, U.S. Cabinet Council on Commerce and Trade, An Assessment of U.S. Competitiveness in High-Technology Industries, Final Draft, May 9, 1982. 5. It should be noted that import figures represent only machines for which import duties have been paid. They do not include foreign-built machines stocked in this country or machines manufactured domestically by foreign-owned companies. 6. National Machine Tool Builders Association, 1980/81 Economic Handbook of the Machine Tool Industry. 

2 Historical Character of the U.S. Machine Tool Industry In 1794 inventor David Wilkinson of Pawtucket, Rhode Island, fashioned a screw-cutting lathe with a slide rest. With its patent in 1798, Wilkinson is credited with founding the American machine tool industry.! In its earliest years the fledgling machine tool industry was nurtured by the new American government which well recognized its importance to the provision of pistols and muskets. The arms- manufacturing process spawned by machine tools, a large-quantity production process based upon the fabrication of interchangeable parts, was to lie at the heart of the entire industrial manufac- turing system that subsequently developed in America. The early history of the machine tool industry was distin- guished by the relatively small amounts of capital with which new businesses were started. This encouraged many young and talented entrepreneurs with new ideas to form their own firms. Indeed this pattern of small businesses, individually or family-owned and managed, persists to the present as a dominant characteristic of the machine tool industry. _ By the early 1870s there were approximately 72 machine tool building companies in the United States, mostly small and con- centrated geographically in New England and the Atlantic sea- board states. Machine tools at this time were still "hazardous affairs with exposed gears and uncontrolled drives" but, as the industrial revolution intensified, demand for them continued to grow. "New firms in such distant places as Cleveland, Cincinnati and Rockford began to compete with the original New England and Philadelphia firms." A major change in the technology of machine tools took place at the turn of the century with their electrification. In 1902 the National Machine Tool Builders Association was formed in order, among other things, to coordinate a set of electrical standards among its members. 13 

14 World War I saw a major increase in machine tool production capacity of the nation, although the pace of innovation in manu- facturing and tooling methods was slowed. After the war, the growth of the automobile industry led to a major expansion in the number of American machine tool companies, and materials and motor-drive innovations proceeded rapidly. These improvements in the technology of machine tools continued even as the depres- sion fell heavily upon the industry. Unit production of machine tools fell by more than 50 percent in 1930 and by another 50 percent in 1931 and 1932. The depression significantly increased the age of the U.S. machine tool inventory (termed the machine tool "park"), and, by 1935, 65 percent of all U.S. machine tools were more than 10 years old, as compared with 48 percent in 1930 and 44 percent in 1925.3 World War II armament needs dramatically heightened U.S. machine tool production. Around-the-clock work was urged for machine tool building, although the shortage of skilled manpower prevented this pace from being adopted universally. By 1942 the machine tool shortage was substantially eliminated, and by the end of the war the industry had produced some 800,000 machine tools, 100,000 of these for export. The end of the war brought a great trauma to the American machine tool industry. Approximately 300,000 government- acquired machine tools were dumped on the domestic market. This action had a severe dampening effect upon the vitality of the industry, and it had not yet recovered when the Korean War once again heightened demand for machine tools. The National Production Authority, established to coordinate war production, diverted orders for machine tools from civilian customers to weapons manufacture. These wartime experiences with government management and allocation procedures left a legacy of suspicion and hostility among machine tool builders that still persists. Yet at the same time government intervention has given the industry one of its greatest technological advances: the numerically controlled (NC) machining capability. A series of U.S. Air Force-sponsored research projects starting in 1949 at the Massachusetts Institute of Technology (MIT) led to the development of techniques of employing encoded numerical data to direct metal-cutting operations to extremely close toler- ances. The U.S. Air Force helped to diffuse the new technology throughout the industry by means of a “big buy" strategy--placing orders for large numbers of NC machines with a number of major machine tool companies. Many of the historical milestones reviewed above are closely reflected in the present character of the machine tool industry. It is useful to describe some of the salient characteristics of the 

15 industry at present in order to understand the nature of the challenges with which it is confronted. NOTES 1. "100th Anniversary Issue," American Machinist, vol. 121, no. 11 (November 1977 and Harless D. Wagoner, The Machine Tool Industry from 1900 to 1950 (Cambridge: MIT Press, 1968). 2. American Machinist, op. cit., p. D-3. 3. bbid., p. F-8. 

3 Present Character of the U.S. Machine Tool Industry The machine tool industry is still predominantly characterized by small, privately owned firms, rather than by large public stock corporations. In 1977 (the last year for which census data are available), there were approximately 1343 machine tool building establishments in the United States. Of these, 874 or 65 percent had fewer than 20 employees. Only 10 employed 1000 or more. The entire domestic industry employed approximately 100,000 in 1980. In addition, family ownership is still a predominant charac- teristic of machine tool establishments. In 1975 only 24 firms that are members of the National Machine Tool Builders Association were listed on a public stock exchange.! Table | identifies some of the larger public stock companies in the industry and details their 1980 financial performance. GEOGRAPHICAL DISTRIBUTION OF THE INDUSTRY As our earlier historical review indicated, during the nineteenth century the machine tool building industry was located primarily in New England. Toward the end of the century, the industry's center of gravity shifted, first southward to the mid-Atlantic states and Pennsylvania and later westward to Ohio and the Midwest. Historically, the growth of the machine tool industry has always closely followed the growth and development of other industries--textiles, small arms, watches and clocks, ships, railroads, farm machinery, and bicycles. In the 1920s, the rapid growth of the automobile industry led to steeply rising machine tool production in Michigan and Illinois. Today the leading machine tool producing states are Ohio, Michigan, Illinois, and New York, accounting for about 62 percent of the industry's employment.“ In the latest Census of Manufacturers, 52 percent of the firms in the industry were reported to be located in 16 

17 Table 1. Financial performance of leading machine tool companies (1980) Change Change Return Change From Net From On From Sales 1979 Income 1979 Assets 1979 Company ($ mil.) (%) ($ mil.) (%) (%) (%) Acme-Cleveland 405.0 18 17.2 -12 7.3 -24 Brown & Sharp 227.0 18 14.5 14 8.5 -10 Cincinnati Milacron 816.0 9 75.6 41 23.3 122 Cross & Trecker 355.0 19 33.4 26 13.0 18 Giddings & Lewis 328.0 27 31.9 10 29.4 60 Gleason Works 242.6 12 16.3 -17 17.3 24 Monarch Machine Tool 130.7 34 12.3 35 28.4 108 (Source: Office of Tachnology Assessment; Standard and Poor's) the North Central states, only 6 percent in the South, and 11 percent in the West (this latter figure despite the heavy concen- tration of aerospace industries on the West Coast). OWNERSHIP AND MANAGEMENT PATTERNS IN THE INDUSTRY As indicated earlier, the overwhelming majority of establishments in the machine tool industry are private firms, often in the second or third generation of family ownership. The trend toward con- centration through mergers and acquisitions, which is well advanced in other industries, is scarcely discernible within the machine tool industry. While the number of acquisitions increases during periods of peak sales, many of these acquisitions are unsuccessful. This is particularly likely to be the case if the acquiring company has not had prior experience in machine tool building. Even mergers between two machine tool building companies often result in combined sales that are less than the prior amounts of both separately. Furthermore, mergers and acquisitions are continually offset by the formation of new and independent companies. A number of factors may account for this relative lack of concentration in the industry. Frequently the financial skills and 

18 strategies predominant in an acquiring conglomerate do not sub- stitute for the technical and engineering acumen necessary for successful management of a machine tool company. Furthermore, machine tools are highly specialized items that confront equally specialized markets. Because different machine tools appeal to separate markets, often markets that have little overlap, there is likely to be little advantage to offering a broad line of machine tools, particularly if they are offered under a single marketing strategy. The degree of specialization of machine tools can deny merging companies the ability to capture economics of scale in either their sale or manufacture. Despite such factors, some industry analysts are predicting a rapid rise in machine tool company mergers and acquisitions." If such concentration were to occur within the industry, its effects would probably be mixed. While concentration would allow for needed capital accumulation and aid the industry in responding to large turnkey type orders, a number of mergers and acquisitions would not necessarily benefit the production of specialized, high-technology machine tools, some of which are best produced by small, independent companies. We will discuss these issues in more detail later in this report when we attempt to profile the characteristics of innovative machine tool companies. Whatever the speculation regarding concentration, the machine tool industry retains at present its character of small-business ownership. This ownership pattern has meant that many machine tool company executives come from machinist or engineering backgrounds and often have little in the way of financial, legal, or managerial experience. Machine tool builders tend to be highly competitive, independent, and individualistic. These are traits that, as shall be seen, have great impact on the behavior of the American industry and upon its position in world trade. INSTABILITY OF THE MACHINE TOOL MARKET Perhaps the most important trait associated with the machine tool industry is the extreme cyclicality of its income, profits, and cash flow. As Figure 3 has already indicated, machine tool con- sumption is subject to major oscillations in all industrialized nations and is particularly severe in the United States. It would be impossible to understand the American industry without appreciating both the depth and wide-ranging implications of these cycles. Somewhat longer than business cycles, oscilla- tions in machine tool demand may run as long as 10 years from peak to peak. The demand fluctuations in these cycles average between 25 and 35 percent, although in individual cycles the range can be much greater. 

19 The primary reason for cyclicality in machine tool demand is what might be termed an accelerator effect regarding purchases of major capital equipment.” Relatively small changes in the demand for commercial products induce great changes in the demand for capital equipment. Take as an example a company that uses lathes for the manufacture of its products. Assume that its manufacturing base consists of ten such lathes and that, because of wear, one replacement lathe is purchased each year. Should the company in response to demand decide to increase its output, it may find that a relatively small production increase, say 10 percent, may require the purchase of an additional lathe beyond its yearly replacement. Here a modest increase in production can lead to a 100 percent increase in the company's lathe demand. The accelerator function can of course work in a downward demand direction as well. Should the company return to its earlier production rate or simply cease its expansion and return to replacement purchases only, its lathe demand could fall by 50 percent the very next year. Such scenarios as those depicted above destabilize the machine tool market when they occur on an economywide scale. While in reality individual companies can adopt strategies of production (overtime, postponing replacement purchases, etc.) that might act to buffer the accelerator effect somewhat, its impact can never be fully suppressed. There are other factors as well that contribute further to the cyclicality of machine tool demand. A very high percentage of machine tool customers are in the metalworking sector and are themselves confronted with cyclical markets. Fluctuations in demand for major consumer durables such as automobiles greatly influence the machine tool market. In actuality, a major source of cyclicality in industry sales has traditionally been the very durability of machine tools themselves. As long-lived products, replacement orders have not generally been a strong foundation of industry sales. Instead it has been only major business growth or product change that has spurred large orders of new machine tools. It has been speculated that this characteristic may be subject to change in the near future, with the more rapid obsolescence of numerical contro! units. In the meantime, the machine tool industry remains unusually sen- Sitive to fluctuations in the general business climate and strongly dependent upon product innovation among its customers for increased sales. For the machine tool industry, the cyclicality of demand has numerous and far-reaching impacts. An immediate consequence is the existence of major backlogs in the delivery of orders during peak periods. In 1979 orders reached about $5.5 billion with a backlog of more than $2.2 billion, or about 16 months at prevail- 

20 ing shipment rates. By the third quarter of 1981, with machine tool demand declining, the backlog fell to $4 billion worth of orders but was still about nine months at prevailing shipment rates. Severe backlogs during periods of intense demand put great pressure on the industry to satisfy its large domestic customers, particularly the U.S. automakers. For these customers, delivery date can be a more important purchasing variable than price, and a number of analyses cite delivery backlogs as a major factor in the increased capture by imports of the domestic machine tool market, as well as the loss of U.S. industry sales abroad. For U.S. machine tool builders, however, the delivery backlog is an inevitable result of market instability and the difficulty of matching production capacity to demand fluctuations. In this context, a backlog can have a positive function for the industry in the degree to which it buffers machine tool production against the downward part of a demand cycle--leveling out activity in the industry even over the fall in new orders. Unfortunately, the downside of demand cycles is often accompanied by the rapid cancellation of orders, so that the backlog falls far short of an ideal buffer. Ironically, machine tool building is in many respects a manufacturing process very poorly suited to a cyclical market. The relatively high skill requirements, long production lead times, and high work-in-process inventories that characterize the industry pose great problems when confronted with oscillations in demand. Many of the major problems that beset the industry--in manpower, capital accumulation, and technological innovation-- that will be the focus of this report stem in no small part from the instability of the machine tool market. CAPITAL INVESTMENT PATTERNS IN THE INDUSTRY From the perspective of the financial community, the machine too! industry is a "mature" industry with only moderate future growth prospects. A recent study of 12 machine tool firms by Data Resources Incorporated forecast a 12 to 15 percent yearly return on equity through the mid-1980s. A 7 to 9 percent current- dollar yearly growth rate is forecast for the industry for most of the decade. While some industry analysts dispute these projections as being too conservative and as misleading regarding the wide company- by-company variations that are likely in both growth and return- on-investment, relatively low profits and high capital costs have historically characterized the industry. The instability of the machine tool market places the industry in the moderate-to- 

21 high-risk investment category. High risk, coupled with low profit and uncertain cash flow, make the capitalization of new equip- ment or production processes extremely difficult for the industry. The average rate of profit in the industry (4.4 percent of sales after taxes in 1978) fluctuates drastically, as might be expected, with cyclical variations in the market. In peak periods the rate of profit among machine tool builders is comparable (or even higher) than other manufacturing industries, but in downturns it is signifi- cantly worse than other industries. Machine tool builders have traditionally understated their expenses as a result of accounting rules that do not allow full weighting of depreciation and capital costs. This has created an illusion of profitability during peak periods that can be misleading and that may lead to some ilk informed acquisitions of machine tool firms during these periods. Some analysts attribute low profits in the industry to the predominance of family ownership. They contend that “the prevalence of small, family-owned firms, who divide profits among family members, artificially keeps prices and hence profits down because the family is ‘satisfied’ with smaller profits. A _ single family that earns $100,000 of profit is content even though this may represent only one or two percent of sales, a rate of geturn that would be too small for a larger firm with stockholders.’ Whatever the weight of this argument, the family and small business nature of the industry renders its capital investment process extremely sensitive to government policy regarding depreciation and investment tax credit and, additionally, to inheritance tax rates. For many diverse reasons, the machine tool industry in the United States is undercapitalized relative to its research and equipment investment needs. This retards the automation of its own machine tools as well as the development of new product innovations. MANPOWER IN THE MACHINE TOOL INDUSTRY If all the employees of the U.S. machine tool building industry were to work for a single company, it would rank only about twenty-eighth in total employment among U.S. industrial corporations. In 1981 the industry's employment was about 100,000. But employment, as would be expected, fluctuates sharply with oscillations in new orders and shipments. (See Figure Se These fluctuations create serious problems within the industry. If employment must be cut significantly, some segment 

22 120 110 100 Thousands 80 70 60 50 Lp m4 1 i de l 1 l 1 | l | A | l | i | l | iL { 4 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 Note: Estimate by NMTBA for 1977 and 1978 Source: U.S. Bureau of the Census, ‘‘Census of Manufactures’”’ and “Annual Survey of Manufactures” Figure 5. Employment in the U.S. Machine Tool Industry: 1958 to date (Source: NMTBA Economic Handbook, 1980-81) 

23 of the highly skilled labor force is irretrievably lost then when orders rise again there is a serious shortage of skilled workers. The uncertainty in employment prospects makes recruitment and training of new workers difficult within the industry. The training of a skilled toolmaker!! may take 4 or 5 years, a period that could easily extend beyond the life of a demand cycle. In recent years, skilled manpower shortages have become chronic in the machine tool industry. The National Machine Tool Builders Association estimates that by the end of the decade there will be a 17 to 20 percent shortfall (about £9,000 persons) in employees relative to machine tool demand. Future prospects for skilled machinists appear to worsen considerably given that the estimated average age of machinists in the nation is 58. Projected shortfalls in skilled machinists among the metalworking industries in general reach as high as 250,000 for the mid-1980s.! For machine tool builders the present labor shortage occurs not only among machinists, but also among precision machine operators, manufacturing engineers, and managers, as well as computer software and electronics specialists. In addition, it is projected that a wide range of engineering and product design skills will be required for the industry in the future as customers increasingly demand total manufacturing systems or turnkey products from machine tool suppliers. The total systems respons!i- bility that customers increasingly demand from builders creates new needs for highly skilled industrial designers. In contrast to the manpower needs of the machine tool indus- try is a national trend away from interest in manufacturing em- ployment. In general, the number of workers engaged in manu- facturing has been steadily declining in the nation from 30 percent of the work force in 1947 to 22 percent in 1972. Various estimates predict even more drastic decreases toward the end of the century when anywhere from 10 to 2 percent of the | force will be directly employed by manufacturing industries. “" Along with this trend has come a decline in the prestige accorded manu- facturing-related occupations. In the face of these developments, it has been difficult for the machine tool industry to make substantial gains in attacking its manpower shortages. Such shortages have indeed pushed many machine tool builders in this country in the direction of more automated production technologies but not, given their capitali- zation difficulties, to the degree of some of their overseas com- petitors. Among U.S. machine tool builders in general, manufac- turing is still a relatively labor-intensive operation. This is not to say that productivity has not increased signifi- cantly among U.S. tool builders. Payroll as a percentage of value