The U.S. Machine Tool Industry and the Defense Industrial Base (1983)

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2 AN INDUSTRY RESTRUCTURED OVERVIEW OF CHANGES We're going through a revolution in manufacturing technology. Formerly, you would have talked about evolution. EDirector of manufacturing research at helicopter plant] The American machine tool manufacturer is not as competitive as his [foreign! competitors are...not as prepared to make changeovers into new technology. [Head of facilities division at aerospace firml The U.S. machine tool industry is undergoing fun- damental restructuring. A structurally more complex and technologically dynamic industry is replacing a mature, less complex one. The industry has been characterized by fragmentation, relatively low levels of capital investment, and con- servative management. Strong forces from outside the domestic machine tool industry, however, have made thi traditional posture of the industry permanently outmoded. These forces include technological as well as economic factors: for example, the increasing use of new tech- nologies in machine tool construction and applications, and the increasingly global view of machine tool markets by foreign suppliers. The machine tool industry has undergone fundamental change over the past decade. Although basic metal-cutting and metal-forming machines are still a critical element in the manufacturing picture, the machine tool industry today is becoming part of a new, automated manufacturing industry that is producing new types of products, such as computer-driven, integrated production systems, that did 7

8 ~ - not exist 10 years ago. It contains new industry which have entered the market to promote advanced tech- nologies. It is diversifying into the processing of new materials. And it is today more than ever part of a world market, with worldwide sources being used even by U.S. machine tool firms. In this world market, however, the U.S. firms are being seriously challenged by foreign manufacturers instead of dominating markets as they did 10 years ago. It is this new, broader, and worldwide industry that forms the basis for an assessment of the machine tool industry's responsiveness to national security needs. This chapter traces how these developments are restructuring the U.S. machine tool industry today, and is divided into the following sections: the traditional U.S. machine tool industry technological trends shaping the industry segments economic trends new entrants and new competitive strategies response of machine tool builders to these changes THE TRADITIONAL U. S. MACHINE TOOL INDUSTRY Any analysis of the machine tool industry in the United States today must incorporate the fact that technological and market conditions are altering the definition of the industry and the players in it. To impart some apprecia- tion of these changes, this report starts with an examination of the traditional U.S. machine tool industry. Definition. According to the National Machine Tool Suilders' Association (NMTBA), the industry comprises manufacturers and sellers of machine tools, defined as "power-driven machines, not hand held, that are used to cut, form or shape metal.~1 Metal-cutting machines include lathes, grinding machines, milling machines, and machining centers. Typical metal-forming machines are presses, forges, and punching, shearing, and bending machines. This product classification conforms to the Standard Industrial Classification Codes 3541 (metal- cutting) and 3542 (metal-forming). Size. The machine tool industry, thus defined, is a relatively small sector of the economy. Production in the United States totaled $3.6 billion in 1982, or 0.12 percent of GNP.2 Total employment in the industry at the end of 1982 was estimated at 68,000, or less than 0.10 percent of U.S. employment.3

9 Until 1971, when U.S. machine tool production was outstr ipped by West Germany, the United States had been the world's leading producer of machine tools since the end of world War II. The United States regained the lead in machine tool production in 1979, only to be surpassed by Japan in 1982.4 The growth of Japanese machine tool production has been especially swift, averaging a~proxi- mately 30 percent annually between 1976 and 1981. Notwithstanding this development, American machine tool builders have sold, and continue to sell, many machine tools for export. Exports have averaged 13.8 percent of domestic machine tool production during 1971-1981, and in 1981 itself stood at 13 percent of domestic production. These exports have also held their own compared with the combined exports of other countries. The U.S. share of world machine tool exports has ranged about 8 to 10 percent since 1970: the rapid rise in Japanese machine tool export trade, in fact, appears to have been more at the expense of West German than of U.S. exports.6 The Committee notes in passing that the Eastern Bloc countries, once a Large market for U.S.-made machine tools, have now effectively disappeared as significant purchasers of U.S. equipment. Machine tool exports to these countries stood at $92.5 million in 197S, or 16.3 percent of total such exports: the corresponding figures for 1981 are $22.8 million, amounting to 2.2 percent of exports. Machine tool exporters, therefore, have had to find other markets to compensate for this loss. Although the Committee's mandate did not include pursuing this issue further, the Eastern Bloc sales situation is viewed by the Committee as an "unsolved further U.S. government attention. Concentration. Most companies - question that merits in the U.S. machine tool industry have traditionally been small, closely held firms with narrow product lines. Table 1 shows the extent to which ~m~1 1 Kohl i ohm ~..^ ~.,1 __ -~_ indust~v. ~ ~~ ~ ~—· t i ~ v ~ ~ ~ U L ~ ~ OU U [ l e In addition, the industry has not been characterized by significant firm concentration. According to Commerce Department figures, the 4 largest metal-cutting machine tool establishments were responsible for 22 percent of industry shipments in 1977. accounted for approximately 70 percent of the machine tool industry's shipments, as Table 2 shows. This means that the other 30 percent of shipments came from the remaining 1,000-plus establishments. In 1981, 15 companies

10 TABLE 1 Size of U.S. Machine Tool Establishments . 1963 1967 1972 1977 Number of establishments Average s ize of establishment (employees} Percent with 20 1,167 1,253 1,277 1,343 71 93 60 62 or more employees 36 40 34 35 Source: NMTBA, 1982-83 Economic Handbook of the Machine Tool Industry. Sales Pattern. Machine tool sales have traditionally been sensitive to changes in the business cycle. The National Academy of Engineering recently observed that perhaps the most important trait associated with the machine tool industry is the extreme cyclicality of its income, profits and cash flow. n It concluded that n it would be impossible to understand the American machine tool industry without appreciating both the depth and wide-ranging implications of these cycles.~7 Year-to- year swings in machine tool orders of t75 percent and -SO percent have occurred (see Figure 1), compared with maximum sales swings of +39 percent and -34 percent in steeL.9 This sales pattern has forced upon the industry a strategy of buffering Business cycle downturns by accumulating order backlogs from boom times.l° As the following paragraphs indicate, this pattern has prevented even large machine tool firms from having the capital investment, R&D, and overseas sales structure found in other manufacturing firms (e.g., office equipment) of . · ~ . sLml jar size. Employment Patterns. This cyclicality has had an effect on employment in the industry. Although the industry generally pays its employees better than the average of durable goods manufacturers (see Table 3),

11 TABLE 2 Shipments by the 15 Largest U.S. Machine Tool Companies Company C inc innati Mi lacron Bend ix Cross & Trecker Gidd ings & Lewis Ex-Cell-O F. Joseph Lamb Textron Acme Cleveland Litton I nger sol ~ M i 11 ing White Consolidated Gleason Works Houdaille Monar ch Esterline Estimated 1981 Shipments of U.S.- produced Machine Tools (Smillions) 498.0 400.0 310.0 286.9 280.0 27S.O 270.0 240.0 200.0 200.0 180.0 160.0 150.0 140.1 112.3 3,702. 3 = 73% o f Total Shipments 5,095.6 Sources: American Machinist, August 1982, p. 51: NMTBA . whether because of differences in skill levels or employment conditions, employment fluctuations have been substantially sharper among machine toot companies than in the durable goods sector of the nation as a whole. Commerce Department figures show that average changes in machine tool production worker employment are more than one and one half times the percentage changes in durable goods employment generally. Industry observers, and the Committee's own surveys, cite this cyclicality as one of the causes for the industry's conservative management and the inability of many machine tool firms to attract and retain the brightest engineering, managerial, and technical talent. Profitability. A common assertion has been that machine tool industry profitability is somewhat higher than the manufacturing average during upturns in the

12 FIGURE 1 Year-to-Year Change in Real Net New Orders of Machine Tools, 1957-82. 75 50 Lo ~ 25 o - > Lo 5: z -25 Al -50 _ _ oil 1- 751 1 1 1~ ~1 1 1 ~ 1 1 1 1 958 1 962 1 966 1 970 YEAR 1974 1978 1982 Sources: NMTBA, Economic Handbook of the Machine Tool Industry, 1982-83: RUMBA, "Industry Estimate of New Orders, Cancellations, Shipments and Backlog (monthly) n . business cycle, but substantially lower on the downside.ll Table 4 sets forth financial ratios that contradict this general assertion at least for the years 1975-81. These ratios indicate that The industry has maintained moderately healthy levels of profits and earnings relative to sales and to net worth, that these levels have risen since the middle of the last decade, and that they compare favorably with corresponding ratios for durable goods manufacturers. In 1982 and 1983, however, many U.S. machine tool companies posted significant lossesl2 and at least one prominent industry analyst has commented that The machine toot industry faces difficult profitability through 1984.~13

13 TABLE 3 Wage Rates for Metal-Cutting Machine Tool Employees Relative to Durable Goods Hourly Wages Year 1960 1965 1970 1975 1976 1977 1978 1979 1980 1981 1982 Source: U.S. Department of Commerce. Percent 106 110 112 108 108 109 109 109 109 107 108 Research and Development. Conventional machine too 1 industry managers have been cited by outside observers and by members of the machine tool industry itselfls for taking a short-term perspective on their market. Technological pre-eminence and a reputation for excellence are difficult to maintain without investment in basic research and development. The willingness and ability to invest in R&D requires a long-term outlook and an understanding that state-of-the-art technology and its potential for developing new products are essential for survival. The Committee found that a few leading machine tool companies have maintained R&I) initiatives. However, the ind stry as a whole has traditionally drawn on outside sources for new technology and new product development-- e.~., from the manufacturers of computers and controllers, manufacturing systems designers, and DOD prime contractors--rather than from internal R&D efforts. As thin report points out, this pattern of technology flow

14 TABLE 4 Selected Financial Ratios Comparing U.S. Machine Tool Industry with Durable Goods Manufacturers Mach One Too l Endue rev Durable Goods Induscry Comparisons Ne c Earn inge Operat ing On Let Profit on Worth After Profit on Nct Voreh year Sales Taxes Sales After Taxes ;oluo~n "c" column "a" c. d. Let Operating Earnings on column "a" column "a" as ~ of as Z of l9,S 9.1 13.8 j.7 9.9 13S.8 139.3- l9,s 9.4 11.0 7.9 13.6 118.9 30 8 197~. '.S 12.3 8.2 14.S 92.6 84 S 19,8 7.8 12.8 8.5 IS.9 9l.? 30 S L9,9 12.2 t6.3 7.6 15.5 L60.5 !OS 1980 13.1 18.1 S.0 11.2 218.3 1$1.6 1981 12.6 t8.0 6. S 12.0 193.8 150.0 L9?S-8I averages 10.2S 14.51 7.34 13.22 t44.S1 114.S8 S ou rc e: Fede re I Tr ado Cocci ~ ~ i on; N!t~BA can be ascr ibed in part to conventional defense procurement practices. Data on R&D outlays by the U.S. mach ine tool industry are contradictory. Two independent sources estimate that R&D investment averaged 1.5 to 1.6 percent of sales over the past decade.16 Figures supplied by the industry on a confidential basis to their trade association put the level at 4.1 percent.17 The NMTBA's data report that R&D climbed to 4.2 percent of sales in 1981 and 1982, reflecting either new RED initiatives and/or the industry's inability to cut R&D below certain minimum levels during recessionary periods. Analysis of this issue is complicated by the fact that the definition of "research and development" in the machine tool industry is not uniform. Because much of the industry's work involves the adaptation of basic machine tools and manufacturing systems to specific customer requirements, many mach i ne tool companies include such engineering application expenses with their R&D accounts. As a result of this accounting practice, which is not unique to the industry, machine tool industry R&D ratios may be inflated. The dollar amounts spent on R&D in the domestic machine tool industry also shed some light on that industry's economic situations Table 5 sets forth these amounts, on both a current and a constant dollar basis.

15 TABLE S Research and Development Outlays U.S. Machine Tool Industry Current Constant Year Dollars (1975\ Dollars 197S S 73,174 $ 73,174 1976 73,231 67,175 1977 83,238 70,541 1978 104,855 79,436 1979 128,216 84,911 1980 171,539 96,91S 1981 188,196 96,018 1982 (est.) 151,38S 75,693 Source: NMTBA. What the table shows is that R&D outlays have been heavily affected by economic slowdowns, and in 1982 fell almost to the level of outlays, in real terms, that existed in 1975. 3~- Table 6 compares capital outlays in the machine tool industry (SIC Codes 3541 and 3542) with outlays in related industrial sectors. It shows that U.S. machine tool industry outlays for capital spending have generally lagged those of other industries. This is consistent with the conclusion, referred to above, that machine tool builders have tended to rely on stretched out order backlog management, rather than increased capacity, to accommodate cyclical changes in demand. Growth and Productivity. The U.S e machine tool industryls share in world machine tool production is significantly below what it was in the late 1960s. In 1968, for example, the U.S. share in world machine tool output was more than 25 percent. Since 1970, however, it has failed to climb above 20 percent.l8 Of more significance, because of its implications for the future, productivity growth in the U.S. machine tool industry has also been poor. Table 7 compares machine tool industry output and productivity growth with cor-

16 TABLE 6 New Capital Expenditures as a Percent of the Value of Shipments-- Selected Industries, 1975-1980 Industry Miscellaneous Machinery (SIC 359) Office Machinery (SIC 357) Blast Furnaces/Basic Steel Products (SIC 331) Construction Machinery (SIC 353) General Industrial Machinery (SIC 356) Engines and Turbines (SIC 3S1) Motor Vehicles and Equipment (SIC 371) Farm Machinery (SIC 352) MACHINE TOOLS (SIC 3541 AND 3542) Special Industrial Machinery (SIC 355) Refrigeration and Service Machinery (SIC 358) Percent 5.9 5.5 4.6 4.0 3.5 3.4 3.4 3.1 2.9 2.9 2.5 Sources: Based on data from the Annual Survey of Manufactures and the 1977 Census of Manufacturers. responding figures for the U.S. durable goods sector. It shows that machine tool industry productivity growth has averaged a negative 0.7 percent annually during 1973-1981, which is substantially less than the performance of U.S. durable goods industries during the same period. Although it is possible that some productivity loss could have been caused by the retention of skilled workers during economic downturns, the majority of the Committee believed that the productivity growth record bears some relation to the levels of capital investment and R&D within the industry. While the connection cannot always be measured directly, it is generally accepted that high levels of capital investment and R&D spending are essentia: to maintaining productivity growth in technology-intensive industries.l9 Marketing. This general picture of a not very robust domestic industry is also reflected in the marketing practices of U.S machine tool builders. The industry itself has recognized that machine tool company management needs to adopt a long-term outlook and willingness to

17 TABLE 7 Growth of Output and Productivity: Annual Average Percent Change 1959- -1973 Growth of output Manufacturing nl'~=h1 ~ _~_ _ _ ~ 4~6 4~8 _~= VJ-V~~ manufacturing 2.3 Machine tool industry 2.3 Growth of oUtDUt Der hall" Of all emolovees Manufacturing Ourable goods manufacturing Machine tool industry 1973- -1981 2.5 0.1 0.1 3.0 2.8 1.0 1.7 1.7 -0.7 Source: Bureau of Labor Statistics, U.S. Department of Labor. invest In effective mark-- i not ^~ Id- ~ ~ - ; ~ ~ ~ ~~ : ~ pet i ton S have . 2 0 I nterV L ~ "= ~-vL ~= cnac 1 As Japanes report, however, revealed Gnat marketing strategy for U.S. machine tool firms is usually reactive and has tended to concentrate almost exclusively upon the stated needs of its larger, U.S.-based cush~m~ra to;. ~ 7 ~ ~ ~ - development of a more varied customer base. Japanese marketing efforts in the United States, on the other hand, began with a focus on mass-produced, low-unit-cost numercial control (NC) machine tools attractive to small and medium-sized users. A further description of Japanese machine tool marketing efforts in the rind h- States is given later in this chapter. Concluding Comments on the Traditional U.S Machine . Tool Industry. The above paragraphs describe an industry that has lost its position as the world's number one producer of machine tools, to a nation whose own machine tool industry has been experiencing dramatic growth which does not appear to be slowing. This decline in the U.S. industry's position fits the pattern of other mature, —~~ LOLL ants 111~ ;> vein little ~ v ~ ~ ~ ~ Cal

18 domestic industries that have in the course of a small number of years come under severe competitive pressure from younger, foreign-based firms. In the case of '~e U.S. machine tool industry, this pattern has evidently been accentuated both by industry structure (e.g., fragmentation) and by the practices of industry manage- ment (e.g., failure to adopt a global, longer-term view of markets). This structure and these practices have influenced decisions regarding capital investment, R&D, marketing, and employment. These decisions seem to have left the industry ill-equipped for necessary large investments in new technology and new marketing efforts: factors which, as the following sections show, are key to the industry's future. TECHNOLOGICAL TRENDS SHAPING THE INDUSTRY In its 1982 annual report, Cincinnati Milacron stated that 49 percent of its sales were of products that it did not make five years ago.21 This observation, coming from one of the most forward-look ing U. S . machine tool firms, demonstrates the challenge facing the entire industry. The key technological trench giving r ise to these new products are (1) the increasing use of computers in factory automation; (2) the increasing use of substitute materials, some with applications that permit substitution for metals: and (3) new methods for metals processing. Computers and Automation Approximately 10 years ago, most machine tools sold were manually operated, stand-alone machines. Today, such machines remain economically appropriate for many applications, but in 1982, 36 percent of the machine tools purchased in the United States were operated by "numerical" (usually computer) control rather than manually.22 Automation of a machine tool's function via numerical control (NC) has been available to manu- facturers for almost three decades. Moreover, higher levels of automation which incorporate not only an individual machine's function but the material handling and control systems as well, are already in use today in metal fabrication and are likely to become commercially more attractive in the near future. Indeed, the new,

19 rapid pace of automation driven by the need to build flexibility into, and costs out of, manufacturing operations is giving rise to forecasts by industry experts of a boom market for automated factory equipment over the next decade. By the end of this decade, flexible manufacturing cells and systems are likely to be in high demand. Flexible manufacturing systems (EMS) represent a new application for machine tools in which groups of machine tools are integrated and controlled by a central computer; the same computer also controls integrated materials handling systems, including robots, that move workpieces from machine to machine and position a workpiece at each machine. Broadly speaking, then, a new manufacturing process industry is developing whose products will soon include not only machine tools as traditionally defined and computerized controls for individual machine tools, but also more complex computer hardware and software, materials handling systems, machines for assembly, nesting, wasn~ng, ptaetng, and heat-treatinq components: and robots. Ants phenomenon is driven, if by no other reason, by events taking place around the globe. The Japanese Study Mission of the National Machine Tool Builders' Association, for example, reported in 1981 that throughout its travels in Japan, ~ t ' ~ . — it was apparent that FMS is upon us. Virtually every Japanese [machine tooll builder was talking about it, preparing products for it and planning to use it in his plants. Several builders have manufactured and sold EMS systems and at least two of them have complete FMS-e~uipped parts-making plants under construction.2 This observation illustrates the increasing emphasis on integration in the machine tool industry, wherein traditional machine tools are used as parts of Larger manufacturing systems incorporating the products of non-machine tool manufacturers such as computer-makers. An even greater degree of automation than individual flexible manufacturing systems could become commercially attractive in a robust economy, and a necessity in view of the heavy pressures of international competition for towering production costs. Turnkey automated factories have been designed for industries, such as chemicals, cigarettes, paper, and textiles, that do not use metal-

20 working machine tools. Among the prospects for automated factories in the U.S. metalworking industry are plants composed of flexible manufactur ing systems where inventory management, scheduling, and routing are all computer controlled, and where robots and other automated equipment for such non-metalworking tasks as painting are also controlled by the same central computer that coordinates metalworking production. In addition, for both FMS and automated factories, the specifications of the parts to be produced can be developed by computer- aided design (CAD) equipment that will be connected to the rest of the production system with the central computer. Increasingly, therefore, new products will arise from the integration of information, electronic, and mechanical technologies. Figure 2 attempts to provide a pictorial representation of how technology is changing the face of the machine tool industry. Although there is substantial evidence that the U.S industry is at least an technologically advanced as the Japanese in the technology of FMS and other factory automation,24 the chief difference between the machine tool industries of both countries seems to be in the application of that technology. As the NM~BA's Japanese study mission further observes Sir a new parts-manufacturing plant in America would, most probably, be a -~'~~- -~' ~~~~~- -- plants. In Japan new machine toot parts making plants use only the latest technology.25 modernized version of existing In all countries, the market for complete flexible manufacturing systems still remains small relative to the economy as a whole. The importance of the FMS concept, however, goes beyond the number and growth of complete systems. More modest, partial, or limited applications of entire automated systems are widespread, consisting of production subsystems and incremental stages of planned FMS projects. From the seller's standpoint, therefore, the market for FMS components is considerably larger than the number of companies capable of purchasing an automated factory. Of the estimated 1,300 or more machine tool establishments in the United States, approximately 37 companies (the count will vary according to the way subsidiaries and divisions of firms are accounted for, claim to be able to manufacture complete manufacturing systems. Six of those firms are among the fifteen largest machine toot firms

21 FIGURE 2 Technology Map HIGH - o J o z Ul - o UJ J U. z in Lo o z o - o z LO o z o - LOW Large and Medium Scale Computers CA D/CAM, Simulation Robots Handl ing _ I Automated | FactorY | Matariai _ Handling _ Sv'.ms Mini- computers, Micro- proc~Or5, Sensors Transfer ~ ine Hard Automation Custom Automation I Programmabte 1 _ I Controllers _ ram; ~ | Tools l _ I Work —l Calls 1 -- -- 1 DNC, CNC NC Tocis, including Gouging and I nsDect ion L APPLICATION Of MECHANIZED TECHNOLOGY HIGH cited in Table 2 , above; together those six firms account for approximately $1.87 billion in machine tool sales. A larger number of firms manufacture equipment, such as computerized controls, programmable robots, CNC controls, and mater ials handling devices, that is ancillary to the machine tools in such systems. Significantly, a number

22 of companies other than traditional machine tool companies are also beginning to participate in this marketplace. New Materials and Methods Another development confronting traditional machine tool companies is the potential for reduction of metal-cutting and metal-forming markets through (1) the displacement of conventional metals by new materials such as composites, powdered metal, ceramics, and plastics: and (2) the introduction of new techniques that reduce the amount of machining required to produce a finished shape. Non-metal Materials. At present, metals have not been supplanted by other materials to a degree that has sig- nificantly affected machine tool markets. Nevertheless, depending upon their application, non-metals can be less expensive to manufacture; can be produced to net or near net shape: have superior performance because of greater strength, less weight, and durability; and save energy. Composites have been used in airframe construction since the late 1960s, and applications have grown as manufacturers have gained more experience and cone; ~~" in composite technology. aircraft have a relatively small amount of composite material, approximately 3 percent of structural weight. The newer F-18 and AV8B fighters contain 13 and 26 percent composites, respectively. These percentages should continue to grow as new airframes are developed. In other words, each new generation of aircraft is likely to have a substantially greater proportion of composites. There are conflicting indications as to how rapidly significant applications may occur, however, particularly in large airframes, due to long development lead times for new aircraft.26 These new materials represent a potential growth area for the machine tool industry. For example, plastics shipments already exceed the tonnage of steel, aluminum, or copper shipments.27 This large volume has created a potential growth market in plastics processing machines. According to the 1983 National Machine Tool Builders' Association Directory, eight NMTBA members manufacture plastics forming equipment.28 One of these firms (Cincinnati Milacron) is among the largest 15 U.S. machine tool companies. Metal Processing. New technology for metal processing can, in special circumstances, reduce the need for conven- ~ ~ a. ._ ~ For example, the F-14 and P-15

23 tional metal finishing, and also increase the precision Of the metal fabrication process. Advances in near-net- shape forming techniques via investment casting, powder metallurgy, and continuous extrusion all produce metal parts close to their final form, with savings in material scrap and machining costs. New metal-cutting and -removing technology includes lasers and chemical milling. Recent developments in metal-forming and -surfacing technology include electro-deposition and ion implantation. Commercially, none of these technologies has substantially displaced prevailing metal-cutting and -forming technologies, and this report does not undertake to estimate the pace of development of these technologies or the scope of their ultimate military and commercial application. At the present time, approximately 10 U.S. machine tool firms are involved in these new technologies.29 .. Five of the fifteen largest U.S. machine tool firms, with combined machine tool sales of approximately 6900 million, are among these ten. The Committee believes that technology flown will continue to shape the industry. The machine tool business worldwide has become a fast-moving sector, technologi- cally, where the United States cannot afford to be outdistanced by countries whose machine tool manufac- turers take a more aggressive approach to pushing technological advances within their own firms. ECONOMIC TRENDS The U.S. machine tool industry has been substantially influenced not only by technological trends but also by economic ones. The recent recession, which has been the steepest of the eight postwar recessions, and the loss of sales to foreign producers have cut seriously into profits. It produced losses in some cases even as the Administration has put into place an expanded defense budget, and even as the signs are increasingly evident that a recovery is under way. New machine tool orders are considered a "lagging" economic indicator; also, an ind icator that fluctuates more widely than do other series such as industrial production. This means that, although machine tool order levels are recovering some- what as expected, it could be a year or more before orders reach levels that signal a recovery in the machine toot sector itself, and much longer before earnings can

24 support needed substantial investments in new machine tool manufactur ing capacity as well as in the moderniza- tion of major sectors of current facilities. Globalization of Machine Tool Competition The globalization of direct machine tool competition is perhaps the most significant economic trend in the domestic industry today, for it is a new and permanent one. International trade in machine tools is not new. In 1949-51, for example, approximately 20 percent of U.S. machine tool production was sold abroad.30 What is new is that sophisticated machine tool building industries have now developed since then in a number of nations, and a substantial number of these foreign machine tool firms are able to compete globally. In addition, the proportion of world trade in machine tools has grown. In 1968, 29 percent of world machine tool output was exported: the corresponding figure for 1981 is 40 percent.31 As part of this trend, the propensity for global sources in the machine tool industry (i.e., looking beyond national boundaries for machine tools and components' is becoming more pronounced. As this report points out, the U.S. machine tool industry itself, by locating more of its own manufacturing facilities overseas, is participating in this trend toward global sources. Although U.S. machine tool firms have consistently been strong exporters, foreign firms are capturing increasingly large shares of the domestic U.S. market. Figure 3, which traces the U.S. trade balance in machine tools, shows that in 1978 the United States for the first time imported more machine tools than it sold abroad. This trade imbalance in machine tools has increased since then. In 1981, the U.S. trade deficit in machine tools was S482 million. As shown in Table 8, imports as a percent of U.S. consumption have risen very rapidly, from less than 10 percent in 1973 to 24.9 percent in 1981 and an estimated 26.8 percent in 1982. The NMTBA estimate for the first quarter of 1983 is 33.8 percent. One way of comprehending the effect that the accelera- tion in imports has had on the sales of domestic machine tool firms is to hypothesize what might have happened if imports had grown simply at the same rate as U.S. machine tool consumption. The Committee has calculated that had

25 FIGURE 3 U.S. Trade Balance in Machine Tools. 400 ~ 2 o o O -200 At o J 400 - -600 ,~,, \' 1 1 1 1 1 ~ 1981 1961 1965 1~9 1973 1977 YEAR Source: NMTBA Economic Handbook of the Machine Tool Industrv 1982-83' p. 123. imports of Japanese machine tools since 197S grown at the same rate as U.S. machine tool consumption during the same period, the Japanese market would be approximately 8500 million less today than it is. This SSOO million figure is equivalent to the sales of the largest U.S. machine tool firm and corresponds to approximately 10.2 percent of shipments of U.S.-made machine tools. The country with the most rapid growth in machine tool trade, and in the value of machine tool exports to the United States, has been Japan. Japanese machine tool exports to the United States surged from 822.1 million in 1973 to 8687.S million in 1981. Although Japanese machine tools were less than IS percent of total U.S. machine tool imports in 1973, they accounted for nearly half of such imports in 1981. Imports from Western Europe, measured as a percent of domestic consumption, have remained generally constant. It is worth examining more closely the elements behind the initial Japanese success in the U.S. machine tool markets, because they bear some relation to the diffi- culties found by the U.S. industry. In its interviews and deliberations, the Committee found five such elements

26 TABLE 8 U.S. Machine Tool Imports and Exports 1973 1976 1979 L981 .982 U.S. Machine Tool Production (millions of dollars) Sl.788.9 S2,178.3 U.S. Machine Tool Exports S4, 064. 0 S5, 111. ~ 33, 744. 0 Amount (millions of dollars) 224.7 352.3 395.6 671.6 426.6 Percent of production 13.1 16. 2 9. t 13.1 11. U . S. Machine Tool Import!< Amount ~ in 3~11:ons of dollars) 167.1 318.3 1,043.8 1,211.0 Percent of cons~tzon All :"cnine tools 9 ~ 14.9 22.2 24.9 26. Metal~cutting types 10 . 7 15 . 6 23. 2 25. ~ n . a Lathes (excl. vertical turret latnee) 15.0 18.6 39.5 55.6 n.a, Amount of imports ( ~lllione of dollars) f roe: Japan ' 22.1 61.2 352.8 687.1 n.a West Germany 51.6 93.3 197. ~ 191.8 n.a Percent of ~mporta froes Japan 13.2 21.1 33.8 48.0 n.a West Germany 30.9 29.3 18.9 13.. n.a Source: NMTBA, Economic HanaDoo~ 1982-83. that deserve mention: delivery times, reliability' targeting' prices, and commercial and government policies and practices. Delivery Times. The traditional practice of order backlog management, which served U.S. machine tool builders well for several decades, was based on an implicit assumption that potential foreign competitors did not have the resources to take advantage of wide swings in the U.S. machine tool market. Whether this assumption was ever valid, it certainly was not so by the late 1970s. By that time, many foreign firms had the resources to offer fast delivery of quality machines to U.S. customers who did not wish to wait for backlogs to be worked down by their domestic suppliers.

27 Figure 4 compares imports of machine tools with unfilled domestic orders. It shows a relatively close correlation between surges in the backlogs, and in imports. The only major break has come in the last three years, when imports have continued to rise (albeit at a slower rate) while unfilled orders fell because of the recession. The figure confirms the Committee's judgment that one important reason for Japan's success in the U.S. market has been this delivery time factor. Surveys conducted for this report reveal that U.S. manufacturers were able to obtain delivery of Japanese machines within one or two months during the late 1970s, when some domestic builders were requiring a 1-1/2 to 2 year wait. For many of those customers, lead time was the prime factor in the decision to purchase a Japanese machine. FIGURE 4 Machine Tool Industry--Cutting and Forming Indices of Unfilled Orders and Imports (1967 5 TOO) ~ 1 ,000 100 a.... ·: :~. / ,7~: /.~: ~e _ it: ..! ....... Imports / —Un f i I led Orders 10 _ 1 968 1 970 t 972 1 974 1 976 1 978 1 980 t 982 1 1 1 1 1 1 1 YEAR Source: NMTBA, Economic Handbook of the Machine Tool Industry 1982-83, p. 130.

28 ReliabilitY. As in other areas such as electronics and automobiles, Japanese machine tools have gained a reputation for reliability. Respondents who were interviewed for this report stressed the superior reliability of Japanese machine tools over the American counterparts, and the meticulous attention to after-sales service. A complete comparison of reliability characteristics between Japanese and U.S.-produced machine tools would require access to proprietary data. The Committee notes, however, that business realities normally force greater attention to reliability by the exporter than by the domestic manufacturer, in order to reduce the expense of _ _ . ~ . ~ . :~`a`~a~n~n~ a curse' arcer-Sales serVlcLng force in a foreign country. In particular, the Japanese attention to quality is substantially at odds with the pressures on Amer ican business to maximize production, sometimes at the expense of quality--what one Committee member descr ibed as a "get-it-out-the-factory-door, we'll-fix-it- in-the-field~ attitude. This attitude, to the extent it describes machine tool industry management, has clearly hurt the industry. Product reliability has become one of the major selling points of Japanese machine tool products, according to prime defense contractor respondents who had bought Japanese tools in recent years. Tar~etinq. Japanese exporters have evidently concentrated on certain segments of the machine tool market, both product- and customer-defined. With regard to product, the Japanese have been most successful in selling numerically controlled machining centers and lathes to U. S . customers. Line 7 of Table 8, for example, illustrates the dramatic growth in the percent of the domestic lathe market which has been captured by imports. This selectivity is deliberate. As the Japanese Study Mission report points out: If [Japanese machine tool manufacturers! find that the potential for market share does not exist, they will skip a product or model. Unlike many U.S. manufacturers, they will not manufacture a product just to round out the product line--they are very selective in machine sizing. ... The Japanese Machine Tool Builders' Association reported that 64 percent of its members' total NC machine tool shipments in 1980 went to small companies. U.S.

29 builders in contrast have tended to rely on larger, easier-to-serve customers such as manufacturers of automobiles, aircraft, farm equipment, and off-road vehicles. Prices. Although price has sometimes been less important than delivery time and reliability, it is nevertheless a major factor in markets and a critical problem in view of the present underutilization of capacity in the U.S. industry. Japanese companies have been able to sell certain machine tools in the United States for 10 to 40 percent below U.S. producers' prices. As Table 9 shows, the Japanese price advantage is largely a Cost advantages that plays a substantial role in Japan's competitiveness. Table 9 provides a rough breakdown of the costs for building a conventional computer numerical control (CNC) lathe in the United States and Japan. While the table is intended only as an indication of general trends, the magnitude of the cost advantages enjoyed by the Japanese manufacturer is impressive. The data show a Japanese advantage at every step, despite estimates of a higher percentage for indirect labor. The resulting 21 percent price differential is typical of the experience of machine tool purchasers who were interviewed for this report. The Committee found the following elements to be the primary contributors to this price differential: Purchased materials. in the table, the Japanese are shown to have a 30 percent cost advantage. That statistic, however, could reflect differences in the mix of nmake vs. buy" decisions between Japanese and U.S. machine tool firms as much as it might reflect actual cost advantages. The Committee was unable to determine whether the Japanese machine tool industry may be more inclined to purchase a relatively small amount of materials (which might explain the lower figure for purchased material) and make a higher proportion of components in-house (which might explain the higher labor-hour figure). o Dollar/yen exchange rate. The dollar-yen rate is a two-edged issue. Although the dollar is currently rather strong against the yen, giving Japanese manufac- turers an across-the-board price advantage in U.S. markets, this strength is also responsible for attracting investment funds to this country in a way that has helped fuel the current economic recovery substantially. A

30 TABLE 9 Manufacturers' Selling Price S120.000 Gross margin A/ 48,000 Manufacturing cost 72,000 Purchased material A/ 32,400 Labor and burden 39,600 Direct labor c/ Dollars 9,900 (Hour.) 1,081 Indirect and burden d/ 29,700 Comparative Costs of CNC Lathe Tool: U.S. van Japan, 1981 United States Japan _ Amount Percent Amount Percent S92,240 36,900 100 55,340 45 22,680 55 32,660 14 41 100 4~ ss 8,165 1,384 24,495 15 44 A/ Gross margin of 40 percent is assumed for both U.S. and Japanese producers. b/ For the U.S., purchased materials are 45 percent of manufacturing cost; for Japan, the cost is 30 percent less than the U.S. material cost. _/ For the U.S., labor cost is estimated on the basis of a 1 to 3 ratio between direct labor and indirect labor and burden. Unit hours are derived by dividing direct labor cost by 1981 average hourly earnings of production workers in metal-cutting machine industry (69.16). (U.S. Bureau of Labor Statistics) For Japan, direct labor hours per unit are derived by increasing U.S. levels Dy 28 percent, in accordance with 1980 estimates by the Japan Productivity Center of comparative levels in the industrial machinery industry. The 1981 hourly average for Japan Is 35.90. d/ Indirect and burden are derived as residuals. The higher proportion for Japan (despite lower fringe benefits) reflects the nigher ratio of non-production workers to all employees in Japan's metalworking machinery industry (40 percent) compared with the U.S. industry ratio (30 percent), according to BLS data. Source: U.S. Bureau of Labor Statistics, Japan Productivity Center, and Committee calculations.

31 premature stifling of these flows could severely damage the recovery, and the spillover effects of this would harm U.S. machine tool builders. ~ Productivity. Japanese productivity growth has been substantially above that of the United States. During 1973-1981, Japanese manufacturing output per man-hour grew approximately 8 percent annually, compared to an average annual decline in output per man-hour of 0.7 percent in the U.S. machine tool industry. Because Japan started from a lower output-per-man-hour base, Japanese overall productivity still lags that of the United States. Productivity growth is an important component in the competitiveness of the industry, however, as it has a direct link with the industry's levels of capital investment. As a general rule, those industrial sectors that enjoy more rapid productivity growth and are associated with larger amounts of capital investment also enjoy greater price stability than the slower-moving sectors. ~ Superior machine tool manufacturing facilities in many cases (i.e., more modern, more highly automated, etc.). Commercial and Government Policies Recording Industrial Development. The Japanese approach to industrial development has been an important aspect of Japan's postwar economic success, and has given rise to the expression "Japan, Inc. n Some of the key elements of this system are: ~ close industry-government cooperation in planning industrial development ~ less restrictive application of antitrust laws, with the effect of allowing vertical integration of larger companies, and horizontal coordination among actual and potential competitors for R&D, product specialization, and other purposes · financial practices that allow higher debt-equity ratios than would be prudent in the United States and, thus, greater access to credit government-encouraged financial support ~ close cooperation by labor with its associated industrial company The effects of these policies and practices are difficult to assess. Observers who are familiar with both the Japanese and U.S. business environments assert,

32 however, that the Japanese "system" in the aggregate provides advantages the United States simply may not be able to match under this country's present customs and labor-management-government relations. By contrast with the Japanese, U.S. companies operate under a less cohesive system, characterized by more restrictive antitrust laws, frequently adverse industry-government and industry-labor relations, uncertain national purpose, and less advan- tageous financial conditicns.33 A final observation regarding the effects of govern- mental policies concerns the management of the macro- economy itself. The economic characteristics of an industry such as machine tools are not completely independent from the characteristics of the overall economy. For a number of reasons, the slow growth of the American economy in the last decade expressed itself in a sluggish demand for machine tools--as for capital goods generally. The weak demand for machine tools has been a significant factor in the slow productivity growth in the machine tool industry itself. Conversely, in Japan, rapid growth in aggregate output has been accompanied by higher rates of investment and more rapid productivity growth in machine tool production. Thus, to some extent, the performance of each country's machine tool sector has been consistent with the differential growth rates of each economy. Because of the key role of foreign competition in determining the long-term survival of the U.S. machine tool industry, the Committee has examined the machine tool policies in three countries: Japan, France, and West Germany. These are presented in Appendix B. NEW ENTRANTS AND N~ COMPETITIVE ST~=GIES The technological advances and the global nature of machine tool competition, described above, have caused a number of changes in (1) the types of competitors in the broadly defined machine tool market and (2) the com- petitive strategies that will be required by those selling in this market. Together these changes raise important issues affecting the longer term health of the American machine tool industry. This section looks at that= i OOlt^= ; ~ ~~ = ~ ~ _ ~~ ~~- ~~~ ~~=LlLl- Vie Able we Interest In maintaining a healthy' across-the-board domestic machine tool productive capability. It is based on the Committee's finding that new competitive conditions will require new qualities and skills of U.S.-based builders.

33 The major changes taking place in the competitors and competitive strategies, including the issues that these changes raise, are threefold: (1) The development of computer-integrated manufac- turing has attracted large, U.S.-based, multinational firms to the market for products used in automated manufacturing that are ancillary to machine tools. These companies have not entered the business of manufacturing machine tools themselves, and it is unlikely that they will do so in the near future. If they undertake to supply an EMS or automated factory customer with machine tools, they will probably purchase the tools from a machine tool manufacturer. However, as the markets for EMS and other factory automation systems develop, there new entrants will be formidable competitors with machine tool producers for the "ancillaryn products needed in factory automation--which in many systems will be of greater value than the machine tools themselves. Indeed. some of the new entrants have gained experience in automating their own facilities, and are well positioned to compete successfully in the new technology of factory automation. A few of them, alone, have greater financial resources than the entire traditional U.S. machine tool industry combined. They also have had extensive experi- ence in international trade, including international joint ventures. Moreover, by their machine tool purchasing decisions, these companies may determine whether a sub- stantial portion of the machine tools consumed in the United States is produced here or overseas. 0 Will the entry of these larger firms change the "rules of the game, n making it even more difficult for smaller, traditional machine tool firms to compete? ~ Will they necessarily turn to U.S. machine tool makers to supply the basic metal-forming and metal- cutting equipment for their technology? (2' Another set of entrants comprises small entrepreneurial firms dedicated to relatively narrow, high-technology product lines related to machine tools. Many such firms have already developed reputations for quality in software, customer support, customer training, and applications engineering ti.e., the combination of services needed to support computer-integrated and flexible manufacturing systems), as well as robotics. Experiences in Japan and Germany suggest that tech-

34 nologically innovative, small firms can compete quite effectively with larger firms if given reasonable access to R&D funds and credit. · Does the existence of such firms offer significant potential for the U.S. machine tool industry to remain a international leader in new manufacturing technology? (3} The structure of the industry is changing, with the solidification and further development of Strategic groupsn34 based on new categories of machine tool production (e.g., robot systems, integrated manufacturin systemsI. Even traditional strategic groups (e.g., stand-alone machine tool builders) are being required to adopt new strategies, such as locating facilities abroad in order to survive. ~ Will the new and the traditional strategic groups each contain, and will they retain, adequate domestic productive capacity to ensure a healthy, competitive industry capable of serving DOD's needs? · To the extent that domestic machine tool makers themselves branch out into overseas production for consumption in the U.S. market, will this help or impair U.S. defense readiness? In concluding that new competitive conditions will require new qualities and skills from U.S. machine tool builders, the Committee observer that developments in world machine tool competition are being driven by two major forces: (1} technology advances in factory automation and materials processing, and (23 an increased need for customer support, primarily in the form of engineering services required from the supplier to match services supplied by foreign suppliers and the increasing sophistication of machine tool products. These two criteria can be used to ~map" the various strategic groups in the machine tool industry today. Figure 5 contains such a map of the industry today, with major machine tool product categories placed according to their relative sophistication of technology and degree of customer support. The two axes--technology, and sophistication of customer support--help define both the strategies of the groups and the criteria for survival in each one. In the lower left corner of the map are stand-alone machine tool makers. In contrast to the products of more

35 FIGURE 5 Strategic Groups HIGtl Degree of Sophisti- cation of Customer Support Required from Supplier LOW Au~ome'sd Factories Int - wed lUanufacturing Systems and Cells Specselized Niche Stand-Al on. Machine Tools Robot Sys~ms Robots Primarily Mechanical Technology Integrated Mechanical and Information Technology technologically sophisticated firms, the products of this group require relatively less customer support and information systems technology. Firms marketing these products' therefore, will compete mostly on the basis of price, delivery time, and reliability. Because this is one group where Japanese manufacturers have tended to compete heavily, competitive conditions will probably require U.S. firm. in this group to become competitive

36 worldwide like the Japanese, to reach small as well as large customers, and to develop economies of scale in production. The manufacturers of integrated manufacturing systems, the group in the middle of the map, face somewhat more difficult technological as well as marketing problems. Because this is an area where the range of possible applications has not yet been fully developed, partici- pants in this group must divert substantial (relative to the stand-alone manufacturers) resources to R&D. Field interviews for this report revealed that many such producers must overcome user skepticism over the prospect of purchasing a highly automated machine, and over the confusing array of options, the fear of down-time, the programming and maintenance costs, the integration of new machines with existing production control systems, and the compatibility of the new machines with future adapta- tions. This means that marketing and after-sales servicing will need to accommodate the first-time user, all of which requires greater efforts at customer support. The number of potential manufacturers thins out quickly once one leaves the lower left corner of the map. Relatively few conventional machine tool companies have the range of necessary skills to compete successfully in the middle group, which currently comprises primarily the large machine tool manufacturers who account for a size- able portion of rig- _. machine tool production capacity. It may well be that this group is, as a practical matter, open only to larger firms that have the resources to offer more comprehensive after-sales service and to gain better access to capital markets. Greater resources are required to sell entire, automated plants. To the skills required by the producers of integrated manufacturing systems, one must add major project management and strong information technology capability. Projects of this kind require the ability to weather long selling cycles, and also require strong customer support and planning abilities. Larger firms are likely to have an advantage here as well, but only when they are able to develop truly coordinated systems (consulting, production, marketing, etc.) within their companies. As yet, no U.S. firm has built and sold a complete, fully integrated batch manufacturing plant. Such complex facilities, however, are being sold in other parts of the world, often by consortia of companies and in some cases by large, government-subsidized companies such as Renault.

37 A few niche positions remain, such as in precision and very high speed machine tools. In these areas, a small, high quality maker can focus attention on special market needs. Such a f irm may still better serve a specialized market than a large f irm address ing broad segments of the industry. On the other hand, many of the former specialty slots will disappear, undercut by the ability of new competitors to provide high performance, multi-purpose systems at modest cos t. Table 10 compares the skills descr ibed above with the characteristics of the traditional machine tool industry which was analyzed earlier in this chapter. While the comparison necessarily deals in generalities, the d irections they lead the observer are clear: each new strategic group requires skills substantially different from, and more complex than, the ones which were adequate for competing in the traditional machine tool business. The ability of the broadly different domestic machine tool industry to respond to defense needs rests, in part, on the makeup of the industry at a particular time. One might reason, for example, that a rapid growth in the number of domestic robot manufacturers signals a healthy response of the U.S. industry to developments in the market for robotics equipment and accessories. Failure of the industry to cove into new product areas, on the other hand, could reasonably be interpreted as an indication that U.S. firms were having some difficulty adapting to new market realities. Table 11 sets forth rough estimates, based on NMTBA. member responses and information obtained from the Robotics Institute of America, of the number of U.S. f irks in each strategic group. Although the f inure set forth in the table must be interpreted as ~soft. (they are based upon voluntary membership responses and are not checked for consistency), they do give some idea of the trend of machine tool manufactur ing: The number of manu- facturers that claim to be venter ing into sophisticated machine tool technology is growing, consistently with the growth of markets for new types of machine tools. Although the table can g ive come cause for hope that U.S. machine tool firms can perform adequately across the range of necessary technology and customer support, it also raises some cause for concern. Many firms remain at the lower led t end of the map. These constitute the bulk (by number of companies but not by volume) of the traditional machine tool industry which was analyzed at the beg inning of this chapter . Such f irks represent a

38 TABLE 1 0 Skills Required in the Emerging 21achine Tool Industry Prof stabil$tY/ Employ~ent Finance Manuf actur inq Patterns Tradit~onal U.S. Mach ine Tool Co~pany ( includes manus! machines and s ingle-stat ion spec ial-purpose ~ach ines ) c - w, S tand-Alon. MaCh ine Toole Mainea~n mode- rately healthy financial ratios while remain inq relatively s~all a. a f itm Financis1 ~n - ~- ~ent ~st support oore invest~nt ~0 Manage sales f luctust ions: .Bufferin~. "hieve greater co~titiveness by stresein. volu~ output Manage employmen f luctuation. Concentrate on product ion eco- no~ies through labor savinas Integrated Help users f t- Integrate diverse More c~lex Manufacturing nance syst~ss parts' use coapensacion Syst~e eainta~n invest- stand-alan. tools ~yste. ~.nt during eff iciently doanturns. A utaseted Whole Plants or Custo. L ines Long selling C.'cle r~uires subetantial f t- nanc ta1 recources help custo~rs wi th inno~rat tve f inance, esp . export ~ Onderatand/make/ buy/integrate divers. perts Funct iona1 career planning workplece stabl- lity r~uized potential resource, but only if ttiey ate capable of adapting to new compet i~ci~re conditions. As the next chapter points out, DOD has . identified some bottlenecks in the surge production of certain weapons systems. The response of the domestic machine tool industry will ~nfluence whether these bottlenecks will worsen or can be r esol~red in the long run. The nex t section of this chapter examines the response of machine tool builder~ to new competitive conditions, and examines some of the issues raised by thi~ response. RESPONSE OF MAcarNE TOOL BUILDERS TO ~ESE Ct~NGES The preceding sections of this chapter have descr ibed changes taking place in machine tool snanufacture, market~,

39 Capital Investment Research and Developmen t Productivity Managemcn t Mar keting Low capital in- vest~ent levels pose ible ~ in- crease produc- t ion t~hrough e~ploy~en t in- creases Low RED levels application en- g inter ing f arms substantial portion of R`D Maintain h lither NC controls, new levels of capital products require investmene more R.D Investment levels S',rete~a integra- must support high- tion, sensors tech standards etc ~ adore RED Investment levels must support bigh-eech standard. and massive projects Mul t $ple R&D efforts, through own labs, un$- versit$es, govern_nt Low productivity levels ~ buffer $ng practices place low premium on latest product ion tech- no~ogy inown operations Substantially h igher levels of productivity growth required Technology ts custo~r~riven relatively low levels of cus- to_r support required Program for large and ~11 customers S bong internat$on- Sophisticated al competition sellis~g~uU - r places preatu. on education h igh product to i ty Strong interne- tione1 co~et- tion places preatu. on high productivity Govern_nt con- tracting cape- bilitysvVery soph taticated customer support and industry structure, and have def ined the ~k ills and qualities that will be required for U.S. suppliers if they aim to meet new competitive condi tione. How the U. S machine tool industry responds is, of course, critically impor tent to its survival and to the country ' ~ national secur ity interests. To gain come appreciation of this response, the Committee caviled a list of recent economic and tech- nological trends shaping ache machine tool industry. Using a questionnaire, it then asked NMT8A members to cogent on the extent and ways these trends were affecting their individual firms and the industry an a whole. In all, 43 N~rBA members responded to the 100 questionnaires that were issued. The Committee also visited several machine tool builders, to interview their .

40 TABLE 11 Estimates of the Number of U.S. Machine Tool Firms in Specified Strategic Groups Strategic Group 1974 1977 Stand-alone machine tools Specialized niche machine tools Robots Robot systems Integrated manufacturing systems and cells N/A Automated factor ies O 223 S6 253 71 N/ N/A N/A N/A N/A 1982 1983 N/A N/A N/A N/A 285 75 39 12 295/ 37b/ b/ b/ c/ . Sources: CUBA Directories; Robotics Institute of America. a/ - b/ According to the Robotics Institute of America, there were 4 U.S. robot manufacturers in 1974, and less than 10 manufacturers through 1977. Approximately 65 NMTBA members reported for the 1983 Directorv that they manufactured computer controlled machinery or cc~ro~uter controls, up f tom 4 5 in 198 2 . At least one U.S . machine tool f irm ~s constructing an automated factory. At least 2 others manufacture the range of products required for such construe tion. executives at greater length about trends affecting their companies. Eleven such site visits were made. The Committee found that a variety of actions charac- terize the industry response to new competitive conditions. These are described below (see Scoping With Change--Specif ic Stepe. ) .

41 Economic P res sur e s By and large, the 43 machine tool builders responding to the survey cons idered the economic trends to carry mar e ser ious consequences than the technological ones. Con- cerns about present economic health--and in many cases survival--appeared to overshadow concerns about the role o f technolog ical leader sh ip in r emain ing compet i tive . In view of the evident vigor and resolution with which Japanese machine tool builders are applying the latest technology, this attitude while understandable--was worrisome to Committee members. It suggested that extra- ordinary ef forts might be required among Amer lean machine tool builders in order to maintain their reputation for technological excellence. Increasing competition, including price competition, from foreign manufacturers in both foreign and domestic markets was ranked by all 43 machine tool builders as being of highest importance to the industry. Two respondents, however, said that foreign competition had little impact on their own firms. This seeming anomaly was explained by the Japanese Targeting of such products as machining centers, to the exclusion of others: producers of some specialized machines have found successful niches. The high cost of capital over a prolonged period has been a double-edged problem for the industry . The numbe r of machine tool orders has dropped, as potential customers are unable to finance major purchases; and the borrowing power of the machine tool firms themselves has dropped recently with decreased sales and profits. As machine tool orders pick up during the current recovery, there is cons iderable apprehens ion among U. S . builders that their position will be further weakened by the inventory of Japanese tools presently stored in U.S. warehouses. According to the petition filed by the NMTBA, Japanese inventor ies of NC lathes and Mach ining centers in this country stand at the equivalent of l-l/2 years production for NC lathes and 9 months production for mach ining centers .35 This description about Japanese machine tool inventories in the U.S. has been disputed in a response to the petition. 36

42 Cop ing 'ad th Change--Spec i f ic S tep s The s ite visits and questionnaire responses revealed that U.S. builders are using a variety of approaches and strategies to become more competitive. Some of these actions, however, raise questions about their longer-term effects on the national security. In two categories, mergers and joint ventures, the Committee considers the issues serious enough to warrant further investigation. The following description of competitive steps being taken by respondent f irms--while not exhaustive~gives some indication of the "shakeout" taking Diary in ~ he U. S. machine tool industry today. there trill be survivors and those that do not survive. Those survivors that continue to manufacture and sell machine tools profitably will necessarily be more forward- looking firms, committed to seeking algal Or on mar kets. Conventional Co~t-cuttinq. . , ~ ~ ·& ~ As in all shakeouts, , , ~ _ ~ a. · ~ These steps include layoffs and furloughs, dividend cancellations, union contract renegotiation, and liquidation of facilities in high-cost locations in order to move manufacturing operations to lower-cost areas in the U.S. or abroad. The NMTBA, for example, has identified approximately 40 rJ.S. machine tool firms with manufacturing facilities outside the United States. Most of there facilities have been used to penetrate foreign markets, especially in Europe. However, at least one industry analyst cites as a ~trend. the moire toward U.S. firms ' involvement in overseas production of machine tools for U.S. consump- t ions 37 This -subject is covered in further detail under Joint Ventures, n below. ~-~rie~=~mn of Inept Strategy. At least one large macalne cool corm nas pledges to "out-Japane~e the Japanese. ~ It has instituted Japanese methods in inven- tory management, quality control, marketing strategies, and customer service, as well as an emphasis on quality and the adoption of EMS technology for its own production. Some traditional U.S. machine tool companies are diversifying into the production.of plastics forming machines, robots, microcomputer components, software turnkey services, and materials handling Systems. Some new f irms have attempted to identify markets (e.g., certain types of controllers' where both Japanese and U. S. competition seems weak . In one successful case of Niche-playing the f irm involved has been able to maintain relatively even growth, in spite of sales

43 fluctuations in the machine tool markets as a whole. ( For more information on niche-playing, see "New Entrants and New Competitive Strategies, ~ above. ) Efforts to Gain New Technological_ Expertise. These include budgeting additional R&D sums for discovering new technology (see, however, ache discussion of R&D spending in this chapter), pursuing some contracts on a "break- e~ren" basis in order to gain experience in useful tech- nolo<;y, and making minority investments in firms that have expertise in relevant technologies. Mergers and Acquisitions. These have been coon for some time as a strategy to remain competitive. Recent examples include the Cross Company's merger with Kearney and Trecker, the acquisition of Unimation ta maker of robots but not of traditional machine tools) by Westing- house (a maker of industrial controls and a seller of factory automation services but not a manufacturer of traditional machine tools), the growth of Newcor and Lamb Technicon through acquisitions, the acquisition of Snyder by Giddings and Lewis, and the subsequent acquisition of G~ddings and Lewis by AMCA International. In the case of the Cross/Kearney and Trecker merger, the U.S. Department of Justice diluted the possible competitive benef its by requiring that the merged company divest itself of certain product 1 ines . Mergers and acquisitions hold out the possibility for economies of scale and the ability ho attract sufficient funding for necessary capital improvements. If managed properly, a machine tool f irm involved in a merger or acquisition could enjoy the benefits of a stronger capital structure, better access to R&D funds, and possibly an international sales and administrative structure. All of these are essential for competing successfully in a modern, global machine tool market. The Committee has two concerns regarding such developments, however, regarding the ability of the merged or acquired machine tool firm to compete. (1) The joining of a domestic machine tool firm with a larger non-machine tool entity could result in severe cost cutting, the use of the acquired firm's liquidity to finance other initiatives within the parent corporation, and the imposition of a large corporate bureaucracy; all these are common ef feats of mergers and acquisitions today. (2) The joining of a domestic machine tool firm with a foreign firm that intended to use its U.S. base chiefly as a sales outle t could strengthen the domestic firm's short-terra financial structure at the expense of an ability to design and manufacture its own products.

44 I f these effects became characteristic of mergers and acquisitions within the machine tool industry generally, the merger/accTuisition movement--instead of enabling individual machine tool firms to maintain their com- petitivenes~--would bring few improvements to the domestic industry. The Committee believes that this possibly harmful aspect of mergers and acquisitions on U.S. machine tool manufacturing canabilitv is an imp issue worthy of additional study. Joint ventures. ~ ~ ~ ,[ —— ~ e~ ^~~W~ ~11 ~ Many firms are f inding that the mos t e ff icient route to gaining access Deco additional skills and product lines is to pursue joint ventures, especially with foreign partners. Joint ventures are corn among companies trying to reposition themselves Strategically. Example. include Bendix-Murata, Acme Cleveland- Mitsubishi, Westinghoune-Mitsutoki, General Motots-Fanuc, and Rockwell International-Ikegai Iron Works. Clearly, many major players are involved. Most of these joint ventures have offered the potential for low-cost, reliable overseas manufacturing for the U.S. pet tner, and an enhanced marketing network in this country for the foreign one. They represent the trend toward global sources taking place in the industry. They raise Rome questions, however, as to the effect that such action. could have on the long-run competitiveness of machine tool manufacturing facilities Located in the United States. When Bendix acquired Warner and Swasey, for example, one of its first actions was to transfer nearly all of its machine tool production to the Murata joint venture in Japan. Subsequently, Acme-Cleveland has announced that its state-of-the-art NC chucked, jointly developed with Mitsubishi Heavy Industries, Ltd., will be produced in Japan, 38 and Or ^~ -~- a,- ~,; that it is not committed to the production of any percentage of its machine tools do~nestically.39 Concern was expressed by the Committee that if the practice of overseas procurement or production by U. S. cornier of 'machine tools for sale in the United States were to become widespread, there would be the long-term danger that U.S companies would end up more as distribu- tion channels for foreign-built machine tools than as manufacturers in this country. ~ ~ ~ by_ ~~— i~~— · ~ ~~

. 4; Requests for Federal Ass istanc e Two recent petit, ons by machine tool builders to the federal government for relief from the competition of foreign machine tools represent another kind of response to the economic trends that have been described. It is not within the Committee' s Chaucer to pass judgment on these petitions. However, because they are relevant, we note them below. The f irst petition was submitted on May 3, 1982, by Houda i lle Industr ies , Inc ., to the Of f ice of the U. S. . Trade Representative, asking for the President to exercise ~ is authority40 tO deny the benef its of investment tax credits when producers have an unfair pr ice advantage as the result of a cartel. Attorneys for Houdaille Indus- tr ies conducted extensive research to document practices i n Japan that could be construed as contr ibuting to a machine tool cartel. Some of their evidence is incor- porated in the Japan section of Appendix B. The petition was denied in April 1983. A second petition is pending as of this we itinq . The National Machine Tool Builders ~ Association has submitted a petition to the U.S. Department of Co~erce under the National Security Clause, Section 232 of the Trade Expansion Act of 1962 (19 U.S.C. Section 1862~. This petition requests a f ive~year period dur ing which imports of both metal~cutting and ~netal-forming tools would be limited to 17.S percent of the value of total domestic consumption. The argument for this action is that ~ the national secur ity of the United States in being impaired by current levels of imports of machine tools because such imports threaten to debilitate the domestic machine tool industry, which is critical to the United States' defense and deterrence posture..41 CONCLUSIONS This chapter has dear ibed a changing machine tool market which, in the course of f ive to seven years, has become significantly more competitive and complex. · Advances in microelectronics, robotics, systems engineer ing, computer science, and substitute mater ials have altered the character of manufactur ins and changed the nature of the machine tool industry, making machine tool construction (as defined in this report' one of the

46 world's "high tech" industries. Further advances in the commercialization and military application of synthetic materials that substitute for metal will also affect manufacturing technology and, ultimately, the size of the market for conventional machine tools. · International competition, especially from the Japanese, has brought intense pressures on U.S. firms to meet new standards of innovation, reliability, pr ice, and customer service. New entrants to the market for automated manufac- turing have brought new (to the traditional machine tool industry) specialties such as computers and software for design and integration; electronic controls; machines for assembling, testing, plating, and heat-treating com- ponents; robots; and sophisticated engineering services. These f irms have combined resources that could expand the financial power of the manufacturing process industry by several times the present size of the machine tool industry as traditionally def ined . In addition, con- ~ lomerates such as Allied-Bendix, Litton, Textron , White Consolidated, and AM CA International have substantial machine tool subsidiaries. The actions they take to rationalize their machine tool operations may accelerate the already rapid change in the industry, providing they invest in strengthening their machine tool elements. The financial power of these new firms, and their ~high-tech. orientation, may require smaller firms to merge in order to become large enough to make the investments now required to remain competitive in a technal~aicall v advanced industry. · New strategic groups in the industry have Relegated many traditional machine tool producers to the flower left. spectrum of an industry map that ranks strategic group) according to the degree of technological sophistication and customer support required. The traditional machine tool firms produce in an environment in which their products are more like commodities than products of greater technological sophistication requiring Extensive computer and other engineering services. In this traditional market sector, which i S now actually part of a larger machine tool market, this strategic group will have to adjust its capabilities to meet intensif fed competition on the basis of price, delivery time, and reliability: factors where such U. S . firms have shown comparative weakness in recent years. ~ The globalization of machine tool manufacture and markets has forced U.S. machine tool builders themselves _ _ _, ~ _,

47 to take a global view of sources and markets, including the location of manufactur ing facilities overseas. These new realities require sk ills and character istic s substantially at odds with the description of the traditional machine tool industry on pages 8 to 18 of this report. Thus, the signs of a far-reaching "shakeouts in the machine tool industry are unmistakable. While some domestic machine tool builders will be unable to respond to increased competitive pressures from abroad and from alternative technologies, there are a number of forward- looking firms--among them traditional machine tool builders as well as new entrants to the market for products and services ancillary to the use of machine tools in automated manufactur ing applications--that have recognized and reacted to the trends that are fore ring changes. Those domestic f irms that have had the fores ight to move toward automated systems development, processing of non-metals, advanced machining and forming techniques, and a global view of markets (or, an some cases. successful nich-e-Playinq) will survive despite a ~ _, ~ . . _, continuing, substantial challenge from foreign producers . These f irms will continue to be able to respond to the needs of the Department of Defense. For some domestic machine tool builders, however, the economic trends--high cyclical demand followed by the especially sharp downturn of the recent recession have had two consequences that may well be fatal. First, the effects of economic cycles have distracted some machine tool builders from the fundamental technological changes that are proving to have a lasting impact on the types of products and services demanded, and on their own ~nanu- f actur ing method.. Failure to respond to those chances has lef t a number of f irms with product lines which, because they incorporate less sophisticated technology or because hey employ traditional manufactur ing methods, must now compete fiercely on the basis of price, delivery time, and reliability, which they have proven ill-prepared to do in the past. Second, new competitors from abroad have made inroads into the machine tool market that ar e unprecedented despite the history of cyclical machine tool demand. While the evidence of a structurally more dynamic industry is welcome, two trends raise questions about th e benef its, from a national security standpoint, of changes that are taking place: . -

48 (1) Sound business decision making today may dictate that a corporation shift its machine tool production to a foreign venture partner, seek foreign machinery to com- plement its own peripheral devices such as controllers, or relocate its own manufacturing facilities overseas. The danger exists that as business comes closer to realizing true economies of production on a worldwide scale, the United States could lose some productive capacity which is valuable to the national secur ity . ( 2) Among the responses of traditional machine tool builders to increased competition has been a request for 1 imited, temporary protection from imports . The danger exists that efforts to provide immediate help for domestic machine tool builders will, without vigorous and success- ful efforts by the industry to improve its own produc- tivity and technological position, actually weaken that industry' s ability to provide the leading-edge technology and to compete successfully on a global basis. To deal with such issues requires an understanding 0 f how the Department of Defense, pr ime defense contractors, and the machine tool industry interact. The next chapter examines these subjects. NOTE: S 1. National Machine Tool Builders' Association (+TBA), Economic Handbook, 1982-1983, p. 1. 2. Petition Under the National Security Clause, Section 232 of The Trade Expansion Act of 1962, for Ad justment of Imports of Machine Tools, Submitted by National Machine Tool Builders' Association (.Petition.), p. 20. 3 . O.S. Bureau of Labor Statistics, Employment and Earnings, July 1983, pp. 78-81. 4. Anderson Ashburn, ea., World Machine-Tool Output Falls 20%, ~ American Machinist, Feb. 1983, p. 77. 5 . TUBA , Economic Handbook, p . 16 4 . , 6 . N=BA, Economic Handbook, p . 16 7 .

49 7. National Academy of Engineering, Competitive Status of the U.S. Machine Tool Industry, " 1983, p. 18. 8. U.S. Department of CoIranerce, Census of Manufactures, 1977 . 9 . Amer ican I ron and Steel Institute, Annual Statistical Repor ts . 10. ~Petition, n page 35. 11. See, for example, ELBA, Economic Handbook, p. 249. 12. It was reported on May 27, 1983, that Cincinnati Milacron and Acme-Cleveland had reported three consecutive quarterly losses. Gleason Works had reported five and Brown & Sharpe had reported six. Value Line (Machine Tools), May 27, 1983, p. 1344 In 1982 annual reports it was stated that Lodge & Shipley lost money during 1982, as.did the machine tool segments of Textron and White Consolidated Industries. 13. Eli S. Lustgarten, Vice President, Paine Webber Mitchell Hutchins, quoted in American Metal Market, June 13, 1983, p. 2A. 14. Otto Hintz, et al., Machine Tool Industry Study Final Report,. U.S. Army Industrial Basic Engineering Activity, Rock Island, Illinois, November 1968, pp. 18-19. 15. National Machine Tool Builders' Association, Remeeting the Japanese Challenge,. 1981, p. 7 . . 16. National Academy of Engineering, op. cit. ~ p. 49; Otto Hintz et al., op. cit., p. 36. 17. ~Petition,. p. 132. 18. N=BA, Economic Handbook, pp. 162-163 . 19. See, e .g., U.S. Congress, Joint Economic Committee, Special Study on Economic Change, Volume 3 Research and Innovation: Developing a Dynamic Nation (1980), possum.

so 20. See, Beg. r NMBTA' "Meeting the Japanese Challenge p ~ 13 e 21. Cincinnati Milacron r Annual Report r 1982 e 22. Testimony of We Paul Cooper r Chairman' Acme-Cleveland Corporation, before the International Trade Commission on June 28, 1983, p. 3. 23. NMTBA, "Meeting the Japanese Challenge,. p. 14. 240 See notes 9, 10, 11 of Chapter 3 of this report. 2S. NMTBA, Meeting the Japanese Challenge,. p. 14. 26. Joint Logistics Command, Heavy Press Study, November 23, 1982. Douglas Aircraft reports that in the next 15 years there will be no major application for composites in large airframe structures due to the many existing technological problems. This position was also supported by Rocicwell-International. Although they ar e using composites (up to 700 pounds of parts) per B-1 aircraf t, they are not among the ~ large bones. of the structure. Boeing feels that as the technology develops, an increasing percentage of aircraft will be made up of composites.... Many of the current generation of composites (i.e., those containing graphite) are unacceptable in Naval surface ship combat environment since debris from composite damage could affect EMI/EMC. 27. Cincinnati Milacson, Annual Report, 1981 28. SCUBA, Directory 1983, pp. 33-94. 29. ,, Ibid., p. 21. Testimony of Eli Lustgarten, Vice President, Paine Webber, Mitchell Hutchins, before Economic Stabilization Subcommittee of House Committee on Banking, Finance and Urban Affairs, July 26, 1983, p. 1.

51 31. NMTBA, Economic Handbook, p . 16 7 . 3 2. NMTBA, "fleeting the Japanese Challenge, " p. 27. 33. For a good historical review of the Japanese "system, ~ see U.S. Congress Office of Technology Assessment, U.S. Industrial Competitiveness: a Comoar ison of Steel, Electronics, and . Automobiles (Washington, 1981) pp. 190-193 . 34. 35. Strategic groups are groups of manufacturers which, for reasons relating to the similarity of product or market, follow similar business strategies. The concept of strategic groups comes from Michael Porter: see, e.g., Porter, Competi~cive Strategy (New York, The Free Press, 1980) . "petition, n pp. 153 - 154e 36. Japan Machine Tool Builders' Association response to NMIBA Petition, ~ Investigation of Imports of Metal-Cutting and Metal-Forming Machine Tools under Section 232 of the Trade Expansion Act of 1962, ~ pp. 136-142. 37. Lustgarten, op. cit., p. 19 38 . Cooper , op. cit., p. 10 . 39. Testimony of Richard T. Lindgren, President and Chief Executive Officer, Cross & Trecker Corporation, before the International Trade Commission, June 28, 1983, at p. 8. 40. Section 103 of the Revenue Act of 1971, 26 U. S.C. Section 48 (a) ( 7) (D) . 41. ~Petition, ~ p. 6 .