We’ve become very familiar with a few specific industries here at 37th & Moss. Today, we’ll share a brief summary of our insights into the Manufacturing Technology industry - specifically, manufacturing software.
China dominates manufacturing, accounting for 35% of gross global manufactured goods (1). “Cheap” Chinese goods threaten to flood international markets leading many countries, including the U.S., to protect domestic industries and manufacturing (2). Politicians protect domestic manufacturing through subsidies (often targeted at politically favored industries) and tariffs on imports (3). Through May of 2024, the U.S. government invested more than $800 billion during the Biden Administration alone in semiconductor manufacturing, EVs, sustainable energy sources, and infrastructure. This investment is part of a broader trend to reduce reliance on China for practical (proximity to end customer, quality control, etc.) and political reasons. As this shift gathers momentum, we think manufacturing firms of all sizes will benefit from increased demand for domestically manufactured goods.
How do U.S. manufacturing firms meet increasing demand for their products? New product lines require significant investment in machinery and equipment and can take years to develop. For example, a new-build semiconductor factory can take 3-5 years and $10 billion to get off the ground (4). Subsidies can offset the monetary cost, but tariffs go into effect immediately and cause a rapid rise in demand for the goods domestic manufacturing firms produce. What if existing product lines could build products more efficiently? Would this lead to more domestic production? Certainly, the U.S. could never meet the cheap Chinese labor costs, but could it make up for that through innovation and productivity gains? We set out to test this hypothesis for U.S. manufacturing firms.
Well-established manufacturing firms continuously optimize for efficiency through extensive use of robotics and other automation. They’ve embraced a movement coined “Industry 4.0” - a broad term used to indicate the modernization of manufacturing including the use of Virtual Reality, Internet of Things, robotics, and AI. However, we thought there might be an opportunity to help smaller manufacturing firms ($20-60M in revenue) that have limited capital to fund the capital expenditures required to buy a new robot from FANUC, for example (Japanese robotics firm specializing in manufacturing robots). We confirmed our hypothesis during a tour of a small manufacturing company. Firms like this follow industry best practices in line management, but frequently can’t justify the steep investment in the automation (robotics) larger firms enjoy. Pen and paper, manually updated excel spreadsheets, and manual inputs into CNC machines through PLCs carried the day. This is a very well-run establishment, but the manual inputs and tracking seemed ripe for automation through well-designed process management software.
In speaking with manufacturing software company owners and factory owners, we learned that our hypothesis was mostly correct. Continuous production processes (like paper manufacturing, waste management, and others) benefit from innovations in AI and software that “close the loop” on the production process. (Instead of batch sampling, the system continuously monitors output and optimizes inputs to eliminate error and inefficiencies.) Plant and line management software and production tracking dashboards are also commonplace (ERP software, “mission control” software, Overall Equipment Effectiveness dashboards, etc.). The industry solved for clipboards and superintendent walkthroughs by creating constantly-updating charts and graphs that can be easily customized to any factory use-case. Implementing a dashboard software like this that tracks factory or production line output is relatively simple as most rely on human-in-the-loop input to build the key performance indicator dashboards. With low implementation costs and clear value, it may come as no surprise that we found a lot of these companies, with intense competition among them.
In addition to ERPs and AI-based continuous improvement software products, we thought we might find a plethora of “Industry 4.0” innovations targeted at the lower-middle market manufacturers - IoT devices designed to backfit analog systems, software products that identify inefficiencies in analog machines, etc. - but these companies were few and far between. As with the investment in robotics, retrofitting a factory line carries a very large capex cost. Factory equipment is often decades old, maintained to stretch the useful life as long as possible to avoid the significant replacement expense, making any modern retrofit difficult. Line workers often know the machines they work intimately, and interact with them through everything from modern PLCs to levers and handles. Implementation costs must include time lost due to training on a new process. Owners purchase equipment from different vendors over the years which also complicates the modernization challenge and makes every implementation custom to the factory/owner/machine. With EBITDA margins often in the high single digits, small and mid-size manufacturing company owners may find that investing in a new, unproven technology that doesn’t immediately and directly increase output introduces unacceptable risk.
“Small and mid-size manufacturing companies are reluctant to embrace change and innovation,” said a vendor at a conference we attended. We don’t think this is necessarily true. Without context, software vendors could conclude that owners are “stuck in their ways”; however, the nature of the business drives the slow, deliberate embrace of Industry 4.0 techniques. As Elon Musk said, “Manufacturing is insanely difficult.” Disrupting the line to add IoT sensors that may break in 6 months doesn’t make sense for small manufacturing firms with a low appetite for risk. The winners in manufacturing tech will produce software that is easy and cheap to implement, and brings clear and immediate savings to the factory owner - who, in our experience, is perpetually searching for new ways to increase margins and productivity.
