Top Risks Facing Industrials and Manufacturing Organizations

The manufacturing sector exceeded expectations of bouncing back in the wake of the pandemic despite the high inflation and capital costs, natural disasters and economic and geopolitical volatility that affected demand, supply chains and operations.

Economic uncertainty has been heightened by geopolitical conflict around the world, along with persistent, severe talent shortages; logistics disruptions; and climate change-related events, such as the Panama Canal drought that has hampered international shipping traffic.

The U.S. market contracted in the second quarter of 2023, but the following three months saw increases in new orders and reductions in unemployment, along with other indicators that economists interpreted as signs of expansion. European manufacturing, however, has been in the grips of a persistent downturn, experiencing drops in demand and production amid a worsening labor shortage. And despite aggressive stimulus efforts, China’s manufacturing growth contracted for much of 2023 thanks to a lingering property crisis, shrinking global demand and reduced consumer spending.

Current Risks

From a financial risk viewpoint, manufacturers and industrial companies remain concerned about an economic slowdown or slow recovery, with most regions experiencing recessionary threats. In response to financial volatility and tightening capital markets, manufacturers and industrials are also concerned with commodity price risk or scarcity of materials and cash flow or liquidity risk.

Top 10 Current Risks

1. Commodity Price Risk or Scarcity of Materials
2. Supply Chain or Distribution Failure
3. Economic Slowdown or Slow Recovery
4. Business Interruption
5. Cyber Attack or Data Breach
6. Regulatory or Legislative Changes
7. Increasing Competition
8. Failure to Attract or Retain Top Talent
9. Failure to Innovate or Meet Customer Needs
10. Cash Flow or Liquidity Risk

Operationally, manufacturers are concerned about their cybersecurity and potential interruptions to their supply chains and businesses, all of which are all highly correlated. Cyber attack or data breach emerged in the top 10 list in 2021 and remains the number five risk in 2023 as manufacturing companies express continued concern over ransomware attacks that bring major production facilities to a halt.

Meanwhile, supply chain or distribution failure, which moved from the number four to the number two current risk in the 2023 survey, is influenced by a wide variety of root causes, including continued pandemic-related production delays of semiconductor chips, global trade disputes, the conflict in Ukraine, transportation and logistics delays and natural disasters. These supply chain issues can lead to business interruption (ranked number four). Even in the absence of interruption, inflation in supply chain costs—whether for energy or for raw materials—as well as rising wages can squeeze liquidity and margins. Inflated costs can also make it more difficult to access capital, which is key to finance energy transition–related projects.

Strategic risks continue to populate the top 10 list of major concerns for manufacturers. Advancements in technology provide both opportunities and threats for traditional industry incumbents, as seen in the number seven ranking of increasing competition and the inclusion of failure to innovate or meet customer needs at number nine. Many companies have leveraged technology advancements to create greater efficiencies in production, while others are making significant strategic pivots to ward off new competitors, but they are clearly seeing this risk gain importance as digitalization, cloud computing and AI are enabling organizations in the sector to forge ahead of their peers.

Also a key industry risk is failure to attract or retain top talent. This reflects the struggles of manufacturers in the U.S. and Europe to meet production targets amid tight labor markets due to a combination of more and more baby boomers retiring, pandemic-triggered reductions in the labor force and an inadequate talent pipeline. The most pressing labor challenge is the competition for top technology talent, with manufacturers and industrial companies now competing with the tech sector for software and design engineers.

Underrated Risks

The global trade imbalances between the U.S., Europe, China and the Middle East, in addition to the wide-reaching implications from the conflict in Ukraine, continue to cast a shadow over growth projections in the manufacturing sector. Despite this, geopolitical volatility failed to enter the top 10 list this year. Instead, respondents may have registered their concerns about global events as economic slowdown—an outcome of geopolitical volatility.

More notable is that, despite capital restrictions in the sector, capital availability was ranked at number 20. Inflation, higher interest rates and the need to finance the transition to cleaner energy all make a big impact on industrial companies, which should therefore focus on cash flow or liquidity risk. Industrial companies should allocate their capital expenditures to optimize their geographical agility with respect to their supply chains and labor force. This can allow companies to mitigate related costs as well as local and regional political risks. As production processes become increasingly automated, any increases in investment require new considerations regarding capital. Furthermore, a digitalized production line will raise the stakes on supply chain risks for manufacturers.

Climate change is also an underrated risk, not appearing in the top 10 despite its broad range of implications for the sector. Access to energy, raw materials and water will remain imperative for manufacturers, but climate change–related impacts from severe weather and natural disasters could restrict or disrupt their supply. Meanwhile, environmental concerns raised about CO2 footprints and other sustainability topics will carry greater weight in companies’ management. Accurate reporting and governance bring additional liabilities and reputational risks. Administrators will need to make decisions along multiple dimensions, particularly as operating licensing is affected.

Similarly, artificial intelligence (AI) is ranked far too low for the industry, at number 50. AI has myriad use cases for industrials and manufacturing, from data modeling to supply chain and operational optimization and beyond. AI may also bring benefits to project design and operational management, but many industrial companies lack the specialized talent needed to capitalize on these benefits.

It is also surprising that, in addition to failure to innovate or meet customer needs, intellectual property risk and damage to brand or reputation are not considered top risks. Intellectual property risk is an inherent risk of innovation. Additionally, reputational risk should be carefully managed as customers’ expectations and buying patterns are evolving alongside regulations and responses to geopolitical and climate events.

Future Risks

The industry’s 2023 top 10 future risk list includes the same risks as its current top 10, albeit in different positions, reflecting respondents’ anticipated priorities. Manufacturers and industrials appear to be looking at longer time horizons to address their current concerns.

Top 10 Future Risks

1. Commodity Price Risk or Scarcity of Materials
2. Economic Slowdown or Slow Recovery
3. Cyber Attack or Data Breach
4. Increasing Competition
5. Business Interruption
6. Supply Chain or Distribution Failure
7. Failure to Innovate or Meet Customer Needs
8. Cash Flow or Liquidity Risk
9. Regulatory or Legislative Changes
10. Failure to Attract or Retain Top Talent

Commodity price risk remains number one on the future risk list because input costs and sale prices bring significant uncertainty and volatility for industrial companies. Successful companies will be those that efficiently manage their costs—and volatility. Insurance tends to have a limited direct role to play in management techniques for commodity price risk, but insurance solutions do exist and can be deployed to address the downstream consequences of scarcity of materials and how they contribute to business interruption in particular. Public sector financing and policies to foster investments may decline as inflation lowers in the future. This is reflected in respondents’ continued inclusion of cash flow or liquidity risk and regulatory or legislative changes in the future top 10.

The top 10 future risks are also consistent with the current top 10 list due to external factors. Circumstances outside of companies’ control, such as the limited availability of natural resources, growing nationalism in financing and exports, and turbulent geopolitical circumstances, are all contributing to the internal concerns already facing industrials and manufacturing organizations. All of these factors create a volatile economic landscape that affects how manufacturers are able to secure financing. Typically, capital-intensive projects are financed over long periods of time; however, the unpredictable and rapidly changing nature of the current economy disincentivizes long-term agreements. To counteract the harm these factors could inflict on an organization, risk management must be fully integrated in management and strategic planning so that the organization can stay on top of established risks to minimize their impact.

How Can Industrials and Manufacturing Organizations Mitigate These Risks Effectively?

The biggest challenge for companies will be to address the interconnectedness of the risks facing the manufacturing and industrial sector. To do this, risk management will need to be further embedded across the organization. Capable talent and teams will need to address the challenges holistically, considering historical data and analytics while addressing new realities. Furthermore, long-term strategies to mitigate risks must also integrate or complement strategies to address short-term needs as they arise or else risk response may become reactive or episodic. More than ever, the three lines of defense—risk, volatility and crisis management—must be strengthened and adjusted to the new environment in which organizations operate.

With the talent shortage being top of mind, companies in the manufacturing sector should make sure they have a competitive employee value proposition. This means that workforce wellbeing and environmental, social and governance policies are no longer optional. Industrial companies will also have to foster partnerships and invest in education to build their workforces.

To navigate increasing competition and the need to innovate, companies will need to understand the diverse and rapidly evolving needs of customers. Successful companies will embrace new technologies such as AI while carefully managing the new and emerging risks associated with those technologies. While cyber risk continues to be a major concern for manufacturers, our survey data shows only 12% of companies have formally quantified their exposure to the wide variety of cyber threats. This process could add perspective to future capital allocations to manage and control the operational and financial volatility introduced by cyber events.

Companies will also need to build reserves of crucial spare parts to shorten repair times and business interruption periods. To save on premiums and guarantee effective first-class loss prevention, manufacturers could consider creating captive insurance companies. At the same time, companies will need to identify what capital is at risk.

To reduce the impact of supply chain risk, companies can evaluate business continuity plans and audit key suppliers. They can use more than one source of key materials and maintain sufficient reserves. In the longer term, organizations can innovate and optimize processes to reduce the need for materials with restricted supplies. Manufacturing and industrial companies need to preserve expertise in their organizations and manage and source talent. Companies also need to keep careful watch of their finances and make sure they are supporting their suppliers.

Addressing the overall risk landscape may require companies to change or diversify their business models and review or diversify their geographical risk. These changes could involve opportunities for mergers and acquisitions.

Complexity and volatility will be challenging for any organization that is constantly reacting to risks rather than preparing for them. Being well prepared should turn the three defense lines of risk, volatility and crisis management into three lines of offense.

General Disclaimer
This document is not intended to address any specific situation or to provide legal, regulatory, financial, or other advice. While care has been taken in the production of this document, Aon does not warrant, represent, or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the document or any part of it and can accept no liability for any loss caused by reliance on it. Any recipient shall be responsible for the use to which it puts this document. This document has been compiled using information available to us up to its date of publication and is subject to any qualifications made in the document.