Vital Link: Manufacturing And Economic Recovery

By Christina Granville AAA

Manufacturing output is one of the vital signs that an economy is recovering from a recession. When manufacturing increases, it is a general signal that accompanying demand has also improved and together these are indicators of an economic upswing.

There are varying types of manufacturing that tend to play different roles in economic recovery. Three of the major types of manufacturing production are make-to-stock, make-to-order and make-to-assemble production. It is beneficial to examine each production strategy independently and then look at the role each potentially plays in an economic recovery.

Make-To-Stock Production Strategy
The make-to-stock (MTS) production strategy is a very traditional one. Businesses determine their level of output and production based upon demand forecasts. Some businesses have moved away from this model in recent years to more fluid types of production models, but it still a tried and true production model that is used by many companies.

One of the reasons companies have moved away from it is that sometimes demand forecasts are off - and if the forecast predicted excess demand, then the company will be left with excess stock. If the demand forecast predicted lower demand than actually turns out, however, the company will be left with too few products to meet the heightened demand over and above the forecast. (One of the difficulties in forecasting demand is forecasting the rate of sales growth, learn more by reading Great Expectations: Forecasting Sales Growth.)

MTS products are those that you see every day when you go into a store and look at what is on the shelves. These products have been produced by the manufacturer based upon expected demand quantities from consumers for each individual item. Blu-ray DVD players are an example. It was expected that there would be high demand for a "new and improved" DVD player when they were first manufactured so the quantity produced was high. In a time of recession, however, fewer were produced - except during the holiday season - since it was forecast that people would buy fewer upgrades of their consumer electronics during times of economic uncertainty.

Sometimes these forecasts are off due to an inaccurate read of the economy or unrelated factors that influence consumer demand. In the case of the iPhone, for example, demand exceeded initial supply. Consumers were forced to wait for more iPhones to be produced. In other situations too much of a product can be produced - through unexpected demand expectations - such as when Coke unveiled a new formula and consumers were dissatisfied, resulting in an excess supply.

Make-To-Order Production
Make-to-order (MTO) production strategies allow consumers to buy products that are custom to the specifications of the buyer. While these take additional production time since the item is not manufactured until the customer places the order, sometimes both the consumer and the manufacturer feel that the excess lag time is worth it in order to create a product to the customer's specifications.

Many MTO products have picked up steam in recent years as they have been marketed as luxury items. This gives the products a certain demographic appeal. An example of this is MTO computers. Dell was a pioneer in the make-to-order production strategy for consumers and was so successful that other competitors such as Apple and Compaq followed suit.

One of the production problems that MTO products avoid is demand exceeding supply. With the MTO production strategy, the products are not manufactured until the customer places the order, eliminating that potential problem. Because MTO production is so highly specialized, it is often limited to more expensive products of which people tend to buy fewer overall. Companies have some products that are made through the traditional make to stock production process and some that are make to order products - generally higher priced, lower volume sale items.

Assemble-To-Order Production
The assemble-to-order (ATO) strategy allows customers to have products relatively quickly but still be able to customize them. The ATO strategy typically has the parts for the good is in stock, but waits for the customer order before final assembly is initiated. In that sense the ATO production strategy is somewhat of a hybrid between the make-to-order and make-to-stock strategies. Consumers are able to have the luxury of customizing their purchases but they can be manufactured more quickly since the basic parts have been already manufactured.

This type of production model is one that is often used with online sales. On the internet, consumers can log on to a site and simply customize the product they want and have it shipped to them. Manufacturers also benefit because they don't have to do as much guesswork with regard to demand. It is a very agile production model where manufacturers can more nimbly shift supply based upon demand for the individual components.

Production Strategies And The Economy
So based on these three types of manufacturing production processes, it is clear that the make-to-stock production is the least flexible type of production model. Since MTS is based upon forecast models, during an economic downturn it is dependent upon predictions about when the economy and consumer demand will improve. This type of production model is most successful when the accompanying forecasts are accurate regarding an economic turnaround.

The make-to-order model, conversely, is the most flexible since the products aren't manufactured until they are ordered by consumers. Products with this manufacturing strategy generally tend to be ones that can adjust quickly to shifts in the economy and are often ones that help the economy recover more quickly from a recession since those consumer dollars flow into the economy faster. (Learn how you can profit if consumers are not buying in Profiting From A Consumerless Recovery.)

Using our computer example, if a consumer who was unemployed but just found a job wants a new computer with certain features but can't find it on store shelves - and has to wait potentially months until that stock on store shelves is re-supplied, perhaps because the economic forecast was too bleak - those consumer dollars aren't flowing into the economy. If, however, that same newly employed consumer orders a Dell MTO computer, those dollars flow quickly to Dell and, en masse, can positively influence a recovery since economic swings are momentum-based in nature.

The assemble to order (ATO) strategy is also one that is flexible enough to play a role in an economic recovery and is often able do so at a higher scale of demand than the MTO strategy.

Thus, an ATO strategy is one that can be a valuable economic driver in terms of being flexible enough to adjust to sudden upswings in demand when an economy starts to recover and being applicable to a wide range of products cost-wise which also increases the potential volume of demand.

The Bottom Line
So while sudden shifts in the economy may catch the MTS manufacturing production model off guard - particularly if an economic upswing wasn't predicted until much later - MTA and MTO production strategies are often flexible enough to move more quickly to adjust to increased demand. This helps to further drive economic recovery which can additionally spur an economy out of a recession at an accelerated pace.

For related reading about industrial production as well as other economic indicators, take a look at our Economic Indicators Tutorial.

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