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Accelerating Digital Technology Adoption Among U.S. Small and Medium-Sized Manufacturers

Accelerating Digital Technology Adoption Among U.S. Small and Medium-Sized Manufacturers

April 19, 2024

It has become much clearer to policymakers, economists and pundits that a strong manufacturing sector is critical to America’s future, especially for reducing the trade deficit, competing with China, and ensuring supply chain resilience, including for military production. This is particularly critical for America’s small and medium-sized (SMEs) manufacturers. The Information Technology and Innovation Foundation (ITIF) convened a roundtable group of experts to explore this issue and discuss potential solutions. (See list of attendees below). This blog is a summary of that roundtable.

The Problem

All is not well. As ITIF has shown, U.S. advanced manufacturing has fallen as a share of global output. Moreover, likely for the first time in history, U.S. manufacturing labor productivity has fallen, with productivity in the fourth quarter of 2023 actually lower than in the third quarter of 2009. With these trends and absent raising manufacturing productivity, the only way for U.S. manufacturing to compete with other nations is to cut wages or see a significant decline in the value of the dollar.

These problems are particularly acute for small and medium-sized manufacturers (SMEs). While the number of large manufacturers (over 500 employees) increased by 14 percent from 2010 to 2021, the number of small manufacturers fell by 8 percent. And research has shown that on average small manufacturers are less productive than larger ones in large part because of the lack of technology adoption.

This is even more problematic given the emergence of a suite of new technologies—what some have termed “industry 4.0” or “smart manufacturing”—that, if adopted, could boost SME productivity. These technologies include advanced computer-aided design, 3-D printing, connected machines, 5G, digital twins, data analytics, artificial intelligence (AI), robotics, and others. Studies have found that small manufacturers can boost their productivity by 7 percent to 26 percent to 50 percent by adopting these technologies.

The Case for Action

There are a number of reasons why policymakers should pay attention to this challenge. One is that helping SMEs adopt these technologies will boost productivity, expand output, enable these companies to raise wages while still being competitive in global markets, and become more flexible in their production processes.

This last point is particularly critical for both national security and supply chain resilience. The defense industrial base, particularly the dual-use sector, is weaker than at any time since the 1980s. And while large prime contractors can be supported directly with defense procurement dollars, they all rely on suppliers at the second, third, and fourth tiers, and most of these companies are small dual-use producers. The national defense production system depends on a healthy dual-use SME manufacturing base and helping them embrace digital manufacturing tools and processes is key to their future sustainability. This is why the National Defense Industrial Strategy published by the Department of Defense in January identified supply chain resilience as a top goal.

Moreover, digital manufacturing technologies can help with supply chain flexibility, in part by enabling more cost-competitive shorter production runs and faster production changeovers and reducing the transaction costs (procurement, design iteration, contracting) between the nodes of the industrial supply chain, allowing those resources to be reallocated in these highly capital-intensive businesses.

In addition, digital manufacturing has energy and environmental benefits. For example, smart systems enable reduced waste, which reduces energy and materials consumption. Finally, our ability to achieve industrial policy goals, including in semiconductors and energy, will be limited without a digitalized supply base.

Barriers to Adoption

An array of barriers makes it difficult for manufacturers to adopt digital manufacturing technologies, particularly for small manufacturers.

Perhaps most important is the difficulty in replacing legacy equipment. In 2015 the McKinsey Global Institute estimated that achieving Industry 4.0 will require upgrading about 40 to 50 percent of the current asset base across U.S. manufacturing industries. In particular, machinery will need to be upgraded or replaced to accommodate IoT sensors and actuators and new software and high-performance computing platforms will be needed to support advanced modeling and simulation as well as AI and analytics to leverage data to design and manufacture products more cost-effectively and sustainably. This imperative will become all the more pressing as existing U.S. manufacturing plant and equipment continues to age. In fact, whereas the average U.S. factory was 16 years old in 1980, in the late 2010s it was 25 years old. The average piece of plant equipment was seven years old in 1980 but was nine years old in the late 2010s. It would be like expecting smart transportation systems if everyone was driving 2010 Ford Escapes, rather than 2024 models that are digitally enabled.

A second challenge is that unlike some other nations where larger manufacturers enter into longer-term partnerships with their suppliers and help them become more productive and technologically sophisticated, most large U.S. manufacturers have an arms-length contractual relationships, with their suppliers pressing them constantly on price. As such, it is often difficult for them to find the time and capital to make these investments.

Third, because the integration of these technologies into coordinated manufacturing systems is so new, at least for many small businesses, many companies are naturally risk averse and do not want to be the first adopters. Moreover, many are unaware of the positive return on investment.

Fourth, the skills needed to utilize these new technologies are often in short supply and companies struggle to find workers with the capabilities to manage the factory floor that is smart.

Finally, in contrast to other nations, the federal government provides very little assistance to help its SME base become more modern, export more, train their workers, and develop new products period. Germany invests 6.2 times the amount the United States does on a per-GDP basis to help its SMEs modernize. Japan invests 54 times more. The flagship U.S. program, NIST’s Manufacturing Extension Partnership (MEP) program, continues to be chronically underfunded.

What Other Nations Are Doing

Many other nations have made helping their SME manufacturing base upgrade through digital technologies a national priority. For example, the new Canadian government budget calls for investing $60 million annually in AI support, including to help small and medium-sized manufacturers scale up and increase productivity by building and deploying new AI solutions. To match this on a per-GDP basis, the United States would need to invest around $600 billion per year, not all that much in light of recent investments in CHIPS and IRA. China has also made digital manufacturing a priority at the highest levels of government, with support provided for over 10,000 factories to become digital. China’s Made In China 2025 strategy featured a $2.9 billion investment in its Advanced Manufacturing Fund.

Germany’s key initiative is Plattform Industrie 4.0, which develops joint recommendations for all stakeholders and serves as the basis for a consistent and reliable Industry 4.0 framework. The platform was originally created by the business associations BITKOM, VDMA, and ZVEI and is today steered by Germany’s Federal Ministry for Economic Affairs and Energy and Federal Ministry of Education and Research as well as high-ranking representatives from industry, science, and trade unions. More than 300 players from 159 government (state and federal), business, science, association, and union organizations participate in Plattform Industrie 4.0. The platform aims to identify all relevant trends and developments in the manufacturing sector and to combine them to produce a common overall understanding of Industrie 4.0. Germany’s Plattform Industrie 4.0, like Austria’s, inventories and describes discrete, specific manufacturing digitalization use cases and processes. (E.g., Germany has documented over 300 specific use cases/sample instantiations of SME manufacturing digitalization). Many countries have also developed “Digital Manufacturing Maturity Indices” and provide “Self-Benchmarking Assessment Tools” (including cybersecurity) for SMEs.

Manufacturers in other nations are accelerating their deployment of digitalization technologies. For instance, in Japan, 28 percent of manufacturers have introduced (16 percent) or plan to (12 percent) AI and/or IoT solutions, while 68 percent of Japanese manufacturers leverage cloud services. In Europe, 27 percent of manufacturers report using multiple AI technologies, while another 20 percent report using at least one AI technology. This makes manufacturing Europe’s second-most AI-intensive (i.e., using) industry behind only the ICT sector. The top uses of AI technologies amongst European manufacturers are for process automation, equipment optimization, and fraud/risk detection.

The United States has work to do. ITIF found in a 2019 report that only 5 percent of surveyed $100-$1 billion-sized manufacturers were currently using AI tools, although 52 percent said they were “experimenting” with AI solutions and 29 percent said they expected to make AI deployments by 2024. Only 42 percent of U.S. manufacturers use specialized software.

A few states have established digital manufacturing grant programs to help their SME manufactures, including Indiana Manufacturing Readiness, Massachusetts’ Manufacturing Accelerate Program, and Michigan’s Industry 4.0 Technology Implementation Grant, which reimburses 50 percent of the costs (up to $25K) for a broad range of qualifying technologies that include additive, robotics, cloud, AI, etc. While these programs are helpful, they reach only a modest number of SMEs.

Policy Solutions

Here are a few ideas and proposals to simulate debate on potential policy solutions:

1. Establish a White House interagency task for on digital manufacturing with members from major agencies that interact with SME manufacturers, including the Department of Defense, Department of Energy, Department of Commerce, and the Small Business Administration.

2. Target and expand existing DOE funds for smart manufacturing to SME digital upgrading. The Office of Manufacturing and Supply Chain Resilience (MESC) has a budget of $50 million for smart manufacturing that it is distributing to States. Congress should quadruple this budget.

3. Reinstate first year expensing of machinery and equipment that was included in the 2018 Tax Cut and Jobs Act. Too many SMEs seek to conserve cash and hold onto fully depreciated machinery that is often multiple generations behind the best in class. Allowing these firms to write off these expenditures for tax purposes in the first year would provide at least a somewhat greater incentive for them to upgrade to current technology. And that technology is digitally sophisticated.

4. Create tax credits for both SMEs and OEMs to encourage investment in SME/supplier digitalization. Tax credits could be used for investment in equipment and integration services.

5. DOD and DOC should provide matching challenge grants to SME manufacturing to become state-of-the-art digital manufacturers, on the condition that they then work with others in the industry to help them master the processes.

6. Fund NIST to continue its work on digital manufacturing and lead a national SME digital manufacturing initiative that would bring together all the major actors in the ecosystem, including research universities, technical colleges, state government technology-based economic development programs, and state and national industry trade associations, (both across all manufacturing, and specialized industry-specific manufacturing associations) federal agencies, federal laboratories, and large OEMs, with NSF’s Advanced Technical Education program at the core. This network should also be tasked with creating a national set of open-source tools and resources for SMEs to facilitate digital adoption.

How to Get There

Other countries, especially ones from Europe and Asia, have made SME digital transformation a top priority. It’s time for the United States to do the same. This will require a broader awareness of the challenge and the need in Washington. Major trade associations, especially the National Association of Manufacturers, will need to move beyond lobbying for tax cuts and regulatory reductions, and instead work to support robust, industry-led, but government-supported digital manufacturing initiatives. At the same time the House and Senate Commerce committees should hold hearings on SME digital transformation. And finally, the Biden administration should continue and ramp up its work in this space.

Roundtable Attendees

ITIF thanks the participants of the workshop. The contents here reflect ITIF’s position.

Andrew Anagnost, CEO of Autodesk

Robert D. Atkinson, President of Information Technology & Innovation Foundation

Jonathan Garon, Telecommunications Industry Analyst at U.S. Department of Commerce, International Trade Administration

Monica Gorman, Special Assistant to the President for Manufacturing and Industrial Policy at Executive Office of the President

Jason Ray, CEO of Paperless Parts

Elisabeth Reynolds, Lecturer in Innovation and Competitiveness at Massachusetts Institute of Technology

Robert Rudnitsky, Associate Director and Strategy and Planning Division Chief at National Institute of Standards and Technology

Liza Tobin, Senior Director for Economy at Special Competitive Studies Project

Bruce Lawler, CEO of Re:Build Manufacturing

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