The 3D printing industry can greatly benefit from understanding the current trends and restructuring of the machine shop industry. We are observing a major consolidation of the machine shop industry. This industry consolidation includes post transaction product and process improvements that are typically eligible for R&D tax credits.
The Research & Development Tax Credit
Enacted in 1981, the now permanent Federal Research and Development (R&D) Tax Credit allows a credit that typically ranges from 4%-7% of eligible spending for new and improved products and processes. Qualified research must meet the following four criteria:
- Must be technological in nature
- Must be a component of the taxpayer’s business
- Must represent R&D in the experimental sense and generally includes all such costs related to the development or improvement of a product or process
- Must eliminate uncertainty through a process of experimentation that considers one or more alternatives
Eligible costs include US employee wages, cost of supplies consumed in the R&D process, cost of pre-production testing, US contract research expenses, and certain costs associated with developing a patent.
On December 18, 2015, President Obama signed the PATH Act, making the R&D Tax Credit permanent. Beginning in 2016, the R&D credit can be used to offset Alternative Minimum tax for companies with revenue below $50 million and for the first time, pre-profitable and pre-revenue startup businesses can obtain up to $250,000 per year in payroll taxes and cash rebates.
Current Machine Shop Consolidation Trends
Many machine shop owners are entering the retirement stage of their lives and often find they have no succession plan. Often their children have independent careers and are not interested in succeeding to the business. Business continuation in the machine tool industry requires a high level of technical skills and large regular capital expenditures. In these two situations we are seeing two common exit scenarios namely:
- Purchase by another machine shop; or
- Purchase by manufacturer
The machine shop consolidations also provide better procurement and purchasing power leverage particularly for metal raw materials where prices are greatly increasing due to global trade wars.
Machine Shop Purchase
A typical strategy by another machine shop purchaser is to expand capabilities and product coverage, often with a common customer. Many machine shops’ largest customers have reduced the number of approved vendors from which they purchase. By adding the acquiree’s product lines, the purchasing machine shop can enhance and potentially secure their preferred vendor position. Machine shop purchasers have told us they find it easier to secure more business by acquisition rather than engage in business development activities with which they are not comfortable.
We are seeing more manufacturers purchase machine shops as part of a vertical integration strategy. A manufacturer can also have a machine shop Acqui Hire strategy. Acqui Hires are a result of a business acquisition strategy where a firm acquires another, primarily for the skills and expertise of their staff. With the Acqui Hire strategy, a manufacturer can obtain a key machine shop executive for a finite period who can oversee all of their captive machining operations, including existing machining functions and the acquired machine business. Often the machine shop seller welcomes regular hours and corporate benefits provided by the manufacturer.
3D Printing Impact
In both the machine shop purchase and the manufacturer purchase situation, the resulting entity is larger and typically financially stronger. The new, stronger, surviving organization is much more likely to be committed to further innovation, including 3D printers.
The ongoing consolidation of the machine shop industry provides new opportunities for the new and improving hybrid machine tool/3D printing machines made by leading machine tool manufacturers, such as Mazak and DMG Mori Seiki. Moreover, the leading machine tool manufacturers and distributors often already have credit line and leasing program approvals in place with one, if not both, of the consolidating parties. The consolidating machine shop industry presents new opportunities for those informed members of the 3D Printing industry who are monitoring these developments. We often see that when machine shop purchases are successfully executed that they are then followed by successive machine shop purchases.
We recommend that the 3D printing industry monitor the machine shop consolidation trend and recognize the opportunity for the new business.
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Charles Goulding & Tricia Genova of R&D Tax Savers discuss machine shop consolidation.