Never before has a recession hit electrical distributors so hard for so long. Beginning with the second quarter of 2001, electrical distributors' sales have fallen for 10 consecutive quarters — a cumulative shortfall of $12 billion from a peak of $76 billion in sales in 2000. That's the worst decline DISC Corp. has seen since the company began collecting data on electrical industry sales more than 25 years ago.

First-quarter 2002 was particularly brutal. Combined sales to the contractor and industrial markets declined 15 percent that quarter, bringing total sales down by nearly 12 percent. That was the low point.

CURRENT MARKET CONDITIONS

Good news came last month when the Bureau of Economic Analysis released advance estimates that show real gross domestic product (GDP) — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 7.2 percent for third-quarter 2003. Unfortunately, this GDP growth may not directly affect the electrical industry. GDP contains several elements that have little or nothing to do with the electrical business. For instance, a surge in retail sales does not affect your company, but retail sales are very much a part of GDP.

For the electrical market, the key economic drivers to focus on are construction and other business investment. Of that 7.2 percent GDP gain, the most important electrical industry statistic — nonresidential construction — was down 2.4 percent at a seasonally adjusted annual rate. At the same time, residential spending in the third quarter was up 20 percent. Investment for equipment was up more than 15 percent. However, software and computer equipment, a large component of equipment investment that has no impact on electrical industry sales, was up more than 18 percent, so it grew faster than the components of equipment investment important to distributors.

Although the overall economy witnessed growth in the third quarter, it will not have much impact on electrical industry sales this year.

Here's why. For first-half 2003, DISC pegs electrical sales decreasing 7.1 percent. For second-half 2003 sales, DISC forecasts a decrease of 0.7 percent. For 2003 overall, DISC Corp.'s latest forecast (completed before the advance GDP numbers were released) estimates electrical industry sales to decrease almost 4 percent.

How much of a bounce can reasonably come from a stronger than expected third-quarter performance in the key economic indicators for the overall U.S. conomy? Zero growth for this year is out of the question because it would require electrical sales in the second half to advance more than 7 percent from a year ago. That's much too big of a bounce.

A year ago, assuming a war scenario, DISC Corp. forecast electrical distributor sales in 2003 to decrease 1 percent. Consider that an upper limit. To hit the forecast DISC made last year for 2003, electrical distributor sales in the second half of this year would need to increase 5 percent over last year's second half. That's not likely.

The maximum bounce we could get is growth of 3.5 percent in the second half of 2003, which would put electrical industry sales at negative 2 percent for the entire year. Consider a more likely impact on second half sales to be up 1.5 percent, putting electrical industry sales down 3 percent for 2003.

A BETTER BUT NOT GREAT 2004

I am more confident about electrical industry prospects for the coming year than I was last October when looking ahead to 2003. I expect weak industry growth of about 1.5 percent for 2004 — the first positive growth since 2001. (See Electrical Sales chart.)

Why so weak? Just look at the economic drivers. In the current cycle of the electrical wholesaling industry, nonresidential construction is the economic driver with the greatest impact on sales. This is private construction and does not include any public spending. Unfortunately, the excesses in nonresidential construction spending in the 1990s created an overhang on the market that won't disappear until mid 2004, at least.

Meanwhile, residential expenditures have been a lifesaver for many vendors and distributors, but its strength hasn't offset the downside of nonresidential expenditures. The contractor market will not lead the recovery in distribution. The distributor-served industrial market led the industry downturn, and I expect it to lead the upturn.

Look for faster growth next year in machinery investment to drive distributor sales to the served industrial market. (See Economic Drivers chart.) But for 2005, the contractor market will be back on track and will lead total industry sales.

Overall, DISC Corp.'s 2004 forecast of 1.5 percent sales growth is barely positive, so it wouldn't take much of a miss to be back in the red. Although I can't guarantee this 1.5 percent performance, DISC Corp. has also run a more optimistic scenario that projects industry performance to advance nearly 3.5 percent next year.

To give you a better feel for the probability of the two scenarios, I would assign a 55 percent probability to the baseline 1.5 percent growth and a 45 percent chance to the optimistic 3.5 percent growth. If the past is prologue, DISC's forecast will be accurate within a fairly narrow range of 3 percent.

Industry growth of 3.5 percent requires higher performance of the economic drivers than those shown in the Economic Drivers chart. For example, nonresidential spending would need to increase about 0.5 percent, not decrease 1.3 percent. Investment in equipment would need to advance nearly 6.5 percent instead of the projected 3.3 percent.

I have included the more optimistic scenario because it's well within the realm of possibility. For the first time in several years, we could get some help from a strengthening economy.

To be sure, the economy is still vulnerable. Still, the uncertainties don't seem as complex as those the electrical industry and the U.S. economy faced last year. There is no impending war hanging over our heads, businesses have a better understanding of the effects of the tax cuts, and the U.S economy is in a business cycle that's getting some “legs.” Although the economy is still recovering, the cycle is maturing. We are slowly working off some of the excesses, and some of the economic indicators critical to electrical distribution are beginning to stir.

Still, the electrical business faces huge excesses in the areas of industrial capacity and office vacancy rates. Manufacturing capacity utilization is still at a sickly 72 percent and office vacancy rates are in the 15 percent range nationally and over 20 percent in many important metro areas.

While I have a somewhat more optimistic view of 2004 compared with electrical industry performance in 2003, electrical distributors still face an uphill battle. The electrical industry is not out of the woods by a long shot, and I believe 2004 will be a challenge.


The author is president of DISC Corp., Orange, Conn., a leading provider of market forecast information for the electrical industry.

THE PERILS OF PRICE DEFLATION

It's not slow growth that's the most dangerous to the electrical industry, it's price weaknesses and a deflationary environment. This may not be true of the entire economy, but DISC identifies it as a problem for electrical distribution. The overbuilding of the 1990s brought about excesses that have left electrical distributors faced with weak demand.

Electrical distributors' prices are soft with little or no strengthening in sight. The continuing upward pressure on total expenses, including benefits and compensation, will be particularly painful. This results in the dreaded profit squeeze. This chart compares prices in a non-deflationary economy at large with a deflationary distribution industry.