Industrial construction is declining, construction is softening, new residential construction may be nearing a saturation point and high-tech businesses continue to sputter and crash.

But even though many electrical manufacturers, distributors, reps and contractors see a gloomy short term, bright spots are starting to appear on the horizon.

“I see 2003 continuing to be a flat year, with some limited growth,” said Hank Bergson, president, National Electrical Manufacturers Representatives Association (NEMRA), Tarrytown, N.Y. “I don't think we're going to get any worse than 2002, but I don't see a lot of recovery. Maybe we'll see some growth toward the end of the year.”

During the last two years, the recession-rocked U.S. economy has been staggered by 9-11 and ongoing threats of terrorism, plundered by corporate crimes and accounting scandals, deflated by a weakening U.S. dollar, downsized by bad business deals, battered by a tumbling stock market, saddled with rising trade-deficit numbers, hobbled by ailing health insurance plans, wounded by expatriate industrial manufacturing plants and now slowed by the winds of war, as a confrontation with Iraq hovers ominously over the nation's psyche.

All things considered, many electrical businesses would be happy to have flat or even somewhat weakened markets in 2003. Compared to the shellacking some Wall Street industrial and high-tech sector stocks took during the past two years, flat looks good. The outlook for some large corporations is downright frightening.

In the macroeconomic view, some key market-indicator numbers during the last two years have been numbing: the Dow is down 20 percent, the federal deficit is way up, unemployment is up and the GDP (gross domestic product) growth rate is down.

Among all the negative numbers, stands out a single positive sign for both residential buyers and builders: Mortgage rates have fallen to a 40-year low on 30-year mortgages.

It's been said that these are the times that try mens' souls, and at least one electrical distributor is concerned that some electrical companies are not up to the task. “With a weak economy and shrinking margins, some electrical distributors might not be smart in their strategy to weather this storm,” said Jim Warshauer, president, Warshauer Electric Supply Co., Tinton Falls, N.J. “Desperate people can do some stupid things.”

Warshauer Electric cut costs last year by being more selective on lines carried and contractors sold to. “We prefer to work with manufacturers who work with us and who are very easy to do business with,” said Warshauer.

One bright sign of the times: most economists expect that — overall — 2003 will be a better year than the gloomy 2002. McGraw-Hill Construction Group's 2003 construction forecast predicts the U.S. economy will grow about 3 percent in 2003, but expects total construction spending to drop 1 percent from 2002 levels.

Over the past two years, the construction industry has exhibited a split personality, said Robert Murray, chief economist of McGraw-Hill Construction Group, New York.

“On the plus side, single-family housing has been robust, advancing to the point that 2002 saw the highest level of new starts in over two decades,” Murray said. “Public works, supported by elevated contracting for highways and bridges, has maintained the steady growth present at the end of the 1990s. Institutional building, led by the school construction boom, achieved a record high in 2001 and should come close to matching that amount in 2002.”

The hot spots in the Southeast for Hughes Supply Inc., Orlando, Fla., run true with the McGraw-Hill Construction Forecast. Andrew Ott, the company's regional vice president, electrical, is planning for a 2 percent to 3 percent sales increase, with residential and government work, schools, wastewater treatment and roadway lighting being the strongest markets.

However, Ott sees some danger signals ahead. “The general lack of confidence in the economy has certainly impacted new development in general,” Ott said. “High vacancy rates for commercial office space does not bode well for a near-term turnaround for this sector. Tourism, while showing some recent improvement, continues to be soft.”

Gary Baumgartner, president, Baumgartner Electric, Sioux Falls, S.D., and national president of the Independent Electrical Contractors, Alexandria, Va., said the commercial and industrial segments will be the first to recover. “They will most likely see a gradual return because they were definitely hit the hardest by the soft economy. The voice-data-video segment of the electrical industry is continually changing and growing, so it will most likely be a strong segment for our members as well.”

The nation's largest distributor also expects business to improve in 2003. “While we will not see the huge sales jump we saw in 1999 and 2000, nor the industry-wide slump suffered in 2002, we do expect to see improvements and to have a solid performance in 2003,” said Dennis DeSousa, senior vice president, sales and marketing, Graybar Electric Co., St. Louis. “Based on economic data and forecasts, we anticipate growth in education, health care, government and industrial MRO.”

Malcolm O'Hagan, president of the National Electrical Manufacturers Association (NEMA), Rosslyn, Va., said while he believes the construction industry would derive some benefit from an improving economy in 2003, it will also have to deal with several constraints. “The states and the federal government are now under considerable fiscal stress due to diminished tax revenues arising from the 2001 recession,” he said.

FINDING NEW NICHES

Some electrical firms are discovering new market niches to sustain themselves during the downturn. Savvy companies are turning away from their traditional bread-and-butter business toward more specialized areas during this recession.

With more than 60,000 electrical contracting firms nationwide, some electrical contractors are weathering the tough times more profitably than others. Electrical contractors who have been through economic troughs before are simply shifting manpower from markets that have gone south into new market segments. For instance, firms that specialized in Internet data centers during the boom times are turning to commercial data and power rewiring after the short-lived dot-com boom and bust.

Jeff Levy, president of Emcor Group, Norwalk, Conn., the nation's third largest electrical contractor, with 2001 sales of $1.37 billion, said his company has shifted its focus from the commercial sector to the education, health-care, water, waste, and transportation markets.

“We've been able to redeploy the forces,” Levy said. “The contractors who were doing steel mills are now doing power plants, and the ones who were doing office buildings are now doing hospitals. We have the flexibility in our company to move into sectors as they become more active.”

Bob Zamarripa, president/CEO OneSource Distributors, San Diego, Calif., sees municipalities (cities, schools and water districts), aerospace and defense, life science, food and beverage, oil and gas, and industrial electrical contracting as the strongest market segments.

Zamarripa also said an economic slowdown provides opportunity to gain market share. All in all, he is “very bullish” for 2003.

“I am expecting significant growth from our Los Angeles, Orange, and San Diego County regional sales teams. I certainly don't have much optimism from our industrial high-tech manufacturers and OEMs. Additionally, no one is willing to give out turnaround times in these markets.”

On the East Coast, stealing market share has long been the plan at Colonial Electric Supply, King of Prussia, Pa. “In 2002, we actually had 14 percent growth,” said Peter Bellwoar, the company's vice president, sales and marketing. “Of course, the economy isn't growing: We're just taking market share,” he said.

Colonial's business plan and motto is 10/10 — that is, 10 percent growth each year for 10 years. So far the plan has paid off. Last year, Colonial did $90 million worth of business. Bellwoar said commercial construction will be the company's strongest market, followed by residential. He expects the industrial market will again be Colonial's weakest segment.

Stealing market share is also the secret behind W.A.C. Lighting's success. Leonard Schwartz, vice president of sales and marketing for the Garden City, N.Y., manufacturer of custom-designed lighting fixtures kiddingly told his sales reps last year that the company is not going to participate in the recession. “And every one made their targeted sales figures last year,” he said.

Schwartz expects another good year for W.A.C. Lighting because of increased market share — and a still-thriving niche in the upscale residential projects and remodeling. W.A.C. Lighting finished its 2002 fiscal year in November up 20 percent over last year. For 2003, the company forecasts growth to be 29 percent ahead of 2002.

“We're projecting a 15 percent increase in regular business and another 15 percent in new product lines that we're starting in January,” said Schwartz. “We do well with electrical wholesalers, particularly at the counter level. The new products W.A.C. is introducing are toward the specifications side.”

HOUSING GOES BOOM

One New England rep agrees with the economists who say the booming residential construction will stay above the peak years of the 1990s, and that housing will remain one of the few bright spots in the economy.

“We see residential to continue strong as long as the interest rates stay low,” said Gregory Reynolds, president, Flynn and Reynolds Agency Inc., a manufacturers' representative based in Lowell, Mass. “Commercial construction is improving and we hope to see this continue. The low interest rates and the lack of good places to invest money are creating a boom in the residential market for us,” he said.

For the residential sector, the McGraw-Hill Construction Group forecasts single-family housing will ease back from 2002's strong level. McGraw Hill expects housing starts to be down 3 percent to 1.215 million units, which translates into no change in dollar terms. Housing starts in 2003 will still be high by recent standards, 6 percent above the average reported for the second half of the 1990s.

Most businesses that Electrical Wholesaling talked with indicated home sales and new-home construction were near strong levels from a year ago. However, several contacts noted softening during the second half of 2002 in the high-end affluent residential market.

“In my region, the residential segment will probably be the weakest,” said IEC's Gary Baumgartner of Baumgartner Electric, Sioux Falls, S.D. “So far it has been holding its own, but the market for residential construction is starting to become pretty well saturated.”

A DEARTH OF U.S. FACTORIES

Even more crucial to the electrical wholesaling industry and the overall U.S. economy is the health of the industrial market. The good news on the industrial front is new construction of industrial plants is expected to rise 6 percent in 2003 from its miserable 2002 level. The bad news is that 2002 levels were still 26 percent below 2001, and more than 50 percent below the most recent peak in 1997, according to the McGraw Hill construction forecast.

“Every year we think plant construction can't get worse,” said McGraw-Hill's Murray. “This past year it did. Manufacturers are moving production overseas.”

“The industrial segment is where I have the biggest concern,” said NEMRA president Hank Bergson. “I think industrial construction is the linchpin of the economy. It's the heart and the soul of our business. The industrial sector is the engine that drives an awful lot of what we do.

“I don't see industrial business coming back with the vigor that's going to drive monumental growth. Plants close down and then reopen in China — not here in the United States. So the electrical market has become very dependent on commercial and residential construction sectors. If the lack of industrial growth creates job issues and employment issues, then it makes it hard to sustain commercial growth.

“Industrial is the segment that I would love to see come full circle. When we are building industrial centers in the United States, it means that we tend to specify American products, rather than competing with French, German and British manufacturers of electrical products.”

Colonial Electric Supply's Peter Bellwoar also finds the outlook troubling for industrial construction. Although Colonial Electric's business is growing, he expects the industrial market will again be Colonial's weakest segment. “A staggering amount of manufacturing jobs have left the Philadelphia area, and they're not coming back.”

Indeed, NEMA's Malcolm O'Hagan said NEMA sees below-average manufacturing capacity utilization and nonresidential construction continuing to hold down growth in the industrial automation and controls sector as well as those portions of the low-voltage distribution equipment and power-equipment sectors.

CHANGES AND CHALLENGES

When the electrical wholesaling industry emerges from this industry recession, it will be a very different world because of some market forces now at work. For instance, in the New England market, consolidation of electrical distributors has forced at least one rep to change marketing strategies. “We have seen rapid consolidation in New England,” said Flynn and Reynolds' Gregory Reynolds. “This forces us to promote more to the end user so that we can better control our destiny.

“The large corporate buyer is not concerned about the latest and greatest product. He or she is concerned about the returns, rebates and not upsetting the boat in trying a new or different product. This is why we must get the end-user to request the products we sell to get the attention of managers and therefore buyers.”

GETTING READY TO ROLE

Some companies have used the down time to prepare for the economic recovery. For instance, according to Graybar's Dennis DeSousa, over the past year, his company completed its zone warehouse network to ensure customers can get virtually any of Graybar's more than 1.4 million products within 24 hours; and Graybar invested in a $90 million enterprise resource planning (ERP) information technology system.

OneSource Distributors' Bob Zamarripa also said the economic slowdown is giving his company time to refocus on critical strategic objectives, sales growth, customer service, profitability and human resources.

Graybar's DeSousa said if he could get all of his company's manufacturers in one room for 30 minutes to talk with them about working more effectively with his company, he would ask them to provide and maintain accurate and timely pricing data by participating in the Industry Data Warehouse (IDW), to work collaboratively with industry partners to achieve cost reductions and drive inefficiencies out of the supply chain, and to generate brand awareness with end users.

TAXING INDUSTRY ISSUES

Taxes play an integral role in the construction industry. A weak economy means the government collects fewer taxes to fund public construction. Conversely, too many government taxes — such as the Estate Tax (the so-called “death tax”) — can burden small businesses to the brink, further weakening the economy.

Death, taxes and insurance

“Taxes, taxes and more taxes” have become the electrical industry's most pressing issue, said NEMRA president Hank Bergson. “Taxes become a big issue for reps because they impact every other segment of our marketplace. The rep by definition is a very small business. The estate tax is a big issue for our members. Another big issue is access to affordable health insurance. A five- or 10-person manufacturers' rep organization can't buy health insurance like General Motors can. We need health insurance reform, so small associations and their members can offer full insurance plans.”

IEC president Gary Baumgartner also believes repealing the death tax is crucial for his members. “The permanent repeal of the ‘death’ tax remains an IEC priority because electrical companies are frequently family-owned and are particularly hard hit by the full force of the death tax — 55 percent,” he said. “While Congress approved a bill in 2001 that slowly phases out the death tax, that repeal is not permanent. On Jan. 1, 2011, the death tax will return in full force unless Congress makes the repeal permanent.”

Tax-credit for apprentices

Baumgartner, also said one of the most important things any contractor can do during a soft economy is to continue to train its employees, and the association has spent substantial effort lobbying for a tax credit for apprenticeship taxes. He said a bill for tax credit for apprenticeships — known as the Skilled Workforce Enhancement Act (SWEA) — has languished in Congress for the last couple of years due to its $19 billion price tag.

“IEC and several other associations who are serious about passing this legislation are meeting with Bush Administration officials in order to craft an economically feasible proposal,” he said. “We anticipate that legislation will be introduced in both the Senate and the House early in the new year, and IEC will be seeking to attach SWEA to President Bush's stimulus bill.”

The Tax Relief Coalition

“The best way to stimulate the economy is by passing economic-growth and jobs-creation legislation,” said Dirk Van Dongen, president, National Association of Wholesaler-Distributors (NAW), Washington, D.C. “As the Executive Secretariat of the Tax Relief Coalition (TRC), NAW is working very closely with the White House to finalize and move such a package.” (TRC is a coalition of more than 1,000 associations and organizations representing about 1.8 million businesses.) In addition to economic-growth and jobs-creation legislation, the NAW's priorities for 2003 include permanent repeal of the death tax, inside sales reform, and asbestos reform, Van Dongen said.

THE BEIGE BOOK

To see detailed regional market conditions, check out The Federal Reserve Bank's Beige Book online at www.Federalreserve.gov/FOMC/BeigeBook/2003/.

Published eight times per year, the “Beige Book” offers telling district-by-district economic snapshots. Districts include New York, Boston, Philadelphia, Cleveland, Atlanta, Chicago, Kansas City, St. Louis, Minneapolis, Dallas, Richmond and San Francisco.

Each district gathers anecdotal information on current economic conditions in its district through reports from bank and branch directors and interviews with key business contacts, economists, market experts, and other sources. The Beige Book summarizes this information by district and sector.

BOOM OR BUST CONSTRUCTION

Several economists have different views on the future economic fortunes of the construction market.

Robert Murray, chief economist of McGraw-Hill Construction Group, New York, believes the current economy is beginning to look similar to the jobless recovery of the early 1990s, with firms continuing to cut costs and postpone additions to staff. “Assuming employment growth remains tepid through 2003, there will be little growth in the demand for commercial space, and little incentive to pick up the pace for commercial construction,” he said.

Demand for cement, another construction barometer, is literally the foundation of future construction. Ed Sullivan, chief economist for the Portland Cement Association, is urging his member groups to “add an extra dose of caution into its 2003 plans.” Sullivan believes the total construction market will decline significantly in 2003, despite gains in residential and public sector construction activity, with a recovery not expected until mid-2004.

Ken Simonson, chief economist, Associated General Contractors, Washington, D.C., said the next several months will be very uneven for construction. He believes construction related to consumer activity will remain strong, and business-related construction will pick up gradually in 2003. However, he expects government-funded projects to diminish once current jobs are completed. Simonson believes employment and value put-in-place are two key indicators of construction-industry health, and said both factors are relatively flat in construction nationally. Supporting this view, the U.S. Census Bureau recently reported that nationwide construction put in place for the first eight months of 2002 was virtually unchanged from the same period of 2001.

In the industrial market, one promising piece of news for manufacturers is that inventories reached a 20-year low in November 2001, which should spur demand for manufacturing. “Manufacturers tend to be confident that once the economy improves, so will their businesses,” said David Huether, the chief economist of the National Association of Manufacturers (NAM), Washington, D.C. “But the manufacturing sector, in general, has been hit harder by the current recession than the overall economy and will probably be slower than the general economy to recover.”