These are scary times because we are aware that it's going to be tough sledding ahead, we have just begun the ride and we don't have a clear picture where it is going to end. It's not your usual run-of-the-mill downturn, and from this point on we think the worst is yet to come. But let me add a little perspective.
Downturns come along about every 10 years in the construction industry — this one is a little early and is caused by some unusual circumstances — but it is something that the industry is used to. One can't tear up their medium- and long-range business plans because of a short-term bump in the road. What I am saying is, manage in the short term but continue planning for the long term. It's like any emergency — cool heads prevail and will be the heroes when the troubles pass — and they always pass.
Just about everyone agrees the economy is in dire straits. That kind of consensus can hardly be called good news. It would be nice to see a few contrarians. All of the important economic indicators are clearly pointing to a significant downturn. Just how significant depends on what industry we are in. By important indicators we mean jobs in the construction industry and jobs in the industrial sector. We see industrial production heading south, and on top of the dismal residential market we now see commercial building going south as well.
I want to separate the recession in the overall economy from the recession in the electrical industry. DISC believes this downturn will hit the electrical industry more forcefully than any we have seen in the last 35 years. That was so long ago I wonder how meaningful the comparison is. But what I do think is meaningful is what happened in the last industry recession compared with the current recession.
How have we fared since the trough of the last electrical industry recession? We are coming to the end of this cycle in the electrical industry and it's important to see what this cycle actually looks like so we can get a better grip on the coming recovery.
Total industry sales, measured from the trough of the last industry downturn to the expected trough of this downturn, will be almost 20 percent higher than in 2003 (see chart 1).
The peak of this cycle will be in 2008 which we expect to be nearly 35 percent higher than the trough in 2003. The bottom of this cycle for total industry sales will be 2009 and it will be nearly 20 percent higher than the trough year of 2003. That is to say we have grown only 20 percent, cumulatively, from the bottom of the last recession to the bottom of the current recession.
We have yet to fully deal with the current downturn but I think it's important to look ahead to the expected recovery which I believe should be part of your own planning cycle.
One of the burning questions is how fast will the industry recover compared with the last recovery? The first year of recovery according to DISC will be 2010 and we expect a slow start out of the gate.
In the last recovery in 2004, industry sales grew a slick 6.3 percent. By contrast we are only looking for a 1.5 percent increase in the first recovery year of this cycle in 2010.
If we peel back from total industry sales, we can measure sales in the distributor-served contractor market from the trough in 2003. The contractor peak will be 2008 and this market will show sales nearly 37 percent higher than the 2003 trough — a few points higher than total sales. The bottom here, however, will be sharper than the total sales downturn, and contractor sales will bottom out a year later than the total industry sales (see chart 2).
So while total industry sales will be increasing in 2010, contractor sales will just be finding its low point. The contractor bottom will occur in 2010 and will stand only 12.7 percent above the 2003 trough (versus a total sales increase of nearly 20 percent).
Now for some good news, if you can stand it. In 2011 (which is an eternity from 2008 and not shown on the above chart), the very first year of recovery in the contractor market segment, we are forecasting the distributor-served contractor market to increase more than twice as fast as the previous recovery. The numbers are 9.4 percent growth in 2011 compared with 4.5 percent in 2004.
The distributor-served industrial market according to our analysis peaked in 2007 when it stood more than 38 percent above the 2003 trough. The bottom of the distributor-served industrial market is expected to be 2009, at 26 percent higher than the 2003 trough.
In trying to be optimistic, here's another piece of good news. We are looking for the industrial market to advance twice as fast as the gain in the total market in its first recovery year, 2010. We are looking for 3 percent growth in the industrial market versus 1.5 percent growth in total industry sales.
That's an opportunity if I ever saw one. Nevertheless, the industrial market will not recover as fast this time as it did last time around — 3 percent this time versus 8.6 percent last time.
I want to turn to the reasons why our numbers are what we say they are. It all goes back to the key economic drivers of industry sales: residential and nonresidential construction spending and business investment.
It's not a great scenario but it is what it is and it is a given. We cannot influence these drivers, but we must learn to deal with them in some way (see chart 3, page 50).
From here it is a short step to our forecast for next year and the recovery beyond (see chart 4).
To cut it a bit closer, we expect the second half of 2009 to decline more than the first half of the year. Look for total sales to decrease about 7 percent in the first half of 2009 and about 14 percent in the second half of 2009 from the year-ago periods.
In summary, regardless of how we slice it the economic outlook for 2009 presents serious issues for electrical distributors, electrical manufacturers and independent reps.
The chances are nil that we will escape an industry downturn in 2009. Moreover, the weakness in the economy has eliminated any concern about inflation. For the electrical industry, price is a non-issue. Expect thin margins and negative industry sales growth in the major market segments served by distributors.
One last point that needs to be made: You have all been here before and you have managed to move forward. Taking share will not be easy in this environment so you will need more than just another plan or program to take business from your competitors. You will want to try to maintain profitability, so recognize the importance of improving your productivity. This means combining your employees' skills with improved technology and generating more output per unit of input.
In determining your productivity, the key measure is how it changes from one year to the next, or one quarter to the next quarter. It's easy to be misled by a simple dollar-per-employee ratio, so you must remove the effect of inflation. Otherwise, you will be measuring a lot of inflation in your equation, and your business is not to measure inflation in determining your ROI.
Here's what I mean. If you measure a simple dollar-per-employee ratio for the electrical industry, you will get $481,676 per employee in 2006, or a change of 7.4 percent from 2005. But if you remove the inflation, the change in average productivity is 5.9 percent. That's a full 1.5 points difference and it's a significantly different number.