HOT TOPIC #1: Where's the economy heading?First and foremost, everyone in this industry wants to have a sense of where the marketplace is heading in order to make wise investment decisions with regard to inventory, personnel, equipment and in some cases, acquisitions.
The business media is filled with economic forecasts. If you examine them closely, you’ll find that they basically extrapolate today’s trends into the future. That works okay until something completely unexpected comes along to change things. It may be a geopolitical event, a natural catastrophe or a sudden cultural shift that nobody saw coming. You can’t plug a 9/11 or Hurricane Katrina into an econometric model.
Mindful of these uncertainties, let’s take a look at where we stand today and see what they might mean for the months ahead.
I was surprised to review the latest CIPH statistics and see that the membership’s PVF sector reports only a modest 3.7% sales increase year-to-year through September. In the United States, PVF distributors are enjoying some of the greatest times in recorded history.
After a three-year slump, U.S. PVF distributors saw sales jump a whopping 17.4% in 2004. That was followed by a 13.2% gain in 2005, according to the annual Operating Performance Report study of ASA. Some of that is due to price escalation, but incremental sales growth also has been strong.
I don’t have numbers for 2006, but all of my indicators suggest another bullish year for ASA members. The main indication is that you need a wire brush to wipe the smiles from these guys’ faces.
An explanation I’ve received for the weak CIPH performance is that your PVF membership tends to be from the eastern part of your country, where economic conditions are not as robust as they are in the West. Alberta and British Columbia are booming with energy-related projects, so your statistical data probably would look a lot better if it had more input from PVF distributors out West.
Outside of oil and gas country, the fortunes of the PVF industry are closely tied to that of manufacturing. In reading up on Canada’s manufacturing economy, I notice a similar theme that I encounter in my home country. The popular press tends to focus on jobs rather than production. From that perspective, both Canada and the United States are leaking manufacturing jobs at a disturbing rate.
This trend will continue. Decent people sympathize with the human pain of job loss, but it’s quite clear that the only way for your nation and mine to compete in the global industrial marketplace is to reduce the labor content of manufactured goods.
This doesn’t mean manufacturing is dead in either the U.S. or Canada. It simply means that our advanced economies employ automation to perform tasks developing nations do with cheap labor. From the standpoint of the industrial PVF community, that is good news. Automated plant processes consume large amounts of pipe, valves and fittings.
Canada’s energy sector looks like it will be booming for as far ahead as anyone can see. Energy production has been notoriously cyclical, but with energy demand burgeoning from China and India, the writing on the wall suggests the peaks in the future will be higher than ever and the valleys much shallower.
Manufacturing is more problematic. I suspect the current sluggishness in Canadian industry stems in large measure from manufacturers going offshore to China and other Third World locations.
HOT TOPIC #2: GlobalizationThis globalization is another hot topic of conversation everywhere I turn. China in particular stands as the boogeyman to many industrial interests.
China faces a massive problem trying to provide employment for its 1.3 billion population. According to one scenario, they have no choice but to continue moving full steam ahead as an industrial juggernaut.
A lot of China’s manpower and infrastructure investment is currently devoted to putting its best face on for the world during the 2008 Summer Olympics. What will replace the Olympics as a focal point for all that manpower and investment beyond 2008? It’s scary to think of China ramping up its industrial base even more with the resources currently devoted to the Olympics.
That’s the yin. There’s also the yang I’m picking up about China’s future direction.
This scenario holds that the Chinese economy is overheated and they have to slow down. In fact, the Chinese government has taken some tentative steps to do just that. Besides inflation, there’s another big problem stemming from China’s cowboy capitalism. It has taken an enormous toll on that nation’s environment and on the health of its citizens.
In the last few years, the Chinese government has finally recognized environmental degradation as a serious national problem and has taken steps to correct it. But that’s awfully hard to do and still provide a living for more than a billion people.
Strange as it may sound, China has recently begun to face labor shortages. Their astounding industrial growth has been fueled by the migration of peasants from the underdeveloped interior, coming East to the coastal regions where most industry is located. Even with that massive infusion of labor, China’s manufacturing economy has been smoking at a faster rate than jobs can be filled. This is leading to higher wages and manpower shortages in certain areas.
HOT TOPIC #3: Knockoffs/Product qualityProduct quality and knockoffs are somewhat different issues, but they generally get discussed in the same breath. Counterfeiting - mostly from China - steals an enormous amount of money from various consumer goods industries. Many PVF manufacturers have discovered their brands being falsified as well.
The Chinese government pays lip service to cracking down on counterfeiting and the theft of intellectual property. A recent court ruling in China favors foreign businesses in protecting their rights. However, it remains to be seen just how serious the authorities will be in implementing the court’s ruling.
Although China has liberalized economically, it still is run by an authoritarian regime. To them, the rule of law is secondary to what the Communist Party determines to be in the nation’s political and economic interests. All evidence suggests that they see it more in their interest to wink and nod at counterfeiting than take serious steps to prevent it. The Chinese government showed all too vividly at Tiananmen Square in 1989 that when they really want to put a stop to something, they can.
Counterfeiting is a blatant violation of economic justice, but not something most PVF buyers encounter every day. A bigger concern is the day-to-day quality of the flood of goods coming from overseas producers all over the world. This isn’t to say it’s all junk. I’m told the quality of imported PVF ranges from A to Z. It’s critical to make sure that the products you buy and sell are close to the front end of the alphabet.
Many industries face this problem, though the stakes are higher with industrial PVF than most other product lines. Your products convey some of the nastiest fluids and slurries known to mankind, and at scary pressures and temperatures. Positive material identification is expensive and time consuming, but it’s never been more important.
HOT TOPIC #4: Commodity pricesMaybe the most prevalent topic of conversation among PVF people is the price explosion in certain commodity metals, especially stainless steel.
What we are witnessing, of course, is classic supply and demand economics. Global demand for these products has risen enormously thanks to growth in demand from China and India in particular.
According to the International Stainless Steel Forum, this year’s global stainless consumption is likely to increase 14.3% over 2005. The same group pegs global stainless production to increase 8.6% this year. That’s a pretty strong pace, but still lags far behind the consumption increase. Demand can increase virtually overnight, but you can’t ramp up mining and production facilities that fast.
Production is increasing, however, and is bound to go up ever faster as prices escalate to the point that investors salivate. In the short term, stainless steel prices look to be moving even higher - due mainly to an unprecedented hike in the price of nickel during October. This gain will lead to alloy surcharges in December and January and push selling prices to their highest level ever. This is according to MEPS, a British firm that tracks the global metals marketplace. One manufacturer recently told me that his surcharges on certain raw materials sometimes exceed the base price.
MEPS expects stainless prices to start declining by mid-year 2007. There are, however, widely differing views from analysts about the price of nickel and subsequent impact on stainless prices.
Now let’s acknowledge one of our industry’s dirty little secrets.
Rising commodity prices aren’t an entirely bad thing for PVF manufacturers and distributors. You folks make your living on gross margin dollars, so as long as you can maintain gross profit margins, the higher the price, the more you make.
That being said, I don’t find many PVF distributors jumping for joy at the wild price escalation of the last couple of years. It’s because a great deal of headaches accompany the theoretical increase in gross margin revenues.
First, it’s not a given that you can pass along the price increases to all customers. Sometimes you have to absorb the hit or part of it.
Second, it raises hell with regard to contracts and bids. In today’s world, escalation clauses have to be negotiated for periods measured in weeks or even days.
That’s when you can get away with it. Customers aren’t always sympathetic. Some take a “that’s your problem” approach.
Some PVF people have voiced concern to me about the possibility of large projects being canceled because of materials price escalation that busts the budget. This isn’t likely to happen due to PVF alone, because PVF usually constitutes only a small part of total project cost. But there have also been dramatic price increases in construction materials ranging from concrete to copper to structural steel. At some point, construction owners may start getting cold feet.
Even more troublesome than skyrocketing prices have been periodic spot shortages, extended lead times and allocations. The Catch-22 of this situation is that manufacturers need better information from distributors about sales projections so they can better plan their production. At the same time, distributors who are uncertain about their suppliers are likely to be even less cooperative while they look for alternative sources to protect their interests.
The surge in raw material prices also has led to major disruptions in inventory management. More dollars spent on one commodity means fewer dollars available for other products. EOQ formulas get thrown out of whack and speculative buying increases, which only serves to drive prices still higher.
I don’t know if the practice is widespread, but I’ve heard at least one PVF manufacturer talk of buying back inventory from distributors where it’s lagging on the shelves, in order to supply other customers who are in short supply.
In summary, the headaches of price escalation probably outweigh the advantages. I think most of you in the PVF business yearn for a boring period of price stability.
And while we’re at it, let’s dream of world peace.
HOT TOPIC #5: Industry consolidationIndustry consolidation is another hot topic that crops up just about every time people in this industry gather. There was about a five-year lull during the late ’90s and early 2000s when acquisition activity cooled off, but it’s sure heated up again.
We’ve certainly seen it with steel makers. A couple of months ago IPSCO bought NS Group in a deal worth a reported $1.46 billion U.S. dollars. Just a few weeks ago, The Carlyle Group, which owns Wheatland Tube, added Atlas Tube to its holdings. These combined companies will have more than $2 billion in annual revenues.
Then there was this year’s blockbuster deal in which The Home Depot took over Hughes Supply. Home Depot Supply - recently renamed HD Supply - is now a $12 billion company, although that’s spread out among various product sectors.
I continually get asked what they’re up to. I don’t think even Home Depot knows, except in the broadest sense that it’s part of their quest to expand trade sales to compensate for their saturated and declining retail market. HD Supply is plenty big, but I don’t know how many synergies exist with all the product sectors represented under that banner.
At the ASA Convention in Chicago last September, an acquisitions specialist named Brent Grover of Evergreen Consulting put on an interesting seminar in which he identified distribution as the fifth most active industry for deals during 2006. He said there were more than 80 private equity firms chasing distributors, and they are offering previously unheard of prices.
This included an outlandish 12 times ebitda in the Hughes deal, and up to eight times ebitda for many other firms. He said these are much higher prices than were being offered in previous spurts of consolidation.
Grover said present economic conditions are such that financial buyers - those looking to make money on the turnover - are paying as much as strategic buyers, such as Ferguson, that are looking for operational growth or improvement.
This hasn’t been the case in the past, and it may not last for long. I think a lot of U.S. distributors are seeing a window of opportunity to get big bucks for their companies and are taking advantage of it. That window may already be in the process of closing for companies tied to the slumping new housing market. The PVF business continues to sizzle on the U.S. side, but nobody with a lick of common sense expects that to last forever.
Over time, I expect consolidation to continue, although with stops and starts in phase with the economic climate for acquisitions. Most other distribution industries - groceries and pharmaceuticals are two prime examples - feature large concentrations of market share by a handful of distributors.
The plumbing & PVF sectors still have a long way to go. Ferguson is still the largest plumbing/PVF distributor in our industry. A couple of years ago I heard former Ferguson President Chip Hornsby, who has since moved on to head Wolseley, say that his company claimed only 12-15% share of the markets they serve. That may be closer to 20% with subsequent acquisitions, but still leaves a lot more business to be gained by them and the other big chains. So I suspect the acquisition binge will continue to play out for many years to come.
Let’s keep all this in perspective. Consolidation does not have to mean death for savvy independent distributors.
They will be around serving market niches and earning business through superior service and the ability to make decisions without vetting everything through an army of corporate advisers.
Plus, buying groups help even the smallest distributors stay close to the big boys in pricing.
Also, I’m pretty sure the manufacturers out there don’t want to see the market dwindle to a handful of distributors telling them when and how high to jump.
From a certain perspective, consolidation can be viewed as a blessing for independent distributors. That’s because it provides exit opportunities for those who are looking to retire or do something else.
HOT TOPIC #6: Increasing velocity of businessA few weeks ago I came across a study done for the National Association of Electrical Distributors. The study assessed distributor service offerings, and one section asked customers which services they would most like to see. The highest ranked were:
- Same-day delivery, 86%.
- Emergency delivery within two hours, 73%.
- Immediate credit on warranties/returns, 71%.
- Early-morning delivery, 70%.
Look at those priorities. “Same day…two hours…immediate…early morning” - customers don’t seem to regard patience as much of a virtue nowadays.
This ties into another program I attended at the 2005 ASA Convention in Orlando. It was a panel discussion by three mechanical contractors who told of their needs and frustrations in dealing with wholesalers.
The dominant topic of discussion in that program was what one of the participating contractors called the increasing “velocity” of his business. He said more and more of his jobs are being awarded on a design/build basis, and that sometimes they begin jobs even before the design is finalized. He may not have a total bill of materials to present to a distributor. He might only have square footage and a rough vision of the final project. When it finally takes shape and he can identify exactly what materials he needs, he needs them lickety-split.
Here’s a direct quote from this contractor: “Our response time continues to shrink while the supply side is not keeping up. I realize you distributors can’t have everything we need on the shelf, but you must find a way to execute faster.”
This is a dilemma to be sure, but also an opportunity. The essence of marketing is to identify customer needs and fulfill them. This customer was telling distributors what he needs - faster execution, whether that means pulling goods from a warehouse shelf or getting them into his hands quickly from someplace else.
Other things the contractors on that panel kept emphasizing were their need for quick and easy technical support, fewer mistakes and better documentation.
This tells me that distributors are not just in the merchandising business anymore. You are also in the information business. Coming up with the answers your customers need, when they need it, is becoming as important as getting the materials to them on time.
Whether you are part of a large chain operation or a small independent distributor, if you are able to deliver the goods and supporting services in a timely fashion, you will do just fine in the future.
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