The recession lasted much longer for electrical distributors than the vast majority of other businesses. Although the recession hit the overall economy in 2001 and was finished by 2002, distributor sales were negative in 2001, 2002 and the first three quarters of 2003.
In effect, electrical distribution lags the overall economy (GDP). Gross domestic product includes not only what consumers spend but also what government spends and what business spends. In addition, the United States must net out the difference between what is bought from the rest of the world and what the rest of the world buys from our country. These indicators do not all move in the same direction at the same time.
The crucial indicator for the electrical industry is what business spends. Distributor performance is driven by a few broad business investment indicators that themselves lag overall economic performance.
Although GDP, led by consumer spending and government spending, was already positive in 2002, the important investment indicators for electrical distributors were still pointing south. Often distributors and vendors focus on indicators that really don't have much influence on the electrical industry — automobile sales or consumer confidence, for example.
These are interesting indications of the health of the economy, but they don't do much for the electrical distribution industry. If you are going to track distributor performance on the basis of indicators, be careful to watch the indicators that really make a difference to the electrical industry.
For the distributor served industrial market, keep your eye on the index of industrial production. As it increases, expect the distributor-served industrial market to follow suit. It's not a one-for-one match, but the direction is important.
Also look at new orders, especially new orders for capital goods. Again, it's not a one-for-one match, but the direction and rough order of magnitude of percent change is informative. These are only two; there are others.
What are the lessons the electrical industry should learn from the recent recession?
First, total industry sales nose-dived badly because of poor performance in two major segments — the industrial and the contractor. At the same time, the distributor served institutional market was comparatively stable. Although the industrial market declined by double digits in 2001, the institutional market was up 2 percent.
In 2002, the contractor market fell at a double-digit rate and the industrial market continued to decrease at a high single-digit rate. The institutional market declined only 2.5 percent, and that was the only year it declined throughout the recession.
We can drill deeper and look at quarterly performance. For first-quarter 2002, the very depths of the recession, total industry sales were down nearly 12 percent. The contractor market was down 14 percent, the industrial market was down more than 15 percent, and the institutional market decreased a relatively mild 3 percent.
By the end of 2004, the contractor and the industrial markets had not yet recovered to pre-recession levels, but the institutional market had exceeded its pre-recession level.
The conclusion is clear. There are benefits to having a service capability in the distributor-served institutional market. It's not as volatile as the other major market segments. That makes a lot of sense when you consider segments included in the institutional market — schools, hospitals, government, retail businesses, etc. — all served directly by distributors, not through contractors. These are a heterogeneous mix of customers less affected by the vagaries of the economy than the contractor or industrial markets.
But does it have the legs to grow in good years as the other markets have? DISC Corp.'s analysis shows that over the five-year period between 2003 and 2008, the total electrical distributor industry is expected to average annual growth of 5 percent. The contractor market is expected to average 4.8 percent, the industrial market is expected to average 5.5 percent, and the institutional market is expected to average 4.8 percent annually. That's not a bad expected performance.
Hedging your risks by developing a service capability in the institutional market could be a wise investment. There will certainly be another downturn. Consider opportunities in the institutional market; the margins can be very good. On the down side, the institutional market is a fragmented market that can be expensive to serve, but good marketing skills go a long way to dealing with that barrier.
What else did we learn about the recent downturn? First, although the contractor market got clobbered, those distributors serving the residential market fared well. The distributors heavily into large project construction felt a lot of pain, especially those serving the commercial construction and industrial construction markets.
Nonresidential and residential construction are highly volatile sectors. If you are wedded to them, there will be times you will make money and there will be times you will lose your shirt. That's the nature of the beast. Distributors and vendors who find a way to balance risks will suffer less pain over the course of the business cycles.
Right now, we're riding high. The outlook for the next two years is for smooth sailing. Perhaps there is not much incentive to prepare for the next downturn, but if not now, when?
Last fall DISC projected industry sales in 2005 to increase about 8 percent but could easily defend an increase of as much as 10 percent. This could be a bit too robust, though, so DISC's current forecast is for growth in the high single digits, 8 to 9 percent for 2005. In 2006, DISC expects industry sales to increase 6 percent. The adjacent chart shows the industry experience over the course of the recent cycle and DISC's outlook through 2006 in current dollars and in deflated dollars.
Herm Isenstein is president of DISC Corp., Orange, Conn., a leading industry market analysis and forecasting company. He can be reached at (203) 799-3673 or [email protected].