2007 economic outlook

Commercial construction remains strong, manufacturing to continue making gains

by Clair Urbain and Rich Vurva

Distributors serving the industrial and construction markets have good reason to believe the healthy business climate they experienced this year will continue into 2007.

After a string of years of solid construction growth, analysts are predicting no slowdown, and in many cases, even more growth in commercial construction jobs. Likewise, analysts say the manufacturing sector should continue to show strong growth in the coming year, with some predicting output will outpace the overall economy.

An exclusive survey of Progressive Distributor readers confirms this trend, but also highlights top concerns distributors have in the coming year.

According to our readers who answered a recent survey, 54 percent indicated that business will increase between 10 to 15 percent next year, with 20 percent saying their business will grow by more than 16 percent in the next 12 months.

Progressive Distributor magazine staff members have poured over statistics, talked with readers like you and visited with market watchers.

Based on that input, here’s how we look to see 2007 shaping up:

Construction overview
Analysts agree that single-family residential construction will soften in the remainder of 2006 and into 2007, but commercial construction will pick up the pace, replacing residential work with commercial work.

“The 2006 U.S. construction market amounts to $1.2 trillion, of which single- and multi-family residential construction accounts for just over $642 billion. That’s half of the construction market,” says Heather Jones, construction economist at FMI, a leading consultant group to commercial contractors and the construction industry. “Our statistics show that as residential construction tails off, commercial projects will pick up the slack, resulting in a 5 percent increase in total put-in-place construction in the U.S. in 2007. Our forecast for non-residential is 8 percent in 2006 and 9 percent in 2007.”

Ed Sullivan, staff vice-president and chief economist at the Portland Cement Association, sees an even brighter picture for non-residential construction in 2007. He predicts a growth rate of 8.5 percent, up from 6.4 percent in 2006 and only 1.5 percent in 2005. “The non-residential market turned in 2005 after five years of decline. But despite the large percentage gains for 2006, most markets could still be considered weak from a historical perspective,” he says.

Jones concurs. “Industrial/manufacturing construction is a good example. It has come alive again, but the numbers are deceiving. When compared with past years, it has grown 22 percent in 2005, 14 percent in 2006 and is projected to grow another 12 percent in 2007. However, the percentages are driven by numbers resulting from extremely low volume in 2005. It will take solid growth through 2007 to get anywhere near the volume set in the ’90s. Much of this work is revamp/rehab work in existing facilities and for heavy industrial projects,” she says.

Manufacturing overview
On the manufacturing front, analysts say productivity gains should continue their upward trend next year. Over the past 12 months, manufacturing output has risen by 5.9 percent, the fastest 12-month pace in nearly two years. Computers and electronics, and primary metals products segments are the fastest growing sectors.

At $1.5 trillion, manufacturing made up 12 percent of the economy last year, virtually the same as the year before. This is the first time in seven years there was no significant erosion in manufacturing’s share of the economy. Analysts expect the strong recovery to continue into 2007.

Dave Huether, chief economist for the National Association of Manufacturers (NAM), expects growth next year but warns that it may not match the gains seen in 2006.

“In manufacturing in the next year or so, you’ll see a bit slower growth than the 5 or 6 percent we’ve seen in the last couple of years. But I think we’ll likely still see manufacturing output outpacing the overall economy,” he says.

Manufacturing gross domestic product (GDP) increased 4 percent last year, faster than the 3.5 percent pace of the overall economy. Most of the increase was in durable goods sectors, where GDP increased by 5.7 percent. Non-durable manufacturing grew a much slower 1.6 percent.

Industrial distributors have watched with great concern while manufacturers moved production offshore over the past decade. The loss of manufacturing jobs has a domino effect on suppliers who provide workers with tools and equipment they use on the job.

Although he expects the offshoring trend to continue, Huether says there’s reason to believe it may subside a bit. He points to the fact that U.S. goods exports have risen faster than imports over the past year. U.S. exports increased by 8.5 percent over the last four quarters, compared to a 6.2 percent rise in imports. Over the past 12 months, exports have outpaced imports in every product category (capital goods, consumer goods, industrial supplies, autos, and foods and beverages).

“That’s a reversal of a trend that started in the late 1990s. I think you’ll still see U.S. manufacturers moving overseas, but that’s less of a phenomenon of finding a cheaper labor market to produce products to send back to the United States, as opposed to investing in high-growth markets overseas to serve customers in those markets,” he says.

Money supply/interest rates
While the economy is chugging along, inflationary pressures have market watchers at the Federal Reserve Board concerned. According to Ken Simonson, economist at the Associated General Contractors, the inflation level in the general economy is 3 to 4 percent, but building materials costs have increased nearly 8 percent and transportation costs have gone up 16 percent.

This is spurring the Fed to increase prime interest rates, and the general consensus believes the economy may see the prime lending rate touch 6 percent next year. This will further dampen residential work, but commercial work will continue barring any unforeseen event, the economists predict.

The economists generally believe inflationary fears will ease and business growth will slow enough by the second half of 2007 that the Fed will ease up on interest rates. This should keep the fire cooking under the economy without it boiling over to feed inflation into 2008.

“Keep in mind the U.S. construction markets do not lose momentum with rising mortgage rates and a slowdown in housing. Growth in non-residential construction is a sign of a growing, strong economy,” says Sullivan.

Materials availability/cost
Get used to higher prices for building materials. Experts across the country see strong world demand and increased shipping costs affecting supply and boosting costs for most building supplies.

“Building material costs are increasing but generally are leveling off. Look at this being a new plateau. I don’t see them coming down,” says Jones.

Cement availability continues to be an issue in many parts of the country and will be a concern in 2007, says PCA’s Sullivan. “Cement consumption will grow in excess of three percent of the record consumption in 2005. Tight market conditions will reappear in 2006 and 2007 as plants are operating at high rates, inventories are lean and our dependence on imports increases,” he says.

Lumber is one building supply that has tempered its price increases. “Prices have opened up some as a tariff on Canadian lumber was reduced, which has increased supply. Lumber prices have gone down in the near term and should remain stable through 2007,” Jones says.

AGC’s Simonson reports double-digit price increases in several building supplies, and that contractors and building owners should get used to it because it may level off but won’t drop to past levels. “Get used to higher materials cost inflation. The average Producer Price Index (PPI) for construction materials jumped 7.8 percent from June 2005 to June 2006. Material costs reached as high as 16 percent for highway construction. We’ve also seen increases as high as 87 percent for copper and brass mill shapes, 48 percent for asphalt, 40 percent for diesel fuel, 26 percent on gypsum products, 18 percent for plastic construction products and 15 percent for cement. I expect a few of these increases to level off as the housing market cools, but most are tied to strong U.S. and world demand for materials and freight transportation.

Worker availability
All sectors of the construction industry are concerned about finding qualified labor as the market improves in 2007. The present workforce is getting older and replacement workers aren’t coming up through the ranks in great enough numbers to meet coming demand.

“Unemployment remains low, worker availability is low and labor rates are increasing. Some believe that as residential housing slows, it will free up more workers for non-residential and commercial work, but not all skills and trades are transferable. That’s why we believe the unemployment rate will rise to 4.9 percent in 2007,” says Jones.

The U. S. Department of Labor Bureau of Labor statistics report job opportunities in the construction field will remain strong for experienced workers. As demand increases and the labor supply stays the same, wage rates will increase, especially for more experienced workers who already are paid higher than average wages. Plumbers and electricians are two groups most affected by this trend, says Randy Giggard, manager of market information at FMI.

In fact, the concern for construction labor is so great in hurricane-damaged areas that the Biloxi suburb of D’Iberville, Miss., is courting China-based construction companies to import Chinese construction workers to build shopping malls, condominiums and casinos in a city where 35 percent of the real estate was damaged by Hurricane Katrina.

Given the debate over immigration and American labor law constraints, this may be a difficult undertaking, but is a sign the lengths that developers and others are considering to meet the looming labor shortage.

The firms, which propose to partner with private developers in the U.S., plan to use Chinese materials to avoid paying higher post-Katrina prices for American materials.

To a large extent, Latino workers are filling the gap of needed workers. Sources report that as much as 45 percent of the workers at some nationally based construction companies are Hispanic. However, growing sentiment to make sure these workers are registered aliens could greatly affect worker availability and increase labor costs for those contractors who rely on short-term workers or day laborers to get their portion of the project completed.

The national workforce is also aging. By 2012, workers aged 55 and older will increase from 14.3 percent to 19.1 percent of the total labor force.

Manufacturers hired back some of the workers let go during the recession that began in 2000. Over the past 10 months, production employment in manufacturing has risen by 171,000, the best performance in eight years, while non-production employment fell by 117,000. Manufacturing employment currently stands at about 14.2 million, which is still about three million workers less than in the mid to late 1990s.

“I expect to see employment grow a little more in the next year. The interesting thing that has been happening over the past year is that growth has occurred among production workers, the people working on the plant floor. The employment rate among non-production workers has been falling and continues to fall,” says Huether.

He says most of the employment gains in manufacturing have been in four industries: non-automotive transportation, computers and electronics, machinery, and fabricated metals.

“If you look at the last recovery in the mid to late ’90s, you had growth of production and non-production workers. But basically the overall changes in employment going forward will be miniscule. You’re not going to see a significant recovery of the workers lost four years ago,” Huether says.

What it all means
As long as the economy continues to grow, distributors can expect to see good business opportunities in the year ahead. But competition will remain tight.

According to participants in the Progressive Distributor reader survey, keeping existing customers and finding new customers top the list of their biggest business concerns.

As domestic manufacturers in North America continue to look for ways to improve efficiency and lower their costs in order to better compete in a global marketplace, they will look to their suppliers for assistance. They are requiring their distributor suppliers to perform functions such as MRO tool crib inventory management, procurement functions, bin filling and other daily tasks that were historically performed by their own personnel.

Manufacturing and construction customers also continue to use practices such as lean manufacturing and construction techniques, vendor consolidation and product standardization to create economies of scale in order to achieve a lower price on commodity items consumed on the plant floor and the job site. In some cases, these consolidation efforts enable manufacturers and contractors to procure a wider range of products from a single distributor. Customers also expect their preferred distributor suppliers to introduce new technologies and new products that can help them improve their productivity or lower their costs.

Distributors will be asked increasingly to produce documented proof of the value they bring to the end-user. Distributor salespeople are finding that it is becoming more difficult to gain an audience with the end-user customer. Product peddlers are seldom welcome on the plant floor and find it virtually impossible to develop relationships with customers at the executive level.

As customer procurement practices become more sophisticated, it will require greater sophistication on the part of distributors.

This article originally appeared in the September/October 2006 issue of Progressive Distributor. Copyright 2006.

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