Implications from the China Syndrome

The manufacturing decline and its effect on North American distribution.

by Scott Benfield

The decline of manufacturing, especially in this election year, is well known. Approximately 2.7 million jobs have been lost in the past 3 1/2 years in the manufacturing arena. Many of these jobs were part of an overall employment decline in manufacturing, as productivity increases were responsible for job losses in manufacturing worldwide. However, many of the lost jobs were a direct result of North American corporations moving plants to China, Mexico and Eastern Europe to take advantage of lower labor costs.  

The decline of manufacturing and its exodus abroad has had a negative effect on distributors serving industrial markets. The overall effect of the offshoring of manufacturing on industrial distributors, however, has not been quantified until our research project on the subject (The China Syndrome and the Effects on Wholesale Distribution). In this article, we will revisit the major points from the China Syndrome and what distributors are doing about it.

A shrinking market
The research on the China Syndrome covered more than 20 different manufacturing industries across 10 different vertical wholesaler markets. Close to 60 percent of the respondents listed their occupations at the executive level; the remaining respondents were in sales functions.

For industrial distributors, the upshot of the research indicates the exodus of U. S. manufacturing to foreign shores is expected to continue well into the future. Respondents saw no abating of the trend, and the loss from manufacturing decline was estimated at 20 percent of the overall decline of business from 2001 to 2003. In short, if the predictions are correct, a declining market for industrial distributors is expected to continue well into the near future.  

The shrinking market is a major reason industrial distributor profits have been at all-time lows. Depending on the vertical industry, distributor profits as a percent of sales are 60 percent to 25 percent lower than they were at their peak in the go-go decade of the ’90s. Based on the survey, 93 percent of industrial distributors agreed or strongly agreed with the statement “manufacturing will continue to move out of the U.S. and there will be an overall decline in market size.” When coupled with an 85 percent agree/strongly agree response to the statement “there will be an overcapacity of wholesalers serving industrial manufacturing,” the idea of a shrinking market is a reality with a future. While future predictions are not always reliable, the fact that respondents are industry veterans with executive level experience is impressive and, as such, should leave an impression on those in industrial markets to change.

Can the decline be predicted?
Almost all distributors are feeling the pain of the past business environment and have a cautious view of the future. In reviewing the industries most likely to move from domestic markets, some notable trends emerged, including:
• Ten of the 20 industry categories included in the survey counted for 75 percent of the loss.
• Industrial and Commercial Machinery, Fabricated Metal Products, Electronic and Electrical Equipment, Furniture, Transportation Equipment, Textiles and Chemicals were the top industries where manufacturing moved offshore.
• Many of the industries are linked. For instance, if a furniture manufacturer moves, then a textile manufacturer suffers, as does the forestry industry.
• Divisions of public companies with more than $100 million in sales were the most likely to move, followed by the larger private firms.
• Accounts buying on integrated supply or managed inventory agreements were less likely to move.

In considering the previous statistics, we advise distributors to review their current customer bases and look for accounts within the industries where losses were most prominent. If the account is a larger division of a public company, the risk from moving is elevated. And, if the industry you serve is linked to industries where the decline is most pervasive, be forewarned.

In the long run, we expect new industries to come forward and assume the lead over more traditional manufacturing. Don’t be surprised to see more traditionally high-tech industries including pharmaceutical, bio-tech, and silicon chip manufacturers to begin to move offshore. As globalization continues and the transference of knowledge becomes easier, the defining factor whether an industry stays will be the infrastructure of the host country, including educational support, cost infrastructure of materials movement, labor specific to the cost pressure in the industry, taxation structure and quality of life for management and workers. Also, don’t be surprised to find that many industries break up the firm by locating marketing, research and development, and finance in North America, and locates plants across the globe.

What’s a distributor to do?
In dealing with the effects of The China Syndrome, the survey asked distributors about their fallback alternatives. The respondents yielded the following regarding their plans to hedge losses and, hopefully, to reposition their firm for growth.

• 43 percent said they were diversifying to new customers.
• 27.5 percent said they were adding new lines to recover lost
sales.
• 12.6 percent said they were developing services for fees.
• 3.9 percent said they were looking for acquisitions outside of traditional manufacturing markets.

While many of the responses are predictable, we found those developing fees for services to be rather large and those looking for outside the industry acquisitions to be rather small.

The survey also reviewed short-term strategies for survival including responses to cost containment. The following areas of cost management are those identified from most to least important including:
• 36 percent said they were cutting back on non-essential
expenses.
• 30 percent said they were cutting back on non-essential personnel.
• 14.4 percent said they were not cutting back and investing for the future.
• 12 percent said they were cutting back on the number of outside salespeople.
• 4.4 percent said they were moving to a catalog and e-commerce solution.
• 3.2 percent said they were increasing price for a short-term gain.

Again, while many of the responses are traditional, we found it surprising that 14.4 percent indicated a willingness to invest further and 12 percent said they were cutting back on outside salespeople. Traditionally, salespeople have been a protected class in the distribution ranks; it appears severity of the situation is causing management to rethink the deployment of a very expensive method of solicitation.

Future work
As we further explore the implications of globalization and the maturation of wholesaling, we are left with many unknowns. Distribution, an historically slow-to-change business, is in need of well-thought but quick change. Profit levels and the tolerance of private investors will precipitate the change, but study, planning and good market strategy will make it successful.

As part of the distribution community, we advise our readers to stay current with our future work in the areas of cost management, sales restructuring and strategy development. These areas will be the future hotbeds of study, debate and survival as distribution adjusts to the effects of globalization.

This article originally appeared in the ISCON 2004 issue of Progressive Distributor. Copyright 2004.

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