The Cutting Edge™ - May 2004

Business Briefing

Jobs, Jobs, Jobs… By Art Raymond, A.G. Raymond & Co., Inc. (araymond@raymondnet.com)

A steady drumbeat of stories about jobs has recently commanded the newspaper headlines and evening news broadcasts. Politicians, economists, and talking heads alike cannot explain the failure of a growing economy to generate employment. Blame is placed on President Bush and U.S. corporations seeking "obscene profits". Next in line must surely be golfer Tiger Woods who employs a caddy from New Zealand.

For at least 70 years people have predicted the disappearance of jobs and the death of the U.S. economy. In 1932 President Hoover called for "the speeding up of social invention or the slowing down of mechanical inventions" to prevent "grave maladjustments". President Kennedy belied his faith in technology and the space program with his comment that automation "carries the dark menace of industrial dislocation, increases unemployment, and deepens poverty". And of course we all remember Ross Perot's "giant sucking sound of jobs being pulled out of this country". Yet since Hoover employment and living standards have quadrupled. Will the future be any different?

The culprit-du-jour for our supposed job woes is outsourcing. CNN on its nightly business program bashes executives who move work to lower-cost countries. The fact is, however, we live in a global village connected by the relatively open flow of ideas, capital, and products better known as free trade. And free trade has historically brought outsourcing and insourcing. In a recent Wall Street Journal op-ed Walter Wriston, former chairman of Citicorp/Citibank, noted that the number of jobs we import from abroad greatly exceeds the jobs we export. Last year, for example, Honda increased its production in the U.S. by 15%. Novartis, the drug giant, is moving its world-wide R & D operation from Switzerland to Massachusetts. Samsung is building a $500 million semiconductor plant in Texas. These companies are benefiting from proximity to our huge market, superior labor productivity, and stable political environment. Such investments resulted in the creation of 6.4 million jobs in 2001 with 34% of these positions in manufacturing. Workers in the industrial heartland of America - Ohio, Michigan, and Indiana - have benefited heavily from this inflow. And importantly, 22% of the products of these U.S.-based foreign companies are exported.

To inform the current outsourcing debate, the Information Technology Association studied the effects of outsourcing on computer services jobs. Their research concluded that the higher overall productivity resulting from outsourcing generated 90,000 U.S. jobs in 2003 and will create 317,000 new jobs in 2008.

Most importantly, the U.S. is not running out of jobs. The problem is predicting with certainty what the future holds for individual workers and firms. No doubt employment in the U.S. in this future will require new skill sets comprised primarily of specialized knowledge rather than rote, sweat, and muscle. Relatively simple jobs that can be reduced to a series of decision rules are most likely to disappear overseas or be replaced with technology. Jobs requiring personal contact and/or special analytical skills will however be in high demand.

It's worth repeating the Economic Factoid from last December's Business Briefing - A quarter of all U.S. workers are now employed in jobs that were not listed in the Census Bureau's 1967 occupation codes. Jobs lost since then were simply replaced by jobs no one could imagine. Therein lies the problem. Predicting the training and education needs for jobs yet defined is difficult at best. The future is uncertain. This uncertainty naturally brings concern especially for those caught in the transition from today's economy to the future.

Economic Factoid - Today's 5.7% unemployment rate is just above March 1964's 5.4%. Kennedy's specter of a "dark menace of industrial dislocation" proved unfounded. His fears, however, resulted in significant lowering of taxes to stimulate business investment and personal consumption, a move similar to last years' Bush tax cuts.

In all businesses and particularly in manufacturing, we do have problems to overcome. Health care costs, tort litigation, and heavy regulation decrease U.S. producers' competitiveness. Health care costs rose by 14% in 2003. Workers' comp premiums are also rising. Even with a slack labor market, labor costs are rising faster than inflation. In 2003 compensation costs increased 3.9% compared with only a 2.3% gain in consumer prices. Since wages and salaries are typically inelastic, the only way companies can lower labor costs is to fire workers and raise productivity of those remaining. Only when employers must absolutely crank up output will new workers be hired.

And such hiring may just be kicking in. In March the economy added 308,000 new jobs. Significant gains were reported in construction, retail, health care, and business services.

Bottom Line: Keep the faith. The U.S. is enduring an economic transition of global proportions with no clear vision of the future. The future rests with cutting edge innovation and the ensuing flood of yet-to-be known products and services. The job-making machine that is the U.S. economy will once again save the day.

Office Furniture - BIFMA reported that February 2004 shipments increased by 2% year-over-year vs. the same month last year while new orders were flat. Analysts, while disappointed in this performance given the easy comparison with the prior two years, are now calling the outlook for this sector positive as the drivers of office furniture spending, employment and corporate profits, improve. Remember this sector saw its sales decline from a $13.3 billion annual rate in January 2001 to $8.5 billion in November of 2003.

Steelcase reported 4Q2004 revenues down 9.7% versus the same quarter last year. Operating margin was down 3.5%. The company is implementing a surcharge on orders to cover higher steel costs

Herman Miller announced that 3Q2004 sales increased 6.2% versus the same quarter last year. Continuing efforts to rationalize the company's cost structure resulted in a 4.4% operating margin vs. 2.6% last year.

Kitchen Cabinets - Cabinet sales continued red hot by growing a torrid 17.6% in February vs. the same month in 2002 according to the KCMA's Trend of Business Survey. Year-to-date 2004 cabinet sales were up 17.8%. The KCMA is forecasting a 12% rise in cabinet sales for the full year. Remember that last year's cabinet sales rose 13.1% following on 10.9% growth in 2001 and 12.4% in 2002.

Producers continue to add more cabinet configurations, options, and accessories to give the consumer more choice. More finish selections - colors, glazes, sand-through, and distressing - also provide opportunities for customization as cabinetmakers offer fuller, more furniture-like looks.

Profit margins continue healthy industry wide, a situation that has somewhat dampened the move to outsource doors and other wood components. Cabinet companies appear unwilling to risk the competitive edges of fast delivery, high quality, and customization to save a few cents on purchased part.

American Woodmark, the second largest U.S. cabinetmaker, reported sales growth of 19% for its 3Q2004. Gross margin fell to 20.8% vs. 22.2% last year. Management blamed the decline on higher lumber and particleboard costs as well as increases in employee benefit expenses. Operating margin also declined, falling to 7.7% from 8.3%.

Home Furniture - The industry continues to await the Department of Commerce's ruling on the anti-dumping petition against Chinese bedroom furniture producers. In late March the DOC announced the selection of India as the surrogate country for purposes of valuing the factors of production. In assessing whether Chinese producers are selling below cost, the DOC must determine the cost of furniture production in China. Because China is a non-market economy under petition rules, the DOC must construct values for wood bedroom furniture using costs from an economy with similar characteristics to China. In almost all anti-dumping cases involving China, the DOC has selected India as the surrogate. The effects of this choice on the petition's outcome are unclear. However, several petition opponents including

Furniture Brands International

The real issue is control of the $65 billion U.S. furniture industry. Will U.S. producers retain a place in the furniture value chain or be disintermediated by U.S. retailers' direct purchases of Chinese products? Without the imposition of heavy duties, an outcome that will hurt the U.S. consumer and perhaps furniture sales, the economics of production in China will win out. Stay tuned.

• A Chapter 11 bankruptcy filing by Bush Industries on March 30 was the biggest sector news. The RTA furniture maker cited its inability to secure alternative financing sources as the primary reason for the filing. Management intends to refinance $70 million of its senior debt and convert $90 million into equity of the reorganized company. The RTA sector has seen its growth flatten over recent years. In addition the bankruptcy of Kmart and smaller mass merchants hammered the industry's balance sheets. Bush's attempts to diversify from its core furniture business have also proven unsuccessful.

• Casegoods maker Stanley Furniture forecasted an 11-13% gain in 1Q2004 sales. Imported product now accounts for about 30% of sales vs. last year's 20%. However capacity utilization of its domestic plants has improved to 70-75% since year end.

• Hooker Furniture announced a 5% sales increase in its 1Q2004. The company has turned in nine consecutive quarters of increased sales. This growth was fueled by an 11% increase in shipments of imported products. On the negative side, lower demand for domestically-produced wood furniture resulted in low capacity utilization. Operating margin for the quarter was 8.7%.

Wood Flooring - February shipments of strip flooring were up 9% over 2003. For the first two months of 2204 shipments increased by 11% as wood flooring continued to benefit from the strength in new home construction and remodeling. Healthier log supplies at sawmills should translate into lower lumber costs as the supply of low-grade oak, the raw material of choice, improves.

Non-Residential Construction - The office construction sector is strengthening. A survey by CB Richard Ellis, a major commercial property brokerage, found the national office vacancy rate fell from 16.8% to 15.6% in 4Q2003. For the same period the U.S. Census Bureau reported that spending on office construction increased 4.2%, the second quarter-to-quarter gain after nine quarters of steep declines. While office construction spending is up only 6% from its low early last year, experts are forecasting a rise of 10% this year and 13% in 2005.

Expanding demand from aging Baby Boomers plus replacement needs are driving higher spending in healthcare construction. Coming off gains of 17.4% in 2002 and 7.9% in 2004, this sector is forecasted to grow another 9.3% this year.