Public Policy

Research & Development
By John Satagaj, email@jsatlaw.com

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If you have ever tried to use the Research and Experimentation tax credit, you know the paperwork necessary to claim the credit alone is a significant deterrent to using it. At the most recent WMMA Public Policy Committee meeting, the committee decided that creating a simple, small business, user-friendly credit should be a top priority for us in 2006. (One of my priorities is getting the name of the credit changed. While most small business owners use the phrase "research and development (R&D)," in typical Washington-style convoluted fashion, the applicable section of the Internal Revenue Code (IRC) does not have a name for the credit. Instead it relies on another section of the Code which provides for a deduction for "research and experimentation (R&E)" expenditures. I think we should get it renamed the R&D credit.)

Currently, IRC Section 41 provides for a research tax credit equal to 20 percent of the amount by which a taxpayer’s qualified research expenses for a taxable year exceed its base amount for that year. (Therefore, it is referred to as an incremental credit because it rewards the additional effort.) The research tax credit is scheduled to expire and generally will not apply to amounts paid or incurred after December 31, 2005. (I expect it to be renewed for another year, between the time I write this and the time you read it.)

I will not go into all the details of the credit calculation here, but consider the following as a taste of why the credit rules need to be changed:

“The research tax credit applies only to the extent that the taxpayer’s qualified research expenses for the current taxable year exceed its base amount. The base amount for the current year generally is computed by multiplying the taxpayer’s fixed-base percentage by the average amount of the taxpayer’s gross receipts for the four preceding years. If a taxpayer both incurred qualified research expenses and had gross receipts during each of at least three years from 1984 through 1988, then its fixed-base percentage is the ratio that its total qualified research expenses for the 1984-1988 period bears to its total gross receipts for that period (subject to a maximum fixed-base percentage of 16 percent). All other taxpayers (so-called start-up firms) are assigned a fixed-base percentage of 3 percent. In computing the credit, a taxpayer’s base amount may not be less than 50 percent of its current year qualified research expenses.”

Had enough? If you want more, WMMA has an issue paper and background material that goes into more detail.

The tax relief related to the research and experimentation tax credit is estimated to be $4.8 billion for 2005. The related tax relief for expensing of research and development expenditures was estimated to be $4 billion for 2005, growing to an estimated $6.3 billion by 2009. In 2002, more than 15,000 taxpayers claimed more than $5.8 billion in research tax credits. Taxpayers whose primary activity is manufacturing claimed two-thirds of the research tax credits. However, firms with assets of $50 million or more claimed nearly 85 percent of the tax credits.

According to the Joint Committee on Taxation (JCT), incremental credits attempt not to reward projects that would have been undertaken in any event, but to target incentives to marginal projects. To the extent this is possible, incremental credits have the potential to be far more effective per dollar of revenue cost than flat credits in inducing taxpayers to increase qualified expenditures.

However, WMMA’s view is that if the credit is unusable, no potential is being realized from the incremental incentive. A flat credit would be easier to use. A flat credit generally has lowered administrative and compliance costs than does an incremental credit. Probably more important, however, is the potential misallocation of resources and unfair competition that result as firms with qualified expenditures determined to be above their base amount receive credit dollars, while other firms with qualified expenditures considered below their base amount receive no credit.

We all know smaller firms play important roles in industries where technological innovation is a central driving force for growth and change. Smaller firms employ nearly four out of every 10 scientists, engineers, and computer specialists working in the private sector, and small firms that file claims for patents produce 13 times as many patents per employee as large firms that do likewise.

According to the Congressional Research Service (CRS), R&D is the lifeblood of technological innovation, which, in turn, serves as an engine of long-term economic growth. Economists generally agree that without government support, private investment in R&D would fall short of the socially optimal amount. Left to their own devices, firms are likely to invest too little in R&D for two reasons. First, firms usually are unable to capture all the returns on R&D investment, primarily because other firms are able to exploit the results of research in spite of available intellectual property protection. A second reason is that some firms lack access to sufficient capital to invest in R&D because they are unwilling or unable to provide investors with the information they require to evaluate the potential returns on planned R&D investments. This tendency to invest too little in R&D represents a market failure in that too few resources are allocated to R&D compared to its potential economic benefits. To remedy this failure, many economists advocate government support to encourage private-sector R&D investment.

As the CRS also notes, large firms can more easily cover the substantial sunken costs involved in conducting R&D and are more likely to capture a large share of the returns to R&D investments through marketing campaigns, the protection of intellectual property rights, and the creation of regional, national, and international distribution, service, and repair networks.

While some suggest that R&D tax subsidies may raise the wages of scientists, and hence research spending, without increasing actual research, the argument for a simple flat credit is that is exactly what we should attempt to achieve—create greater opportunities for engineers. This, in turn, would have a ripple effect on a greater interest in engineering as a profession, and more educational opportunities.

WMMA's solution is to create a simple flat credit. To readdress the current imbalance in usage and to limit the tax revenue impact, we could limit the credit to companies with 500 or less employees or an asset size of less than $50 million. If you agree, join us in Washington in February at the WMMA Public Policy Fly-In to convince Congress to act on our proposal.

International Business Development

Thoughts on Lestechprodukzia/Woodex, Moscow, October 25-29
By Harold Zassenhaus, hzassenhaus@fernley.com

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WMMA and three members jointly exhibited in one of Russia’s most important woodworking equipment trade fairs. Another five members exhibited on their own or through their distributor. The following are observations of the fair, the Russian woodworking equipment market and potential for WMMA members.

Lestechprodukzia/Woodex 2005
The fair, supported by EUMABOIS, the European Federation of Woodworking Machinery Manufacturers, drew about 12,000 trade visitors and occupied 8,000 – 10,000 net square meters. According to the exhibitors catalog, there were slightly less than 500 companies represented at the fair. The fair was well run with ample power, lighting and most booths well designed.

The fair was predominately made up of secondary wood processing equipment and cutting tools, although there were a few exhibits of sawmilling/rough mill equipment. It was comprised of four exhibit halls, including a smaller one of about 1,500 sq. meters in which the German Woodworking Machinery Association (VDMA) organized a pavilion of about 40 suppliers, sponsored by the German government.

The fair was dominated by the stands of 8-10 distributors, (see comments below), underscoring the importance of having a dealer in the market.

Russia also hosts one other major woodworking equipment trade fair, Lesdrevmash, also held annually in Moscow. Lesdrevmash, a bit larger, usually has more forestry, sawmilling and rough mill equipment.

EUMABOIS is still debating which fair it will endorse in 2006 with the larger European primary equipment producers arguing support for Lesdrevmash in September 2006 and the secondary machinery producers pushing Lestechprodukzia/Woodmex. To accommodate EUMABOIS the Lestechprodukzia organizers have changed the dates and venue of next year’s fair to early December and to the recently completed Crocus Exhibition fairgrounds in the outer Moscow suburbs. The fair would then follow the popular annual Russia furniture mart held in October. EUMABOIS will make a decision in late November. The odds are they will endorse Lestechprodukzia.

I came away with three major impressions of the Russian market:

The Russian Woodworking Market
Russia has a population of 144 million. Its GDP grew by 6% in 2004 and through June 2005 grew at about the same rate. Consumer purchasing power and spending, especially in the urban areas, is increasing dramatically. However, industrial output has begun to slow and inflation is increasing to over 10%.

The Russian forestry market appears to be a study in contradictions. To begin, Russia accounts for an estimated 25% of the world’s timber resources. The forest sector’s share of Russia’s economy is only 3%, still insignificant related to its potential. Logging, rough lumber and even some downstream production continue to face constraints due to relatively poor infrastructure, inconsistent tariff regulations, inadequate business legislation affecting property and investment, illegal logging on a grand scale and poor law enforcement all of which have led to undercapitalization in the sector.

Per the US Department of Agriculture, Foreign Agricultural Service (FAS), round wood output was estimated at 81 million m3 in 2004, or 25% of the total allowable cut. According to Russian government sources, to obtain an annual increase in logging of 60 million m3, an additional 3,000 km of forest roads per year must be constructed. In order to address this problem, the federal government has announced plans to launch a federal forest road infrastructure development program as early as 2006.

Despite the above problems, the outlook for the remainder of 2005 and 2006 calls for sector growth of 4-6%. The growth is due to the development of the pulp and paper industries, as well as growth in particleboard, MDF (up 14% in 2004) and veneer all from relatively low baselines.

Growth is also due to continued strong exports as well as increasing domestic demand for rough mill and secondary products. Russia’s wood exports (excluding logs) were about $4 billion in 2004 and through the first 6 months of 2005 amounted to $2.7 billion, a 28% increase of the same period in 2004. About 90% of the total was treated or untreated rough or sawn wood. Even though small, Russia’s exports of mouldings, windows, doors and bedroom furniture are growing rapidly. Rough lumber exports chiefly go to China; more downstream production goes to Europe.

Domestic demand is increasing not only for furniture but housing in general as a result of the economy’s performance over the past 5 years as well as:

As little as a year ago, the US government, in a Department of Commerce market study noted “… a majority of sector experts believe that obsolete manufacturing equipment and the lack of modern technologies are major problems faced by local furniture manufacturers. Basic wood processing equipment is a particular problem.” However, after meeting with the larger equipment dealers and German and Italian participants, I do not think this is the case today. If so, it is changing rapidly. In 2004, Russia imported close to $300 million in woodworking equipment and cutting tools, a 42% increase over the previous year. For the first six months of 2005, imports were $105 million. Imports from Germany account for more than 29% of total imports. Up until 2005, Italy and Finland were the next largest suppliers. In 2005, China became the second largest supplier nation with a 9% share.

Distribution
The race is on!! There are 8-10 major dealers only one of which is over 9 years old and most less than 5. All state they cover the entire Federation with at least 4 offices. They all have warehouses, stock parts and have service technicians. Most have more than 100 employees with one stating they have over 400. From the look of their stands and in private conversations, they do well. One major dealer mentioned 2004 turnover was about $25 million. The following are some other shared traits:

As you can imagine from the above, it seems that the emphasis of most dealers is on selling large systems. One dealer mentioned he concentrates the vast majority of his time and resources on projects of at least $500,000.

Two final comments picked up by some of the distributors and a few European suppliers:

In some respects, the Russian market seems to be where the China market was in the late 80’s and early 90’s. The market is growing rapidly. Distribution channels are becoming well developed (in China, legislation allowed the few dealers operating from Hong Kong to open offices on the mainland). The few major dealers were chasing large system sales hoping to sell European equipment but willing to throw in cheaper Taiwanese products where the client wanted/needed to pare costs. If correct, the distributor channel will undergo some changes in the next few years as senior managers decide to leave and create their own distributorships taking some lines with them. This may provide an opportunity for WMMA members to enter the market.

The Absence of US Suppliers
Finally, in discussions with dealers, all but one stated he knew practically nothing about US sources of supply. What they did know was limited to the few in the market, such as Wood Mizer, Koetter Dry Kilns and several suppliers they saw at Ligna (Black Bros., Midwest Group One, JL Taylor were some examples mentioned). Even here, they were unfamiliar with a number of other members that have traditionally exhibited. They did not know they were from the US. When I began discussing the WMMA membership, most found it “questionable” that the members were really US producers and not subsidiaries of European manufacturers or Chinese or Taiwanese importers.

Clearly, members have a challenge in the Russian market. Aside from overcoming the lack of knowledge about US sources of supply in general, there are the basic issues of:

WMMA members are going to have to demonstrate to the Russians that they can be consistent suppliers; will train their staff in service and sales; will visit the market frequently to develop their lines; will provide quick technical support when called upon and; in the most basic of ways, prove to them that they will be “partners” in developing the Russian market. This last requisite is not easy, especially in a market where things are not always transparent and Russians as a whole are not outwardly appearing to be open.

Selecting a Russian Distributor
WMMA has amassed a Directory of International Distributors. It includes the names of over 500 dealers in over 40 countries, including Russia. Information captured includes contact information as well as lines carried. As a WMMA member it is free to you. You can find it at http://www.wmma.org/members/intldir.cfm. You will need to use your ID and password. If you have forgotten it, please contact Karen Boyle at WMMA for assistance.

When initiating correspondence with a potential distributor, even if you have an email address for the company, it is a good idea to send a fax as well and ask the company about the best method of communication. Although most companies have email access, it is still not always reliable or preferred. You should write to a target company in a direct and clear manner that presents your company and states your interests. At the initial stage of correspondence, effective promotional information can be a simple introductory letter with brief company and product information, including photos of the products. Additionally, a description of your international experience, if any, and the type of cooperation you are seeking, preferably translated into Russian is helpful.

Visiting a Russian trade show or making an exploratory trip to Russia is a good intermediate step before establishing representation in the country. Simply sending catalogues is not nearly as effective as personal contact.

If you are planning a trip to Russia, it is important to translate your promotional materials. Even if your potential Russian partner speaks good English, the fact that you translated your materials shows serious intentions and respect for potential partners.

Whether you decide to appoint an exclusive dealer or keep the line open, there are several factors to be considered in selecting a prospective Russian distributor. There are the obvious ones that apply to dealers all over the world:

You should also consider the following advice provided by the US Foreign Commercial Service in Moscow and confirmed in meetings with local dealers. Russian distributors generally prefer to work with companies that are ready to offer continuous support in promoting the product in the region, especially if the product is new to market, somewhat complex, and/or expensive. This support can include training for specialists, organizing conferences, providing marketing materials, sending product samples, visiting a dealer or bringing a dealer to the United States, and other value-added services. These value-added services become critical for the long-term successful cooperation with your Russian partner. If you are only interested in selling your product to Russia, without committing resources to effective market penetration, your good relations with a Russian dealer may not last. As client demands are growing and competition increasing, Russian dealers will switch to working with those U.S., Asian, or European suppliers that will be flexible in their approach and strongly interested in effective cooperation.

It is also important to be open to starting with small orders. Finally and very important, when entering Russia, as in other foreign markets, it is important to develop a consistent distributorship policy to which you will adhere. This may include: writing out common terms and conditions of a distributorship agreement; identifying transparent criteria that a potential distributor will have to meet; developing a transparent pricing policy and a system of discounts; having a specialist on staff responsible for working with Russia; and understanding peculiarities about shipping to Russia and working with the Russian market in general.

Russia is a dynamically developing market, and U.S. companies are increasingly seeking business opportunities there. For additional support your may want to take advantage of the information and counseling, as well as the special services available to you through BISNIS, the U.S. Commercial Service, and Foreign Agricultural Service. Doing business with Russia may be challenging in the first place, but very rewarding as business ties strengthen and relationships develop. Key success factors are flexibility, willingness to take risks, and focus on the long-term.

Manufacturing Strategies

WMMA Introduces Manufacturing Newsbrief Service
By Harold Zassenhaus, hzassenhaus@fernley.com

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On Thursday, November 17, WMMA launched “Manufacturing NewsLine: Strategies for Improvement,” an email newsletter covering issues and providing information and insight to woodworking industrymanagers. All WMMA key contacts should have received Manufacturing NewsLine. If not, click here for the current issue. Contact Karen Boyle, WMMA, (215) 564-3484 to add your name to the subscription list.

The service, developed in response to a member survey, provides timely news about manufacturing issues combed from over 7,000 periodicals and websites. This new member benefit will be emailed monthly to WMMA members and posted to the WMMA website (Members Only area) along with archived issues for easy reference.

We encourage you to forward Manufacturing NewsLine to your industry colleagues. If you want your employees to receive it directly, contact Karen Boyle with their names and email addresses.

Finally, we welcome your feedback so we can continuously improve the value of this service for you. Email Karen Boyle with comments.

Research

Respiratory Health Study of Wood Workers Completed

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On November 8, 2005, the American Forest & Paper Association (AF&PA) announced the completion of a long-term study into the potential respiratory effects of working in the wood and wood products industries. The study was commissioned by AF&PA and eighteen other wood products trade associations and carried out by the Tulane University Medical Center. “Our industry has a long history of conducting research to ensure the continued health and safety of our industry’s employees,” explained Sharon Kneiss, Vice President of Regulatory Affairs for AF&PA. “We are happy to learn the researchers found no statistically significant adverse effects from wood dust at the facilities participating in the study. This is good news for our employees and our industry.”

The six-year study followed more than 1,100 employees from ten plants scattered around the country, representing a cross-section of the wood products industry. All the plants and employees participated voluntarily, answering health questionnaires and participating in dust monitoring and lung function testing. While this study was specifically looking at potential effects of exposure to wood dust, the researchers did note pulmonary effects unrelated to wood dust at two of the ten facilities, a milling facility and a sawmill-planing-plywood facility. The study authors suggest the results from the milling facility may be due to a masked smoking effect—that is participants underreporting their smoking habits. The results from the lone sawmill-planing-plywood facility are harder to explain, but do not stem from exposure to wood dust. The researchers have proposed additional study of non-wood dust factors, and the facility’s owners have begun an independent study.

The groups funding the study are: American Forest & Paper Association, American Home Furnishings Alliance, APA—The Engineered Wood Association, Appalachian Hardwood Manufacturers, Architectural Woodwork Institute, Association of Woodworking & Furnishings Suppliers, Composite Panel Association, Hardwood Manufacturers Association, Hardwood Plywood & Veneer Association, Kitchen Cabinet Manufacturers Association, National Hardwood Lumber Association, National Wooden Pallet & Container Association, NOFMA—The Wood Flooring Manufacturers Association, Northeastern Lumber Manufacturers Association, Southern Forest Products Association, Western Wood Products Association, Wood Machinery Manufacturers of America, Wood Moulding & Millwork Producers Association, Woodworking Machinery Industry Association.

For more detailed information, click here.

AF&PA and its member companies are continuing to analyze the findings from this study and will be sharing results with standard setting organizations. For more information, contact Michael Klein, (202) 463-2478.

Spotlight on Member Benefits

Another Business Cost Containment Idea for WMMA Members: Loss Control and Safety Compliance in a Box
By Tim Foy, tfoy@cpgins.com

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Your insurance company may not be paying proper attention to your individual safety needs. If that is the case, you can take control of any lingering "Safety Issues" and also have an impact on your bottom line! Interested? If so, then a new tool from CPG, with the assistance of ACS (American Compliance Systems)might be worth evaluating. It is called Loss Control and Safety Compliance in a Box. This tool is a positive step towards documenting risk management exposures for companies with 150 or fewer employees, and there by lowering your insurance premiums. Insurance Company Underwriters like clients who are progressive business owners, want to document their safety practices, and show an orderly approach to risk management. CPG thinks this approach may help your short-term and long-term bottom lines when marketing your insurance proposals by showing the insurance company your concern about Safety Compliance. After implementing such a plan, ask your company for a 5% to 10% safety credit off your insurance premiums. Most insurance companies have a credit available that you may qualify to receive. For more information, please click here or contact Tim Foy at tfoy@cpgins.com or (888) 852-5203.

WMMA Offers Members ITR Economic Forecasting Reports

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The Institute for Trend Research (ITR) has been serving the needs of American businesses since 1948. The quarterly Economic Outlook Report is currently offered to WMMA members through the Members Only section of the website. This member benefit offers reliable forecasting of future economic and business trends, which will provide you with the information you need to grow and maximize your capital resources. To view the Fall Economic Outlook Report, click here.

As a WMMA® member, you also have the option to tap into the expertise of ITR and secure information specific to your own business. Have ITR perform a customized analysis of your individual business and provide you with a valuable look into the future. The analysis will look at the unique characteristics of your business and provide you with analysis and commentary using the leading economic indicators to your business. The cost to WMMA® members has been reduced to $400. To learn how to get your own detailed company analysis, click here.

ITR also publishes EcoTrends, a monthly economic report. EcoTrends provide the tools necessary for company forecasting and in-house planning efforts. An annual subscription to EcoTrends is $795.00. ITR will invoice you directly for your EcoTrends subscription.

Member News

WMMA Welcomes Wood Industry As A New Member

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WMMA’s new member, Wood Industry, is a trade publication founded by Blair Tullis and Kerry Knudsen. Wood Industry is published six times a year in the standard journal format for Canada’s secondary wood products manufacturing industries. The premier issue, in September 2005, mailed to over 18,000 people across Canada. Wood Industry joined WMMA to better serve the interests of the members in their efforts to sell woodworking equipment to Canadian buyers.

Association News

IWF Payment Deadline Dates

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Mark your calendars for IWF 2006! WMMA members are entitled to a 20% discount on booth space at IWF 2006 provided the payments due April 22nd (passed), January 20, 2006 and May 12, 2006 are postmarked by a government postal agency or overnight delivery service (not a company postage meter) by the respective due dates. Visit www.iwf2006.com for details.

15th Annual Woodworking Industry Conference

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The 15th Annual Woodworking Industry Conference will be held May 3-6, 2006 and is the premier forum for education and networking. Attending the WIC '06 at the Wailea Marriott Resort, Maui, HI, is the right choice for your business.

The 2006 Woodworking Industry Conference is just months away! Mark your calendar and begin planning now! To learn more about the WIC '06, visit:
http://www.wmma.org/events/wic.cfm