Machine shortages in the recovery stage

The vibes from attendees at the annual Associated Equipment Distributors (AED) annual convention, held this year in Orlando, FL, were generally positive. A consensus among attendees was that the decline in business reached bottom and improved slightly in the fourth quarter. Very few said their business is expected to grow substantially this year. Most said that they had made hard cut backs caused by the worst decline in business since the early 1980s, and that they are profitable at the current level of business.

A “new normal” has emerged. Everyone would like to see business return to pre-2008 levels, but most understand those days won’t return for a number of years.

A number of distributors commented on current customers opting to rent equipment instead of buy because of their uncertainty of how many projects are ahead of them. Many distributors noted they had a lot of rentals converted to sales in December as customers took advantage of the depreciation bonus extension.

There were also confirmations that some customers were buying Tier III machines ahead of the switch over to Interim Tier IV on January 1.

Major exceptions to the “new normal” consensus were those distributors that participate in the mining industry. Sales of equipment to U.S. coal mining customers is very good right now, as well as sales in energy-producing regions and with oil and gas producers along the Gulf Coast. Western Canadian distributors are pleased with the business in the Alberta oil sands.

The curious aspect of the current business environment is that throughout the year manufacturers had a shortage of new machines. There were stories from distributors who placed large machine orders only to receive a fraction of their order.

The shortages are curious for two reasons. First, most manufacturers reported robust quarterly top line revenue gains during 2010. I believe a great deal of those gains were sales to distributors for replenishment of their depleted inventories including distributor rental fleet inventories which were also reduced substantially in the past two years. Second, a shortage implies that the manufacturers could have had higher revenue gains if their production was higher.

So, why didn’t they take advantage of the booming market?

Many manufacturers are unable to ramp up production quickly because their component suppliers, too, are unable to ramp up their production. This is due to many U.S.-based suppliers going out of business during the recession, while the suppliers that weathered the recession and survived had to cut back so drastically, that they are now unable to keep up with their manufacturer customers.

Overseas suppliers, especially in China, were busy selling their products to customers in their home market where product markets are up an average of more than 60%. It’s the ugly side of outsourcing. In order to gain control over their supply chain, OEM manufacturers will have to take back some production that was outsourced years ago.

Another reason for the shortage is the positive business in 2010 for other areas of the world, especially in South America. Manufacturers diverted machine shipments to those regions, especially where the low value of the dollar gave them a cost advantage.

Manufacturers need to take control of the situation and rebalance their business — domestic vs. overseas. Many companies did not pay enough attention to protecting their domestic channels-to-market in the recession of the early 1980s. Some distributors went bankrupt, some sold out to adjacent distributors and others closed their doors because the owners had better investment opportunities. Manufacturers that did not protect their domestic distributors spent the following decade rebuilding their networks. There were instances where manufacturers were forced into establishing and owning their own distribution.

The solutions for protecting the U.S. domestic market are not easy. Unless production can be ramped up to accommodate both domestic and international demand, the choice is to reduce overseas shipments. That decision must be made.