Grainger CEO: Outlook 2003

I'd like to start with how macro-economic trends are shaping our industry. I'll then provide an overview of Grainger's place in the competitive landscape. There are three major trends: the weak economy, the long term trend of manufacturing moving offshore, and a shift in customer buying behavior.

Let's start with the weakened state of the economy. Looking back, many economists agree that the current recession began around the fourth quarter of 2000, and some are now talking about seeing a recovery. We can see the beginnings of that here, with an upturn in the leading economic indicators.

Taking a look at our daily sales over the past two years, you can see that we had negative growth starting in March of 2001. September 2002 marked the first month of positive daily sales. October sales were flat, but we gained momentum in November, with daily sales up 3 percent. Based on the first two weeks in December, we see that positive trend continuing.

Offshore manufacturing

The second long-term trend is manufacturing moving offshore. Even prior to this latest downturn, U.S.-based companies had been steadily shifting manufacturing jobs outside the United States, first to Mexico, and now, increasingly, to China. The Brookings Institute estimates that be the end of this year, China will become the fourth largest trading nation in the world behind the United States, Japan and Germany. As this trend has accelerated, Grainger has prepared in two very important ways.

First, we got out ahead of the curve in 1997 by creating Grainger Global Sourcing to find sources of low cost, high quality products for our private label brands. We currently source from over 20 countries, with more than two thirds of our globally sourced products coming from Asia. As China's manufacturing capability continues to improve, we anticipate that in the next two to three years they could provide a sizable proportion of our private label products. This year Global Sourcing will generate roughly $120 million in revenues at a significantly better than average gross profit margin. As a result of our sourcing and export activities, we've also gained a better understanding of overseas industrial markets.

Another way that we prepared for a shrinking manufacturing industry in the United States is by strategically emphasizing government and other institutions such as hospitals. In fact, Grainger has a much broader customer base than our competitors, leaving us less exposed in an economic downturn.

A third major trend shaping our industry is a shift in our customers' buying behavior. The slow economy has given our customers an increased sense of urgency in lowering costs. More and more, customers are looking beyond product cost and examining the total cost of buying indirect materials. Forty percent of customers' overall spend on indirect materials is tied up in process costs. These are the costs related to searching for products, placing orders, and paying invoices.