The 2020 Mid-Year Economic Update_long

Closing the Growth Gap

quarterly revenue growth averaged a healthy 6.8 percent from 2002 through mid-2006. However, the average growth rate drops to only 1.9 percent after adjusting for inflation. The wholesale distribution industry has experienced limited real growth in the past two years despite historically comparable top-line revenue growth.

The revenue-enhancing benefit of product price inflation will dissipate as the growth in commodity prices eases. It will become harder for wholesaler-distributors to show top-line revenue growth, making volume growth more important as a source of revenue growth. Total gross profit dollars will shrink even if gross margin percent remains stable.

An over-reliance on inflation-boosted growth indicates that a revenue slowdown is coming to your company. Wholesale distribution executives should analyze the relative contributions of volume versus price growth to their company's recent top-line revenue growth. Will your company face a growth gap? How much would your top-line revenue growth slow down if product prices remain flat over the next 24 months?

Our free research report Closing the Growth Gap provides benchmarking data on ways that wholesale distribution executives plan to maintain top-line revenue growth at their companies. Use this information to begin planning for this inevitable shift in your business.

©2006 Pembroke Consulting, Inc. Adam J. Fein, Ph.D. is the founder and president of Pembroke Consulting, a firm that provides business and marketing strategy advice to executives operating in channel-intensive industries. He can be reached at 215-523-5700 or on the web at www.PembrokeConsulting.com. This article is adapted from the new research study Closing the Growth Gap, which was sponsored by Lawson Software (www.lawson.com). The complete report is available for free download here.

Unusually high commodity price inflation is making revenue growth much easier to achieve. Adjusted for inflation, year-to-year average growth was limited at just 1.9% from 2002 through mid-2006. Distributors should use a more strategic and focused approach and move away from a dependence on inflation-boosted growth.

The U.S. wholesale distribution industry is going through a period of remarkable top-line revenue growth, with total sales of U.S. wholesale distributors up by 40 percent since 2002. Sectors as diverse as industrial products, pharmaceuticals, and plumbing/HVAC are all registering double-digit growth. Ironically, this growth surge is now setting the stage for a new competitive challenge.

Top-line revenue growth is derived from a deceptively simple combination of selling more product (volume), achieving higher prices for those products (price), or a fortunate combination of both factors. While the current economic expansion boosts unit volume, wholesale distribution executives must recognize that unusually high commodity price inflation is making revenue growth much easier to achieve. Wholesale distributors will have to work harder for real growth, requiring a more strategic and focused approach.

A Growth Boost
Think back to the economic environment just a few years ago. Prices for a market basket of products sold by wholesale distributors declined through much of 2002. Then-Federal Reserve Chairman Alan Greenspan startled financial markets in early 2003 by saying that the threat of deflation though minor, is sufficiently large that it does require very close scrutiny and maybe – maybe – action on the part of the central bank.

Deflation wreaks havoc with the income statement of wholesale distributors, who are "paid" for providing services to customers and suppliers in the supply chain in the form of gross profit. Product price deflation translates into fewer gross margin dollars to pay for the value that these services actually provide.

Today, the situation has reversed dramatically as a commodity price bubble creates inflationary pressures. Prices of certain core commodities have literally skyrocketed.

  • Steel mill products increased in price by more than 60 percent since mid-2003. Although prices began to decline in the second half of 2005, prices remain relatively high by historical standards, due in large part to China's commodity-intensive manufacturing activities. (China's imports of all commodities have risen more than tenfold in the past 15 years.)
  • Oil remains $60 per barrel versus $32 in late 2003, triggering energy-related price increases throughout the supply chain and increasing the prices of derivative products. For example, prices for plastic pipes and fittings are now growing at 20 percent per year.
  • Prices for building materials such as lumber products spiked in 2004 and remain above historical levels. Inflation for concrete products remains high as demand continues to exceed supply.

Many analysts believe we are in the final stages of a speculative bubble in commodities. The Federal Reserve is aggressively ending the "easy money" era through higher interest rates, suggesting a slowing inflation rate or more moderate economic growth.

The Real Story
Exhibit 1 compares the top-line revenue growth for the wholesale distribution industry before and after accounting for changing product prices. (See the complete research report for details on our methodology.)

Before adjusting for inflation, year-to-year quarterly revenue growth averaged 6.1 percent from 1993 through 2000. Although the gap between adjusted and unadjusted growth fluctuated throughout the period, the wholesale distribution industry still experienced consistently positive real growth averaging 4.5 percent.

The situation today is substantially different. Year-to-year

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