Articles & White Papers

Furniture Manufacturing in the 21st Century (Volume 1)

Proprietary Research by Anderson Bauman Tourtellot Vos & Co.

INTRODUCTION

This report has been prepared by Anderson Bauman Tourtellot Vos & Company ("ABTV") for the purpose of analyzing the current condition of and trends in the furniture manufacturing industry. In preparing this report we have relied on numerous sources of information including recent relevant interim management and consulting engagements conducted by the firm.

INDUSTRY OVERVIEW

The domestic furniture industry has experienced significant growth over the past ten years with total industry sales in 2000 of approximately $25 billion, an increase of 56% from 1990 sales of approximately $16 billion.

According to Furniture/Today, the leading trade publication, the top 10 manufacturers recorded total sales of $10.5 billion in 2000, up 91% from $5.5 billion in 1990. Much of the extraordinary growth in the top line of the largest manufacturers is attributable to consolidation in the industry led by La-Z-Boy's recent acquisition of Ladd Furniture. In fact, a careful examination of the top three manufacturers by sales volume shows a trend towards furniture conglomerates covering numerous price points, styles and furniture categories.

The 1990's also saw growth in the vertical integration of certain manufacturers, namely La-Z-Boy, Bassett, Thomasville and Ethan Allen. This has largely been a response to poorly managed, independent furniture retailing as witnessed by the high profile failures of Levitz, Heilig-Myers, Montgomery Ward and HomeLife. Manufacturers are increasingly willing to explore opportunities in the retailing segment in order to more tightly control supply and demand of their products.

The furniture industry has experienced some significant challenges over the past five years. Many of these challenges stem from the fact that management in the industry has failed to pursue strategies which have the capability of protecting their respective companies from external competitive and economic pressures. The technological and financial barriers to entry in the industry are so modest as to not provide a deterrent to foreign competitors capable of taking advantage of relatively lower labor and compliance costs. In fact, while brand management strategies have become common in other consumer product industries in order to distinguish between otherwise commodity-like goods, the furniture industry has been a laggard. Few brands are recognized by consumers within the United States, much less the rest of the world. Even those brands that are recognizable are not, with few exceptions, able to earn premium pricing and higher margins due to consumers' perceived value associated with these brands. In addition, the downward price pressure resulting from import activity, particularly from China which has increased exports from $100 million in 1990 to nearly $3.7 billion in 2000, has caused a general deterioration in U.S. manufacturers operating margins. The outlook for the industry domestically appears increasingly negative as the 1995 WTO agreement is phased in through 2005 with a gradual, but significant, reduction in tariffs.

Recently, the failures of the major national furniture retailers discussed above have also had a major negative impact on the long-term fortunes of certain manufacturers who relied on these chains to provide significant sales throughput. Immediate cash flow problems are not uncommon, either, as the manufacturers have written-off significant receivables associated with these retail chains.

On the positive side, the Federal Reserve's recent decisions to ease monetary policy has paved the way for greater home construction and purchasing activity in the short term, although preliminary data for August indicates a 6.9% decline in new housing starts generally attributable to the slowdown in the economy as a whole. Over the long term, though, there exists a high degree of correlation between new housing starts and purchases of consumer durable goods such as furniture. We should therefore see improvement in durable goods purchases as interest rate reductions take hold. In the short term, however, it appears that consumers are reacting to the economic slowdown by curtailing their purchase of big-ticket items such as furniture. As evidence of this slowdown a review of current news reports provides numerous examples of stories about furniture manufacturers experiencing year-over-year sales decreases and statements by CEO's that the bottom has not yet been reached.

FACTORS/TRENDS AFFECTING THE INDUSTRY

• Management
  
  The failures of major retailers predominately selling promotionally priced furniture have resulted in significant manufacturing overcapacity problems. Specifically, over $3 billion of retail sales (approximately $1.5 billion at wholesale) have essentially evaporated over the past 24 months. Manufacturers are now forced to restructure their operations to accommodate lower volumes through downsizing or must attempt to steal market share in the remaining distribution channels from competitors. Protecting margins in this type of environment will be extraordinarily difficult since retailers will attempt to squeeze manufacturers, playing one off of the other, in search of the best deal. Lack of brand equity for most manufacturing companies means that getting floor placement in any given retailer's store is by no means a sure thing. This trend will cause additional consolidation in the industry as some companies pursue a one-stop shopping philosophy in order to distinguish themselves from the competition while weaker and smaller players are increasingly confined to smaller, niche markets. Additional focus is being placed on improving customer service, reducing delivery times and liberal credit policies.
  
  
• Manufacturing
  
  As discussed above, furniture imports are rising quickly, particularly from countries with cheap labor. From 1990 to 2000, imports have grown from $3.4 billion to $12.2 billion. Any major manufacturer in the U.S. who has not already explored the possibility of sourcing some, or all, of its product from abroad will be facing major problems in the next five years. The most immediate effect with respect to import competition will be felt by case goods manufacturers as a result of the relative ease with which case good parts can be packed and shipped versus upholstered items. In fact, the only true barrier protecting the U.S. industry today relates to the cost of freight in shipping from overseas and the associated damage to goods shipped in this manner. Domestically, technology has not advanced sufficiently fast enough to improve plant productivity to combat the lower costs associated with imported products. As a consequence there should be a continuing trend towards U.S. plant closures as manufacturing capacity moves offshore. Additionally, the lack of innovation in manufacturing processes over the last ten years has hobbled the industry in its quest to achieve manufacturing efficiencies to offset high labor cost.
  
  
• Asset Quality
  
  The deterioration in the manufacturing sector of the economy as a whole has already caused property and plant values to diminish. As companies recognize excess capacity in their respective industries, plants are typically shuttered as a first-step corrective action. This has resulted in an abundance of manufacturing facilities coming onto the market, particularly in the textile, apparel and furniture industries in the southern U.S. Compounding the glut in manufacturing properties is the fact that many of these plants are positioned in rural locations, originally to take advantage of cheap labor in the U.S. Unfortunately, this fact further reduces the value of these facilities when placed for sale.
  
  The bulk of a furniture manufacturer's value can be associated directly with its working capital assets. It should be noted, however, that lenders should still cast a wary eye when evaluating these assets as inventory can quickly become obsolete and some manufacturers are not sufficiently aggressive when writing inventory values down. Raw materials can also be subject to major obsolescence problems particularly when an upholstered furniture maker purchases fabric according to projected demand only to find that they have been far from accurate in their forecast and ultimately are saddled with potentially thousands of yards of useless material. Management's ability to effectively run their business can often be determined by careful analysis of their inventory management practices. Receivables constitute the other half of the asset equation and, similar to inventory, the financial management of a manufacturer can quickly be measured by reviewing the controls, credit and collection policies and chargeback history of the company.
  
  
• Marketing and Sales
  
  The furniture industry is not well known for innovative marketing and/or sales programs. Most marketing programs are the responsibility of the retailer with some POP support from the manufacturer. In addition, little national branding occurs. It appears that most manufacturers are content with allowing local advertising and marketing efforts to occur through the retail channel. This has the effect of further commoditizing the product since most retailers addressing the mass market focus their message on price and selection in terms of sheer volume, rather than on specific product attributes which their inventory may have that other retailers are unable to match.
  
  Sales organizations are typically built around either permanent, dedicated sales staffs or contract salespeople who sell complimentary products from numerous manufacturers. In either case, reviewing the internal support mechanisms for these salespeople is crucial when analyzing a company's ongoing sales prospects. Customer service and support ultimately is the make or break factor in maintaining solid relationships with the manufacturer's retail outlets.
  
  The trend with respect to sales has also changed as innovation in products has slowed. Today, customer relationships are as much based on credit terms and pricing as product offerings, largely because best-selling designs can easily be replicated at lower prices. This is a classic sign of the commoditization of an industry and has certainly been a factor in the recent history of the furniture industry.
  
  
• Distribution and Delivery
  
  The most important trend in the industry related to distribution and delivery of product involves the compression of the delivery cycle particularly in the upholstered segment. In the past it was not uncommon for products to require 10-12 weeks before delivery to the end-consumer. Even today higher-end manufacturers will take at least this long before fulfilling an order. Increasingly, manufacturers capable of short turn-around times are gaining a competitive advantage. We see turnaround times continuing to decrease over the next five years and any manufacturer not implementing plans to deal with this trend will be at a major disadvantage vis-à-vis his competition.

ANALYSIS OF RECENT 2001 RESULTS

The chart below shows the results for certain industry competitors ranked by their operating profit margins as a percentage of sales:

Note that Ethan Allen has successfully integrated a retail business with its manufacturing operations and does not sell its manufactured products outside its own retail division. As a consequence operating and gross margins are significantly above industry norms. In comparison, neither La-Z-Boy nor Bassett, both of which have been attempting to control demand of its products through vertical integration, have been able to obtain meaningful margin improvements. Manufacturers attempts to integrate their operations vertically have been a marginal strategy at best. Typically, management is unfamiliar with the vagaries of selling directly to end consumers. The problems arising from their retail operations often serve to distract management from their core business of manufacturing with often times disastrous results. To combat these issues both La-Z-Boy and Bassett have adopted a decentralized management structure with respect to their retail locations. ABTV would not be surprised to see other manufacturers attempt the same strategy over the next three to five years, however, due to cannibalization of existing sales and the headaches associated with managing a retail operation, we do not believe this is a strategy that will meet with much, if any, success in the long term.

COMPARATIVE ANALYSIS

The chart below indicates numerous financial measures for selected companies versus the furniture and fixtures industry as a whole. This data is provided to ABTV's clients for benchmarking purposes:

Based on the above data, it appears that the selected manufacturers are, for the most part, doing a good job with respect to receivables management. Additionally, the group is not particularly highly leveraged with the exception of Rowe. ABTV expects many participants in this industry to pursue debt financing over the short term in order to assist through the downturn and to provide cash for potential acquisitions in the medium and long term.

ABTV CONCLUSIONS/OBSERVATIONS

• Recent retail bankruptcies, increasing levels of imports and a general softening in the marketplace have caused a major overcapacity problem among domestic manufacturers.
• Management in this industry has generally been slow to recognize the shift to offshore manufacturing. This issue should be carefully analyzed to determine the extent to which any given company may have exposure and/or opportunities.
• Consolidation in the industry is likely to continue creating a two-tier system in the industry with full service giants on one end of the spectrum and small, niche players on the other. Mid-size manufacturers will be further squeezed and will have to grow quickly in order to achieve economies of scale in order to survive.
• Appropriate management of working capital accounts is key to obtaining bank-type financing since other assets are of limited collateral value.
• Strategic planning must include tactics for achieving faster delivery times.
• Effective brand management may be a major opportunity to create value for a manufacturer, particularly if there are features that distinguish the manufacturer's products from its competitors.
• Vertical integration is unlikely to insulate manufacturers from demand-side problems.
• Analysis of the "selling proposition" of a manufacturer's sales force should include a detailed review of credit policies to insure that the focus is on selling furniture, not credit.
• Quality is the hidden killer in the industry. Chargebacks due to poor quality can shave as much as three to five points off of a company's margin. Companies utilizing overseas manufacturing may experience significantly higher levels of returns and customer chargebacks, in some cases potentially exceeding 10% of sales.