By most accounts, 2004 will be a turnaround year for industrial distributors. Economists expect a pickup in many of the key manufacturing sectors distributors sell to, and the overall economic outlook bodes well.

Economic activity in the manufacturing sector grew in November for the fifth consecutive month—its best month in 20 years, according to the Institute for Supply Management, which monitors manufacturing business activity with its monthly Report on Business. The overall outlook remained strong at the end of the year, with analysts predicting GDP growth of 4.5 percent in 2004. Comparatively, the U.S. economy saw GDP growth of 3.1 percent in 2003 and just 2.5 percent in 2002.

But better business conditions aren't necessarily a harbinger of greater sales and higher profits. The problems distributors have faced in recent years—a shrinking customer base, margin erosion, the need to do more with less—aren't going away, and it will require innovative thinking and hard work for distributors to succeed. In particular, experts say the long-term decline of U.S. manufacturing means that distributors must work harder than ever to sell more to existing customers, especially by way of services.

Indeed, those companies whose business strategy is to ride the wave of an improved economy may reconsider that course of action as the year unfolds.

"I think 2004 is going to be a good year," says Adam Fein, president of Philadelphia-based Pembroke Consulting, which advises wholesale distributors, manufacturers and B2B technology companies on a range of business issues. "The rising economy is going to benefit all distributors, and to some extent will mask some of the decisions that need to be made…The savvy distributors who are ready to take a hard look at their businesses will be the ones who are here for the long term."

The U.S. economy is emerging quickly from three lean years of recession and sub-par growth, says Jim Haughey, director of economics for Reed Business Information in Boston. He expects GDP growth of at least 4 percent for several more years.

Haughey and others attribute the abrupt turnaround to a combination of low interest rates for a sustained period, a massive shift of the federal government budget from a $350 billion surplus to a $350 billion deficit, a 20 percent-plus depreciation of the dollar that improved the trade deficit, and the emergence of Canada, Mexico, Japan and Europe from their recessions. Both manufacturing and construction felt the first boost from the economic recovery at the end of last summer. Growth is expected in both markets during 2004, though at a slower rate than the overall economy.

Construction spending is expected to rise 3.3 percent in 2004, which is about the same growth seen in 2003. The difference this year is that commercial and non-building contractors will account for all the growth, as opposed to residential contractors, who experienced the most growth last year.

Manufacturing production will expand 3.9 percent in 2004, Haughey says, recovering the 1.6 percent decline over the previous two years. Normally, he adds, a 6 percent gain would be expected, but this is an unusually weak recovery period in manufacturing because about a third of the anticipated 6.5 percent gain in goods purchased in 2004 will be met by higher imports.

Haughey expects manufacturers of consumer packaged goods to expand production this year by 3 percent to 4 percent, only a little short of normal. Manufacturers of apparel and textile products and consumer durables, however, will have a much weaker than usual pickup because they have more competition from China.

Fein predicts a similar scenario in his 2004 Economic Outlook published by the National Assn. of Wholesaler-Distributors. He anticipates a positive year for distributors, noting that key markets, such as aerospace and defense, semiconductors, industrial machinery and computer equipment, will expand.

At the same time, Fein points out that manufacturing will never rebound to the levels of five years ago. For the first time ever, retailing and wholesaling contributed more to GDP than manufacturing did in 2002, for example. In addition, American manufacturing has lost 2.5 million jobs in the last few years, a situation that has had lingering effects on distributors. Industrial distribution employment levels are down 13 percent since 2000, though Fein expects those levels to rebound slightly this year, mirroring some improvement in manufacturing employment.

This means distributors face the challenge of maintaining a customer base that is consistently under siege.

"Industrial distributors are going to have to figure out what they can do to help manufacturers lower the cost of doing business so they can survive," Fein says, adding that success will be measured by productivity gains for manufacturers.

One way distributors can help manufacturers become more productive is by performing some of the functions that aren't directly involved in producing a product, but are nonetheless a necessary part of the job. Fein cites two examples that are growing in popularity: kitting of MRO products and contract manufacturing. Kitting means putting like products, or those that will be used together, in a ready-to-use package for customers. Contract manufacturing refers to the fabrication of custom or proprietary components and assemblies by a distributor on behalf of a customer or supplier. Both services allow customers to spend more time producing the product and less time on prep work and other peripheral functions.

Fein and his colleagues questioned distributors about such services for their upcoming Facing the Forces of Change study, a report that examines trends in wholesale-distribution and is published by NAW's Distribution Research & Education Foundation. Fein says 77 percent of all the distributors interviewed said they will offer kitting services in the near future, and 70 percent of OEM distributors expect to offer contract manufacturing. In both cases, the majority of distributors said they will charge for those services.

"Providing services that directly impact the productivity of your customer creates value, and distributors can get paid for that value," Fein explains. "Distributors who give things away for free won't survive."

A fee-based service approach to business is not a new concept in distribution, but it represents a major change in the way many distributors go to market.

"This will be a challenging decade for industrial distributors," Fein argues. "The industry is not going away, but the distributor's role and how [he makes] money will change over the next decade."