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November 1, 2005

Four More Years

The home appliance industry is coming off some of the best years in its history. But can it continue the campaign?

When Hurricane Katrina hit the Gulf Coast in August, appliance industry analysts were predicting slower but still strong growth for the industry. At press time, the storm’s devastating impact on the economy was only beginning to be calculated. But just a week after the hurricane hit, the Congressional Budget Office predicted that the disaster could trim as much as a point off economic growth in the second half of the year.

Peter Greene, president of NPD Houseworld, a market research firm, says the rebuilding effort is likely to show up in appliance sales next year. While he doesn’t expect it to have a huge impact on units sold in 2005, he says it could provide a small bump in December. (However, units shipped are likely to jump to replace what was lost at the retail and wholesale levels.)

Even without the demand generated by the hurricane’s force, 2005 should be a record year for the home appliance industry. Sales of appliances in the main categories of washers, dryers, dishwashers, refrigerators, freezers and ranges—the largest products and biggest users of metals—should set a record for the fourth year in a row, says the Association of Home Appliance Manufacturers (AHAM). Separate research from NPD Houseworld finds that, in units shipped, the appliance market was up 8.6% for the first six months of 2005 over the same period in 2004. Things have been so good that even Maytag Corp., a lackluster performer but with excellent brand recognition, was hotly courted by an international collection of suitors, ending with a bidding war eventually won by competitor Whirlpool Corp.

So why are so many appliance company executives nervous that they could get stuck in the spin cycle? Because not everyone agrees with AHAM’s forecasts, and the post-Katrina rebuilding effort will not sustain the industry for long. The same trends that earned record sales—namely the economy and the housing boom—could be headed for a downturn. Even the famously stoic chairman of the Federal Reserve Board, Alan Greenspan, worried aloud in August that the hot housing market, which feeds a need for dishwashers, refrigerators and other white goods, could be headed for bust. Creeping interest rates have already slowed the refinancing trend that put equity into homeowners’ hands, sent them on a home improvement binge in 2003 and 2004, and fueled a rush to refurbish kitchens with high-end stainless-steel appliances.

SLUGGISH NOW, BUST LATER?

This year started sluggishly for the industry, but five straight months of declines turned around in June when sales of room air conditioners pushed sales of major appliances up 16.4%, past the 9 million mark for the first time ever, the AHAM found. Pre-Katrina, AHAM predictions were relatively flat for the appliance industry as a whole, with volume shipments expected to grow only 2.2% in 2006, to just over 80 million units.

Then there is the strong possibility that high energy prices could put a crimp in the economy. “If you look over the long term, [appliance] sales are more closely correlated with GDP than with home buying,” says Laura Champine, an analyst at investment bank Morgan Keegan & Co. “It’s a cyclical business that mirrors economic growth.”

Champine expects that appliance manufacturers will have a hard time repeating the strong pricing power of the last few years. “Prices have increased 7% year over year. That’s big-time inflation for an industry that normally sees a little bit of deflation every year,” says Champine. As innovations are copied and products move toward commoditization, prices generally come down. And even while prices climbed, margins at many appliance companies were declining partly due to the higher cost of raw materials, especially metals.

THE MERGER

“Raw materials are skyrocketing and consolidation could be a reaction to that,” Champine says. Obviously, the Maytag-Whirlpool merger will give the larger combined company better purchasing power over suppliers.

The merger will be scrutinized for anti-trust violations by the Federal Trade Commission, where there will likely be some major sticking points. A timetable has yet to be set for the regulatory review, but it is expected to be a long process that will likely hold up the completion of the merger. If it is confirmed as is, the combined company would control roughly 70% of the laundry appliance market and almost half of the U.S. market for major appliances.

THE ASIAN INVASION

While the Chinese appliance company Haier Group Ltd. failed in its own bid for Maytag, the invasion of Asian companies into the North American appliance market is unstoppable. Along with Haier, two Korean companies, LG Electronics and Samsung, mostly known for electronics, have entered the U.S. home appliance market. LG has built on its cell phone success and now is making inroads with air conditioners, refrigerators and dishwashers. Samsung offers a full line of upscale appliances, including refrigerators, dishwashers and ranges.

The move has surprised some industry watchers. “A few years ago the American major appliance industry did not see much in the way of foreign competition,” says Stephen Smith, editor-in-chief of TWICE (This Week In Consumer Electronics), a magazine that covers the home appliance market. He says it was too expensive for foreign manufacturers to ship such large products across the ocean. Now, many do some of the assembly in North America, particularly in Mexico. “The Asian companies are making the biggest impact,” Smith says.

For the most part, Asian competitors have caught American companies off guard. Smith says they have hit the market with high-end products with innovative designs. Higher-end products command higher margins and thus compensate for higher freight costs.

They also have succeeded in persuading large home improvement retailers to carry their products. Maytag said that it was hurt when Home Depot, the third largest appliance retailer, made room for more LG products last year. In June, Lowe’s Cos., in second place behind Sears, announced that it would begin carrying a premium line of Samsung kitchen appliances.

BIG BOX

“More market share is going away from independent retailers to giants like Home Depot and Lowe’s,” says Smith. He says while that has increased volume for many white goods manufacturers, profitability has been hurt. “They are forced to make price concessions, which hurts them in the end.” And, he says, they are likely to push those pricing pressures down the supply chain to raw materials providers. “Somebody has to get beat up.”

More pricing pressure could result as the mom and pops are forced to cut prices to compete. In fact, a recent study by Consumer Reports found that independents priced large appliances just as low as the major chains, although they scored better on service and delivery.

The hope for independent retailers could be in the still-high demand for high-end products like Sub Zero refrigerators and Viking ranges. Timothy Somheil, editor of Appliance Magazine, says, “Appliance companies have realized that they need to create the same level of interest in their products as consumers have in their cars.”

The trend emerged when some consumers began buying commercial-grade products for their homes. This was a huge departure from the “white box” days, says Somheil. “Things were heading toward commoditization. There wasn’t a lot of differentiation in the market.” The move toward premium brands, however, is showing that consumers want more features and unique looks. “They are proving that consumers will spend money to buy a more highly featured appliances,” Somheil says.

NPD Houseworld’s Greene says that upscale front-loading washing machines continue to drive expansion in the category, and other categories are seeing interest in new designs and more features. Refrigerator manufacturers, for instance, “are bringing cool designs to the market,” Greene says. “They are building them with the consumer in mind.” The new appliances are such a departure from the old white boxes, he says, that when an appliance breaks it can spark an entire kitchen remodeling effort. “They find that the new stainless steel dishwasher doesn’t fit with the rest of the old appliances, so they replace everything.”

Baby Boom-age buyers also are looking for more environmentally friendly machines. “They are willing to pay a little more for energy efficient appliances,” Somheil says.

TWICE’s Smith agrees. Home appliances “used to be a replacement business. You only bought a new fridge when the old one broke down. Now, it has become more of a fashion statement.” Such discretionary spending may go out of fashion quickly if the economy slows, however. Analysts say the high-end brands would be the first to suffer if that happens.

OUTLOOK

Although the near-term market outlook is still difficult to read, some analysts are bullish. “Based on everything we have looked at, sales are strong and should continue to be,” Smith says.

The outlook could get a boost from Washington. Tucked into the energy bill passed in August is a provision that provides manufacturers of energy-efficient appliances a tax credit of $50 to $175 for each product produced over a base number. The credits will be earned on the number of qualifying products produced over and above the average in the previous three years. Energy-efficient products are those that meet standards established by the U.S. Department of Energy under its Energy Star program. Customers can claim tax breaks of up to 10% of the purchase price for replacing older appliances with Energy Star models.

The bill could also help U.S. appliance manufacturers compete with foreign companies because the tax break applies only to domestic producers.

Even without the one-time bounce that will follow Hurricane Katrina, home appliance makers should fare well by creating new appliances with interesting designs and new features.

“It’s the most exciting time for the appliance industry and for consumers,” says Greene. “The evolution is going to continue for awhile, and that should continue to bring new buyers into the market.”