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Healthy Canadian economy bodes well, but...

Manufacturers, retailers struggle to stay competitive in import-saturated market

By Michael J. Knell -- Furniture Today, December 25, 2005

Retailers' challenge
Major threats

Ottawa — A healthy Canadian economy seems to bode well for this country's furniture makers, importers and retailers in 2006, but executives in all segments note there's underlying trepidation and uncertainty, stemming from a variety of sources.

The big question as 2006 nears is whether the Canadian International Trade Tribunal will investigate a complaint lodged by Canadian furniture manufacturers alleging the sudden rise in low-cost imports from China has caused material damage. Should the complaint carry the day, safeguard tariffs as high as 75% could be imposed on all household furniture imports from that country.

At press time, the CITT had yet to decide whether to investigate, and it seems unlikely any investigation would begin before the New Year, meaning debate on this issue will consume much of the industry's attention during the first quarter, and certainly will be the most important talking point during next month's Canadian Home Furnishings Market in Toronto.

Seeking safeguards is seen by many as a desperation measure and is criticized by importers and most retailers as short-sighted, doing little more than turning off a consumer already too easily dissuaded from buying furniture.

When pressed, most retailers admit it's crucial to their businesses that Canada continue to have a viable furniture-making sector, since special orders remain a key marketing and merchandising tool, and Asian factories can't offer the variety and speedy service that Canadian producers can.

In the past few months, almost 2,000 furniture manufacturing jobs have been lost, and Canadian producers believe as many as 10,000 more are vulnerable in the immediate future. The most commonly expressed fear — by both factory and retail executives — is that once lost, manufacturing capacity can't easily be restored, making retailers even more dependent on imports, which haven't guaranteed profitability despite their relatively low cost.

While Canadian manufacturers are focusing on finding ways to remain relevant in an import-saturated market, retailers also are struggling to stay competitive.

Retailers' challenge

"From our perspective, it's going to be a challenging year for independent retailers," said Michael Graydon, president and CEO of Mega Group. "The economy is going to continue to be fairly strong, but the big boxes aren't performing as well as they would like, and this means it's going to be very price competitive."

For one thing, furniture retailers aren't simply competing with each other any more.

"The challenge is that there is no business anymore that does business in one commodity," said Dennis Novosel, president of destination store Stoney Creek Furniture in Stoney Creek, Ontario. "Look at grocery stores. Who would have thought of a grocery store as a place to buy furniture a couple of years ago? But that's what they've become."

Bill Tepperman, president of Tepperman's, an 80-year-old regional retailer based in Windsor, Ontario, said change is the one thing that's constant in retail.

"It's going to be a very demanding year. It's going to be a very challenging year. So what else is new?" he said. "We have faced numerous challenges that some said would be the end of the independent retailer. We were told the onset of Woolco would put us out of business. We were told the onset of Sears would put us out of business.

"But we're still here. It's just that you have to focus on getting better at what you do. You have to get better at servicing the customer. We continue to offer value and service, and we couldn't be going into our 81^st year if that message wasn't getting across," Tepperman said.

The underlying problem for furniture makers in this country is the value of the Canadian dollar. Since January 2003, it has risen from an average of 68 U.S. cents to the dollar to about 84 U.S. cents in the fourth quarter of 2005. In addition to making Canadian-made furniture more expensive in the United States, the industry's only significant export market, the stronger Canadian dollar has driven down profit margins.

In some cases, with Shermag the most notable example, it has pushed once profitable, growing companies into the red. And that's despite the fact that Shermag's sales to U.S. retailers have grown by healthy amounts over the past few years.

Although many observers believe the Canadian dollar will fall a cent or two in 2006, that still would leave it well above the 73 U.S. cents most industry executives see as ideal for Canadian manufacturers.

Meanwhile, in a report written for members of its Cantrex Group division, Sears Canada's Market Insights and Research department noted the dollar's volatility has negative implications for retailers.

"The Canadian economy is being held in a delicate balance by the value of the Canadian dollar," the report said. "If the dollar continues to increase, growth could slow, interest rates fall, and unemployment rise. On the other hand, a weakening dollar has the potential to accelerate interest rate hikes, leading to higher debt service costs, lower consumer spending, and disincentives for business investment.

"While most forecasters have provided alternative scenarios for significant changes in the dollar, most also foresee the economy continuing in balance and posting good growth, given the current underlying strengths."

Major threats

The major threats include rising oil prices and continuing fiscal and trade deficits in the United States, the report said.

Although prices at the pump have moderated recently, forecasters continue to call for increased gas prices and jumps in the cost of home heating fuel now that winter has set in. That's seen as keeping consumers out of furniture and other stores.

A recent report from the Conference Board of Canada said consumer attitudes toward big-ticket purchases — specifically homes and cars but including furniture, bedding and appliances — have dropped in recent months, with 54% of Canadians believing now is a good time to buy big-ticket items, down 6% from just a few months ago.

Consumer spending grew 3.5% in 2004, but is expected to post slightly smaller gains in 2005 and 2006, slowing again in the 2007 to 2009 period, according to the Sears Canada report.

On the plus side, interest rates continue to be low, although home mortgage rates are likely to rise in 2006, moderated by low inflation and the strong Canadian dollar.

Canada's unemployment rate reached a 30-year low in 2005's fourth quarter, while personal disposable incomes continued to grow, although most observers forecast that real income growth will slow considerably from 2007 to 2009. This country's gross domestic product is predicted to grow at moderate, sustainable rates through 2009.

The key barometer for furniture sales remains housing starts, which, according to the Canadian Housing and Mortgage Corp., will moderate in 2005 and 2006 after posting a 17-year high in 2004. "Residential construction activity will slip 4.2% to 223,600 units in 2005," the federal agency said recently. "Starts will remain strong in 2006 at 207,200 units, the fifth consecutive year over the 200,000 level."

Historically, furniture sales in Canada lag housing starts by about 18 months.

Meanwhile, sales of existing homes also are expected to moderate. "They will establish a new record of 475,000 units in 2005, then dip to 453,000 units in 2006," the agency said. "After posting its strongest increase in 16 years, house price growth in 2006 will moderate to 4.9% as markets become more balanced."

In sum, the Canadian furniture industry's outlook for 2006 is decidedly mixed.

The strength of the overall economy indicates both manufacturers and retailers should enjoy growth and prosperity. But the uncertainties of exchange rates and global trading patterns will produce a variety of competitive pressures that will require finely honed strategies and flexible managements.

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