Despite falling somewhat short of last year’s strongly optimistic projections for sales and profit growth in 2004, the record number of E&S manufacturers, dealers and end-users surveyed for this Industry Forecast 2005 report are once again looking for healthy gains in volume and earnings. In the following pages, we analyze their causes for ongoing optimism, potential growth-limiters and which products and market sectors are likely to be hottest in the year ahead.

Overview
After a stormy year notable for steady national economic growth, an upturn in inflation and interest rates, the first democratic elections ever in Afghanistan and continuing turmoil in Iraq, the nation seemed to settle into a state of relieved reflection following a contentious presidential campaign and the return to office of the incumbent.

Now, with most experts predicting a slowdown from 2004’s GDP expansion of 3.7% to something closer to 3.2%, the predominant question on many E&S professionals’ minds is how much growth will the industry be able to achieve in 2005? As always, the answers begin outside foodservice E&S and will emerge due to factors outside our control. Various geo-political events, a further hike in oil prices, a constriction of supplies, political gridlock in Washington and swings in currency valuations (which could dramatically impact the cost of credit) would all affect the economy’s ability to grow. However, with the Dow residing firmly above 10,000, unemployment down more than a full point (to 5.4%) since the end of ’03, productivity continuing to rise and increases in corporate benefit costs finally slowing, there is ample reason to believe that a historically on-trend rise in national GDP is in the cards for this year.

Of more immediate concern, though, is the currently weakened condition of the U.S. dollar (down 50% against the euro over the past three years, for instance), the lowest domestic household savings rate in recent memory (1.8% of disposable income on average vs. 4.6% 10 years ago), a federal budget deficit of 4.5% (or approximately $422 billion as of the fiscal year that ended September 2004) and an overall inflation rate of 2.5%. When these factors are considered together, it is obvious that there is little room for further federal stimulation (such as tax cuts) or price cuts to spur new demand. Fortunately, with the prime rate still only just above 2%, money for capital improvements and projects remains relatively cheap, and consumers remain awash in offers of additional credit and equity refinancing plans, thanks to the continuing strength of the real estate market.

Click on chart for larger image Chart 1 - Operators' Projected 2005 E&S Expenditures Chart 2 - Operators' Equipment Purchases By Channel, Manufacturers' Equipment Sales By Channel Chart 4 - Dealers' Greatest Projected Sales Opportunities in 2005 Chart 6 - Manufacturers' Greatest Projected Sales Opportunities in 2005

All in all, putting aside unpredictable geo-political concerns, the economic forecast for the United States this year looks mixed, though certainly not bad, and slowing but widespread growth is evidentially the most likely prospect. Therefore, what’s the specific outlook for members of the foodservice E&S industry? Here, projections vary among the involved professions.

At the top end of the distribution channel, manufacturers continue to be beset by cost increases for everything from stainless steel and energy to workers’ compensation, transport and insurance. Responding to the higher costs of their inputs, most major equipment makers either instituted price increases at the end of ’04 or plan to do so early this year, with rises typically ranging from 3% to 8%. Though higher prices will buy most factories some breathing space, making these increases stick across the board will remain a challenge, as will market overcapacity and growing foreign imports and competition. (This last fact was cited as the number-one obstacle to gaining profitable new sales by manufacturers surveyed for this report.)

Dealers of equipment and supplies, who overall enjoyed a stronger year in 2004 than ’03, will also face an array of concerns in the months ahead. Key challenges for many dealers include consistently passing along manufacturers’ price increases to end-users, as well as learning to operate profitably as their back-end payments, rather than being based on sales volume, are increasingly tied to the performance of functions that cut manufacturers’ costs or generate sales for factories. Dealers will further have to evolve to continue to succeed due to the proliferation of distribution options in the channel, an expected slowdown in contract work during the first half of 2005 and growing expectations for 24/7 service, delivery and information on the part of customers.

For their part, foodservice consultants largely had a banner year in 2004, with many firms recovering all or more than the revenue they lost in the aftermath of the dot.com meltdown and 9-11. Due to the abundance of new construction and renovation projects they participated in last year, most large and small design consultants will have clear opportunities for further growth in ’05, with bigger firms continuing to expand business abroad and with national hospitality companies and smaller shops finding profitable niches in such thriving market sectors as resorts/casinos, education and B&I. All consultancies, however, are likely to find themselves competing for work more often against the growing number of capable dealer design departments, especially for kitchen remodeling and/or facility expansion projects.

The prospects for manufacturers’ reps this year are less likely to be as positive as those consultants are encountering, if only because the current over-supply of E&S products in the market is putting downward pressure on both prices and commissions. At the same time, though, the rising number of domestic and overseas-based factories seeking more U.S. market share means that reps have more lines available to them and more value attached to their ability to provide knowledgeable local representation. In general, therefore, rep firms’ fortunes should depend in ’05 on the economic health of the operators in their particular regions and their selection of appropriate manufacturer-partners.

On the post-sale side of the industry, service agencies now have several factors working in their favor that should make 2005 a positive year. Among these are the initiative to standardize practices and accountability for equipment installations, the development of more comprehensive service agreements with national accounts and manufacturers, and the emergence of online service databases and training programs. The growing number of NAFEM Data Protocol-compliant equipment pieces networked to create “smart” kitchens should also help service agencies perform better and move to more efficient internet-integrated business models.

While all these scenarios seem probable at this writing, all members of the E&S industry will be directly affected by the economic performance and purchasing decisions of end-users, everyone’s ultimate customers. With this in mind, here’s a close-up look at the projections offered by the operators surveyed for this forecast.

Operator Findings
During October 2004, when our Industry Forecast survey forms were fielded, FE&S received replies from some 625 leading commercial and noncommercial operators nationwide. Our largest respondent group, some 29% of operators, reported annual F&B sales of $2.5 million or above and spent an average of $130,000 on equipment and supplies last year. Good news coming from our operator respondents included the fact that over one-third expect to increase their E&S budgets in 2005, by an average of 12.5%. In addition, some 70% of operator respondents said they expect to grow their sales this year over 2004’s levels, by an average of 10% among those who expect to achieve increases, and 56% of our surveyed end-users indicated that their 2005 gross profits will increase by an average of 9% compared to last year. Together, these findings indicate improved demand for E&S products, though nearly one-half of our operators do expect to spend no more on equipment and supplies this year than in ’04, mostly because they have no need for new replacement equipment.

Chart 3 - Products Dealers Expect To Achieve High Sales In 2005* Refrigeration/Ice Machines 47% Smallwares 32% Primary Cooking Equipment 31% Tabletop 25% Warewashing/Safety Equipment 15% Furnishings 12% Storage/Handling Equipment 7% Serving Equipment 5% Food Preparation Equipment 4% Other 44% Source: Reed Research Group/FE&S 2005 Industry Forecast

There are several reasons why a significant proportion of surveyed operators expect to record increased sales, gross profits and E&S expenditures in 2005. To start, some 33% of responding operators told us that they are now serving growing numbers of customers, a rising enrollment and/or more tourists and visitors, all indicating improving national economic conditions and still-strong consumer spending. What’s more, a quarter of our respondents believe that a healthier economy (than in ’03) and customers with more money to spend had resulted in higher check averages and total revenue last year. On the other hand, rising food and operating costs are expected to limit profit growth even among restaurants and foodservices experiencing sales increases. Dealers and manufacturers should note that this should boost demand for equipment that controls or reduces energy, labor, food waste or other operating expenses.

When it comes to surveyed operators’ equipment purchasing plans for this year, the most often-cited reasons respondents offered to support increases in their E&S budgets this year included the need to replace older kitchen equipment (34%), a decision to buy additional equipment to meet rising traffic or demand (18%) and to offset growing food and equipment costs (15%). These findings reinforce the conclusion presented above, but also reflect an unusually high percentage of expected replacement purchases, which upholds the assumption that new construction projects will go through a slow period during (at least) the first half of 2005.

Our surveyed operators also told FE&S which products they are allocating the greatest portion of their budgets toward in 2005 (see chart 1). Interestingly, there was a great harmony of intentions among commercial and noncommercial operators in this area. In fact, only in the categories of paper goods, furnishings and tabletop items were there notable discrepancies between the two types of operators: Surveyed noncommercial foodservices said they have dedicated 19% of their 2005 budgets to paper goods vs. 11% by commercial operators. Commercial operators also forecast that both furnishings and tabletop will each receive a total of 7% of their E&S budgets, while noncommercial foodservices plan to spend only 4% of their budgets on each of these types of equipment.

When we examined operator respondents’ equipment buying plans for 2005, we found that items more likely to be bought this year than last include steamers (33% vs. 25% in ’04), combi ovens (22% vs. 18%), steam-jacketed kettles (15% vs. 13%) and rotisseries (8% vs. 4%). Motivation for the purchase of these and other E&S products will largely be driven this year by the need for replacement items (67% of all respondents) and facility renovations (21%), with new construction in ’05 mentioned by only 13% of those operators surveyed by FE&S.

One other significant finding revealed that operators still do a majority of their E&S purchasing through dealers and dealer web sites, approximately 56% of all purchases (see chart 2). This figure, however, is down by 10% from the previous year. Though this is a noteworthy statistic, it should be stressed that FE&S’ data on this subject covers only two years. As a result, there is obviously not enough information to state with any certainty that this is a long-term trend. FE&S will continue to track this statistic in order to ascertain whether the decline is ongoing.

Dealer Findings
This year, our dealer sample base totaled 200, an increase in respondents of more than 35% vs. 2004. Some 87% of responding dealers told us that they expected either to meet or exceed their 2004 revenue goals, due in large part to last year’s improved economy and increased sales to new and existing customers. Our dealers’ sales expectations for 2005 are also strong, with 77% predicting average growth of 17% as a result of greater anticipated sales of both heavy and light kitchen equipment. Nevertheless, it is important to note that less than 50% of surveyed dealers reported increased gross profits last year, with 36% stating that their profits were flat and 16% admitting that their gross profits had declined. FE&S believes that these profit numbers most accurately reflect the actual state of business most E&S dealers experienced in 2004, as margins were squeezed for many by rising operating costs, over-capacity in the market and the proliferation of distribution options in the channel. That said, some 63% of surveyed dealers expect their gross profits to increase (by an average of 13%) this year compared to 2004 levels, while 33% expect no change from last year’s profitability levels and just 4% anticipate a decline in profits.

Chart 5 - Products Manufacturers Expect To Achieve High Sales In 2005* Serving Equipment 26% Primary Cooking Equipment 22% Warewashing/Safety Equipment 20% Tabletop 20% Smallwares 18% Refrigeration/Ice Machines 17% Storage/Handling Equipment 12% Furnishings 9% Food Preparation Equipment 8% Source: Reed Research Group/FE&S 2005 Industry Forecast

Despite these optimistic projections, dealers surveyed by FE&S for the IF 2005 report seem well aware of several obstacles to profitable new sales this year, citing most often lower prices offered by competitors, increased factory discounts to non-traditional E&S distributors and higher product costs as their chief concerns. To counter such challenges, 79% of responding dealers indicated that they, too, plan to increase prices on their heavy and light equipment this year.

Also of particular import is the fact that a sizable minority of dealers we surveyed last fall expect to increase the number of manufacturers whose products they stock and sell during 2005. Some 19% said they will add more refrigeration manufacturers, another 17% indicated they will add one or more new suppliers of permanent tableware, 16% plan to partner with more grill and griddle makers, and 14% of responding dealers will be looking to increase the number of shelving or worktable factories with which they do business. This finding correlates closely with the items that responding dealers report as their best sellers in 2004, among which were refrigeration and ice-making equipment, primary cooking equipment (including grills and griddles), tabletop items and food storage and handling products.

Looking ahead this year, responding dealers told FE&S that they expect their best-selling items to include (once again) refrigeration and ice machines (listed as a probable top-seller by 47% of responding dealers), smallwares (32%), primary cooking equipment (31%), and tabletop items (see chart 3). These projections indicate that many dealers are seeing still-strong demand from operators for various types of E&S that promote food safety and HACCP compliance, cut the cost of meal production or help keep front-of-the-house appearances contemporary and differentiated from competitors’.

The number of dealers who told us they are now doing business on the internet increased by 2% from last year’s survey, reaching 50% for the first time. Dealers currently doing 3% to 5% of their total sales online remained constant at 14%, which seems to us to be an accurate reflection of the slow but steady growth of “clicks ’n mortar” businesses activity in the E&S industry.

As chart 4 depicts, dealers surveyed by FE&S expect the commercial family dining sector to yield the best new sales opportunities in 2005 (named as one of the biggest opportunities by 51% of surveyed dealers), followed by casual/theme restaurants (47%) and healthcare foodservices (42%). Interestingly, fine-dining establishments were viewed as providing the greatest new sales opportunities this year by 27% of respondents (compared to 16% last year), while the percentage expecting the best new sales with QSR chains rose to 24% compared with 14% in last year’s forecast. We feel these increases are supported by the stronger economy’s boost to higher-end dining traffic and the quickening proliferation of multi-unit, ethnic and “healthful” quick-service concepts.

Manufacturer Findings
Over 100 NAFEM-member E&S manufacturers participated in this year’s Industry Forecast survey, a nearly 20% increase over last year’s study. Similar to dealer respondents, a very high percentage (94%) of surveyed manufacturers reported that they expected to meet or exceed their 2004 sales goals by year’s end, with an average volume upturn of 12%. Ninety-one percent of responding manufacturers anticipate better sales this year, as well, with an average improvement of 11% among those expecting volume to rise once again. As is also the case with dealer respondents, a markedly lower percentage (47%) of surveyed manufacturers reported higher gross profits in ’04 vs. ’03, while 35% said profits were flat and 18% noted that their gross profits had declined last year. Some 64% of responding manufacturers expect their gross profits to rise in 2005, by an average of 8%, which represents (logically enough) the top end of most recently announced and imminent price increases. (Some 72% of surveyed manufacturers stated that they intend to raise product prices during this year.) Manufacturers anticipating top-line growth expect it to come primarily from new and/or improved products, and new advertising and marketing programs, though they cited foreign-based competition, more aggressive pricing and escalating operating and materials costs as their chief obstacles to profitable new sales.

Our survey also revealed that responding manufacturers’ best-selling products in 2004 included serving equipment (for 25%), primary cooking equipment (24%), tabletop items (20%), warewashing and food safety equipment (19%) and refrigeration/ice-making machines (18%) (see chart 5). Similar to dealers’ responses, the presence of warewashing/food safety equipment and refrigeration/ice machines on manufacturers’ best-sellers list speaks to operators’ ongoing need to control foodborne illness outbreaks and maintain HACCP compliance, while the large number of factories whose top-seller were serving pieces was a likely outcome of end-users’ move to increasingly diverse (and distinctive) front-of-the-house concepts.

In 2005, manufacturers surveyed by FE&S expect their best sellers largely to reprise last year’s list — serving equipment (for 26%), primary cooking equipment (22%), warewashing/food safety equipment (20%), tabletop items (20%) and smallwares (18%). (Refrigeration/ice-making machines were listed next by 17%.) The inclusion of these top-five types of E&S by responding manufacturers is consistent with the projected rise in replacement orders operators are expected to place this year. One less-positive correlation between operators’ and manufacturers’ activities, however, was a decline in transactions with traditional E&S dealers (see chart 2). Though we stress again that the reported downturn in average manufacturers’ sales through dealers is still only a year-on-year comparison, a reduction from 58% in ’03 to 51% last year certainly gives cause to monitor this statistic closely in the future.

Finally, our surveyed manufacturers see only two operator market segments as offering the same strong new sales potential that dealers told us they perceive — casual/theme dining establishments (for 52%) and family-style restaurants (48%) (see chart 6). Otherwise, our manufacturer sample said that the higher-education sector (44%), QSR chains (42%) and hotels/motels (41%) represented their most likely venues for new sales and market-share growth.

In 2005, then, there is a likelihood of steady but slower economic expansion, continuing increases in higher-education enrollment, stronger demand for fine dining as the economy improves, the ongoing revival of leading QSR chains’ sales and the return to pre-9-11 lodging occupancy levels. While not without some negative data, FE&S’ 2005 Industry Forecast, therefore, indicates a strong, positive, mid-single-digit answer to the question of how much the E&S market will grow this year.