Volume 1, No. 8
October 2005

Judy Ravin
Judy Ravin guarantees accent reduction within 28 days
Mercantile bank staff
Walt Beyers new President of Mercantile Bank
Arbor Networks
Arbor Networks, local technology success story
Alpaca farming
Local couple turns alpaca farming into a new business

Local Firms Searching
For Silver Lining

Hurricane Disaster Coupled with High
Fuel Costs Hit Already Weak State Economy

LaRoe and Fingerle
Paul LaRoe (left), of LaRoe Remodeling and John Fingerle, President of Fingerle Lumber Co. discussing building materials pricing.

Larry Hill
Larry Hill, Vice President at O'Neal Construction, has to deal with regular increases in materials for construction projects.

By Kate Kellogg

The summer of record-high oil prices also became the summer of the deadliest natural disaster to hit the country in a century. Michigan’s already strapped economy appears even more uncertain as it absorbs the impact of these combined hits. Businesses have adopted a wait-and-see attitude in the hope that consumer confidence will rebound when oil prices eventually stabilize.

But before we look at how local business owners are faring, a couple of facts are worth noting. Michigan’s current problems hardly compare to those of the hurricane-ravaged Gulf Coast. And Michiganders should be proud of their state’s willingness to lend a hand. Many Michigan companies have provided funds and assistance to Katrina victims. According to Newsweek, our state—despite having the highest unemployment rate in the nation—ranked ninth nationally in the number of hurricane refugees it sheltered.

What the Experts Say
Even before Katrina hit, consumer confidence had plummeted in all U.S. regions, mainly due to high gas prices, according to Richard Curtin, the director of the University of Michigan’s Survey of Consumers. “Consumers anticipated higher inflation, higher interest rates, higher unemployment, and a slower pace of economic growth during the year ahead,” Curtin said in his August survey. While home sales have not yet fallen dramatically, consumers are purchasing in anticipation of increased prices and mortgage rates. Vehicle buying plans are more dependent than ever on deep discounts, the survey reports.

The survey was released pre-Katrina, before oil prices had reached nearly $70 per barrel and gas was selling at more than $3 a gallon in most of Michigan. In a mid-year forecast, also released in August, U-M economist Saul Hymans predicted that oil prices would fall back to less than $50 a barrel in the next two years and that the national unemployment rate will continue to edge down.

Zooming from the national scene into Michigan, U-M researchers George Fulton and Joan Crary offered both good and bad news in a September forecast update of their Michigan Economic Outlook for 2005-2007. The bad news is that the Michigan economy continues to struggle with job losses totaling almost 17,000 in July. Those losses were concentrated in manufacturing and government and are expected to be reversed later this year.

The researchers forecast that modest job gains in the state will be sustained through 2007 and then finally begin to keep pace with the rest of the country. However, they predict that the Big Three industry market share will once again decline during 2006-2007 and that the recent uptick was just a result of employee discount incentive plans.

Prepared before the extent of Katrina’s damage to the Gulf energy infrastructure was assessed, the forecast does not factor in possible effects for Michigan. The researchers do note the potential for lengthy supply disruptions.

In view of Katrina’s potential for keeping oil prices higher than anticipated, the forecast includes a “what if” scenario. Fulton’s and Crary’s hypothetical scenario predicts how Michigan’s economy would fare if oil prices remained at $70 per barrel through 2007. Like Hymans, the researchers had made the pre-Katrina prediction that oil prices will retreat over the next two years.

If prices remain at current levels, “the less fuel-efficient pickups and SUVs that have been the bread and butter for the Big Three producers in recent years” would most likely be hard hit, the researchers predict. Employment would be lower than in the actual forecast by 18,000 jobs in 2006 and by 40,000 jobs in 2007. Real disposable income would be 1.8 percent lower than if oil prices retreat to $50 per barrel in late 2006 and 2.4 percent lower in 2007.

No wonder the state’s small business owners appear highly uncertain about their economic futures. The National City Small Business Confidence Index is based on a survey of small business owners in seven Midwestern states. The August survey showed the lowest confidence reading for Michigan businesses since April when auto production was in a steep decline.

Tough Times for Truckers
Ann Arbor area businesses are in no way immune to these ripple effects. Many are preparing for a long haul of higher materials and transportation costs. Some anticipate a continuing lull in sales and business activity as the state lags behind the nation in economic recovery. All of those we talked to are budgeting carefully and hoping for the best.

Few businesses have been more affected by fuel prices than Con-Way Transportation Services Inc., an Ann Arbor-based trucking company. The company, which operates service centers throughout the country, has had to pass costs along to customers by raising surcharges for diesel fuel. Con-Way generally uses the U.S. Department of Energy National Average Price for a gallon of diesel fuel as the base for calculating fuel surcharges.

Fuel surcharges have been running about 16 percent for less-than-truckload shipments, says Ned Moritz, vice president of marketing for CNF Transportation Inc., the company’s holding company. The surcharge has been climbing steadily since it was averaging about 10.5 percent average last January. Customers can view surcharges for each upcoming week on the company’s web site.

Con-Way has service centers in areas affected by the hurricane, including Gulfport and Jackson, Mississippi and Baton Rouge, Louisiana. As of early September, all centers but the one in New Orleans were back in operation. “However, the delivery of freight in the area is sketchy due to road closures and lack of electricity,” says Moritz. “People’s lives have been disrupted, let alone their businesses. We’re being very careful about contacting shipment destinations to make sure someone is there to receive the freight.”

Con-Way trucks are now busy making emergency supply deliveries to damaged areas in the gulf region, he adds. Generators are needed, as are replacement parts and nonperishable food. Debris must be removed. “It will be a continuing and massive delivery process.”

The supply as well as the cost of diesel fuel has been a concern. More than a week after hurricanes hit, coastal states as far north as Virginia were short on diesel fuel. A number of Con-Way trucks had to buy fuel on the open market just to make sure their tanks were full, says Moritz. “We’re trying to deal with the crisis as best we can, like anyone else in the market.”

The High Cost of Everything
The construction industry and related areas have been hit with double and triple whammies. Not only are their own fuel costs higher, but the surcharges contractors must pay for shipping have increased. And Katrina has pushed the already high costs of many construction materials even higher.

“Materials prices are really out of hand,” says Larry Hill, vice president and chief estimator for O’Neal Construction Inc. “For the past couple of years, steel and wood prices have been high and so has cement, due to shortages. Now fuel prices are up as well. Overall, we’re seeing a six to ten percent increase in the costs of fuel and materials.” Those increases, of course, add to the cost of all construction projects for O’Neal’s customers, which build primarily large, commercial projects. “Since inflation usually runs at about 2-3 percent, they’re stunned when they see double-digit increases in projects,” he says.

The construction industry revolves on a broader cost cycle than the rest of the economy, he explains. The industry is currently caught in a cycle of material and energy cost increases that may worsen as the effects of Katrina come into play. Yet the company has developed a secure backlog of work for next year and has a number of projects lined up for 2006. Due to the uncertainties of Michigan’s economy, O’Neal Construction is taking a frugal approach toward hiring for those projects. “Most customers will have us start a project on schedule, but you never know whether they may decide to delay the work. We’re a low-turnover company and don’t like to lay people off,” Hill says.

In the meantime, the company is trying to save as much fuel as possible by keeping trips to and from meetings to a minimum. Last month, O’Neal increased its mileage reimbursement for employees. “Gas prices rose so much in the past year that our previous reimbursement rate was almost laughable,” says Hill.

Since all materials that go into new construction also go into remodeling, LaRoe Remodeling Inc. has been similarly burdened. Concrete and cement especially have gone up, as have drywall and roofing materials, says owner Paul LaRoe. High energy costs in manufacturing are producing a trickle-down effect.

“The harsh reality is that materials manufacturers are paying more for natural gas to run and heat their plants and that raises prices across the board,” he says. “Price increases are passed from manufacturer to distributor, then on to us. Since we can’t afford to absorb these costs, we must pass them along to customers.”

Added to materials costs, are increases passed along from freight contractors, many of them small businesses. The cost of fueling LaRoe’s own trucks is still another annoying business expense. And with the jump in the price of natural gas, LaRoe foresees higher bills for heating his company’s 4,200-square-foot building this winter.

He is uncertain whether the reconstruction of hurricane-destroyed areas will impact supplies of vital materials. More unsettling to remodelers, are the uncertainties of Michigan’s economy. Since the remodeling market is linked to consumer confidence, that market is soft right now, according to LaRoe. Business was down 30 percent for the first half of this year; his company has had to revise the annual budget to reflect the drop in sales. “If people feel insecure in their jobs, they will put off home remodeling until next year,” he says. “The softening in the housing market also affects us because people like to remodel when they see the value of their house going up. People are saying, ‘I don’t want to over-invest right now.’ I haven’t heard that since the 1980s.”

With manufacturers like Visteon and Ford closing plants in the area—and even Pfizer laying off workers—the economic climate is not conducive to spending money on anything beyond the essentials, he believes. “We’re completely tied to how people feel about their jobs and their futures.” And high gas prices only exacerbate the problem.

On the bright side, business has somewhat picked up in the second half of the year, LaRoe says. Clients who have secure jobs in areas such as health care or higher education are keeping the design part of LaRoe’s design-build work flowing. But in his eyes, the job is still fragile until the building begins. “I hold my breath until that construction contract is signed,” he says.

Be Prepared
The retail lumber business entails the transportation of heavy materials. Fingerle Lumber Co. has incurred the direct cost increases of running their fleet of trucks as well as higher surcharges from suppliers.

“We made a modest adjustment to delivery charges prior to the hurricane, but it was probably long overdue,” says John Fingerle, company president. “The majority of our products are sold and delivered on an individual basis with no specific delivery charge. We’ve elected to absorb fuel surcharges and not pass them on.”

Fingerle attributes cost increases for lumber, plywood, and strand wood mostly to the high cost of diesel fuel used to transport those products. He believes another factor may be the anticipation of shortages of these products. Dealers nationwide expect heavy use of lumber products in the rebuilding of the Gulf Coast area. “They think shortages will cause prices to go up and so they stock up on these materials,” says Fingerle. “Stockpiling may create a self-fulfilling prophesy.”

Fingerle Lumber extended its own inventory position by just a couple of weeks after the hurricane hit, he adds. Many lumber products come from the southern states and no one yet knows how widespread the damage has been to saw-mills. In fact, many of the hurricane’s economic effects are as yet unknown, he observes. “It’s possible that major construction projects that were underway in the gulf area may be abandoned indefinitely, making materials available for other markets.”

He notes that even with recent spikes in lumber prices, those prices are still lower than they were a year ago. Many wood-producing regions in the U.S. and Canada continue to yield large supplies of lumber. Overall, the building material business is going at a good clip nationwide, says Fingerle. “We’re still as busy as we were last year at this time—and last year was a decent year.”

For the Big Three auto companies, things couldn’t get much worth. High fuel prices have cut deeply into the profits they once enjoyed for sport utility vehicles. As Curtin noted, G.M. and Ford are heavily dependent on discount pricing to move their inventories. However, gas prices have been less problematic for dealers of more fuel-efficient models.

“If anything, gasoline hikes have created more exposure for hybrid and diesel fuel vehicles,” says George Davis, general manager of Howard Cooper Imports. He says customers are clamoring for diesel Volkswagen Jettas and hybrids such as Honda Civics, Accords, and Insights. “I think people are trying to be more practical in their decision-making,” he says. They’re looking for vehicles that provide superior gas mileage without loss of performance. It’s another horizon.”

He says the dealership hasn’t experienced the predicted negative effects from the hurricane, such as shipment delays. That’s the case so far, he says, adding, “But we’re prepared for that to happen.”

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