There are a number of significant occurrences that have a major influence on the connector industry’s profitability. The most important are:
- Rising raw material costs without the ability to raise connector prices. Materials make up, on average, over 50% of a connector company’s cost-of-goods-sold. As a result, rising raw materials costs without offsetting prices increases has a significantly negative influence on operating income.
- Sales growth or sales declines are also a big factor in profitability. Sales growth can hide a lot of spending sins and growth also lowers the impact of fixed costs on profits. Conversely, large declines in sales, as we experienced in 2009 with sales down -20% year-over-year, will destroy profitability. In 2009, operating income of the connector industry was -22.0%, producing the first loss for the connector industry since the 2001 and 2002 dot.com fiasco.
- Price, in our opinion, has the largest influence on profits. A business environment that allows price increases will generate more profit per unit sold. Conversely, a price erosion environment will cause a serious decline in operating income.
Currently we are in a fairly lethargic growth environment. 2012 sales declined -2.7% and 2013 is forecast to grow only +4.2%. However, regardless of this very benign grow scenario, the connector industry is achieving the highest operating income in over a decade. In 2011 industry operating income was 12.7% of sales. In 2012 operating income was 12.6% of sales. This is the industry’s highest profitability since year 2000.
The following graph shows industry operating income, as a percentage of sales, since 2002. You will note that 2011 and 2012 achieved the highest operating income of the decade.
Connector Industry Average
Why is operating income higher now than in any of the past years?
Certainly cost-of-goods-sold (materials, labor, overhead) influences profitability. All companies work to be efficient and lower costs through productivity programs and utilization of sophisticated purchasing techniques and hedging strategies. Internal cost reduction programs, consistently implemented over time will make a positive contribution to profitability. However, that’s the norm. Companies always have done this, including in the years where profitability is lower than in 2011 and 2012.
We believe the last three years, especially, the last two years, have been more profitable because the connector industry has not experienced price erosion. As evidence, the following table displays operating income, as a percentage of sales, next to the year-over-year change in sales and the change in connector prices for the years 2002 through 2012. You will note that prices increased in 2010 for the first time in over a decade and prices remained stable during 2011 and 2012 i.e. no price erosion. As a result, operating income is at higher levels than we have seen since year 2000.
Operating Income, Sales Growth, Price Erosion
In 2010, industry sales grew 28.4% recapturing all the connector demand lost in the 2009 financial crisis. Additionally, connector prices increased an average of 3.0% in 2010 as connector companies raised prices to offset soaring raw material costs. Since 2010, raw material prices have stabilized and have been declining modesty in 2011 and 2012. This is important, connector prices have not declined with the decline in raw material costs. As a result, the industry is achieving the higher operating margins. The higher profits are being achieved in spite of a lethargic growth environment (sales up +6.6% in 2011; down -2.7% in 2012).
Certainly a robust growth environment coupled with on-going cost reduction programs has a very positive influence on a company’s profitability. However, in our opinion, nothing is better than rising or stable connector prices. The industry is in a sweet spot, stable prices and declining material costs.
Our 2013 wish is for continued price stability for connectors and raw materials and sales growth. The industry will probably all three wishes in 2013. If so, the connector industry will achieve still higher operating margins.