The small-supplier saga: small companies have shifted their focus from survival to doing well in an improving market. It remains to be seen just how well they can do, given increased pressure on margins

Railway Age, July, 2004 by John T. Kelsh, Lee A. Clair

Rail supply companies, particularly those associated with equipment manufacturing, have been riding a wild roller coaster. Things are on the upswing again, and the "buzz" is now all about parts shortages and soaring steel costs.

Most suppliers are small, often family owned businesses. In the current Railway Supply institute member company listing, only 9% of the companies report annual rail industry revenue of more $100 million. Eighty-six percent report annual revenues under $30 million, and most of those are under $10 million.

Norbridge, Inc., discussed recent demand swings with 20 small equipment-related suppliers to better understand how they have persevered. These suppliers are particularly challenged by the cyclical nature of rail supply. Pricing also is a concern. While they believe price pressure is partially a result of the recent downturn, they also believe competitor and supplier consolidations are contributing factors. However, they maintain an optimistic outlook.

Cyclicality is the most serious challenge, because it limits options. There are four primary. impacts. The first is limited access to capital. The unpredictability significantly limits the willingness of financial institutions to provide financing and the price of the financing.

Second is caution about how much is invested during times of strong demand. Future cash flows cannot always be projected, or relied upon. In the past, many companies took on considerable debt to fund expansion during up cycles--and found themselves severely cash constrained when the down cycle came. This is a mistake they are not anxious to repeat, even flit means missing demand and growth opportunities in the current recovery.

Third, owners find it difficult to extract value from their companies. During times of soft demand, small rail suppliers focus on survival and preserving cash. During peaks, some hesitate to extract cash, as it may be needed during the next downturn. For some, opportunities to sell companies abounded during the late 1990s and evaporated during the downturn, but activity is now resuming.

Finally, it's difficult to attract and retain good employees. Companies lay off experienced employees during downturns, only to find that many move on to less cyclical industries. Consequently, hiring and training new employees drives up costs and slows down the ability to react to market expansion.

Some suppliers are addressing cyclicality through diversification. Many already have non-rail product lines; nearly two-thirds expect to begin or continue diversification.

While the recent downturn created intense price pressure, customer consolidation and competition from larger suppliers and foreign suppliers also contributed to price erosion.

Some small suppliers are finding it increasingly difficult to compete with larger competitors. It's felt that customers want fewer suppliers, and that those with more products are more likely to win business. Additionally, as customers consolidate and reduce headcount, small suppliers are more likely to get locked out as customers move toward long-term contracts. In this environment, winning orders is becoming more dependent on price, and less dependent on personal relationships and customer service--which small suppliers have traditionally excelled at. This shift away from relationship-based business has not gone unnoticed by foreign suppliers, and is occurring at a time when steel-related material costs have skyrocketed.

In the words of Zeftek president Mike Murphy, "Further supplier consolidation will drive down the number of small companies in the next few years--except for those that offer niche products. To be small and survive, one must be innovative, and extremely service oriented." Adds Hadady President Bob Cantwell, "Small companies drive much of the innovation in this industry. If we lose that, it will be a major setback for the industry."