What an office-supply cabinet says about the future of the economy

November 6, 2012

For a sense on how things are going in the nation’s service sector, take a look in your workplace’s office-supply cabinet. Two major companies’ latest financial numbers give a sense of the economic trends afoot in offices across the United States, and they’re flashing signs that no major upswing is on the way.

Although there is a wealth of measures of how things are going in the U.S. manufacturing and construction sectors (industrial production, factory orders and a wide range of housing-related data, for example), things are murkier with service businesses. It is reasonably easy to figure out that a given auto factory has the capacity to produce 20,000 cars but is only making 15,000. How, though, do you assess how much insurance an insurance company has the capacity to issue? How many real estate deals a brokerage firm can broker? How much educating a private college is capable of doing? These questions give economists who are trying to measure business activity fits.

On Monday, the Institute for Supply Management survey of non-manufacturing businesses reported slower expansion in the sector in October (the index was 54.2, down from 55.1 in September). But that is a pretty broad measure for a sector that accounts for 84 percent of U.S. private-sector jobs. To get a more granular sense of what is happening among the nation’s millions of office workers and the companies that employ them, we can look at the earnings numbers for the companies that sell them the goods they need to do their jobs, namely Office Depot and Office Max. Both reported third-quarter earnings Tuesday morning. (Numbers for office supplier Staples are due out next week.)

When companies are expanding and hiring workers, they presumably need more desks, computers, business cards and pens, creating more demand at major office-supply companies. When they are in cutback mode, there is less need for new furniture and equipment, as employees get more snippy memos from the office manager about not wasting paper clips.

The numbers out of the two office-supply giants (Office Depot has 1,114 stores in North America; Office Max has more than 900) show these firms are still facing a very difficult business environment, one in which their customer base is not growing enough to overcome structural shifts that hurt sales.

Office Depot reported a 5 percent decline in sales, compared with the third quarter of 2011, and an operating profit swing, from a $19 million profit to a $55 million loss. Office Max said sales fell
1.7 percent, and operating profits fell to $33 million from $41 million. Both companies closed stores in that span, but even on a “same store” basis, taking out those that were closed, sales were down 4 percent at the Office Depot North American Retail Division and 2.1 percent at Office Max’s retail division.

But there’s another reason, in addition to the weak service economy, that office supply firms are struggling: the constant tech revolution. A shift in consumers’ computer preference for tablet devices instead of more expensive laptops has hurt sales (though, interestingly, helped profit margins). More and more people purchase software by downloading it rather than buying a box in a store. There is a longer-term shift toward storing information digitally, which means less demand for filing cabinets, paper and other goods that are the bread and butter of office-supply retailers. Brick-and-mortar retailers in all industries are facing intense competition from leaner online retailers.

But while many of the companies’ challenges are tied to structural shifts in the economy rather than cyclical weakness, both firms are reshaping their plans on the premise that there is no groundswell of expansion among its customers coming anytime soon. Office Depot said it will spend $60 million next year to downsize many stores and close 25 to 30 of them. Office Max has a similar strategy for becoming leaner.

“We expect the tough economic environment in the United States and Europe to continue through at least 2013,” said Neil Austrian, chief executive of Office Depot, in a conference call with analysts. “We will continue investment in store downsizing, e-commerce and services. The new strategic plans “will position us to see further growth when the economies of the U.S. and Europe improve.”

“The economy is not giving us any tail wind,” said Ravi Saligram, chief executive of Office Max, at an investors conference in September. “I don’t see any improvement in terms of a significant level.”

In other words, the companies are not building capacity to accommodate the demand created by a growing economy. Rather, they are still in the ugly adjustment period of getting their capacity — how many stores of how many square feet with what mix of inventory — to match up to the demand in the post-crisis recovery. That adjustment process adds more economic challenges, as workers in those newly closed stores and landlords, used to getting rent checks, do without.

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