Adam J. Fein: Where productivity is growing in wholesale distribution

Productivity is fundamental to economic growth. The U.S. economy has been able to produce more goods and services over time by making production and distribution more efficient, not simply by adding more labor time. Output per hour, the most commonly cited labor productivity statistic, captures the combined effect of changes in technology, capital per worker, level of output, capacity utilization, managerial skill, and many other factors. 

Productivity is also crucial to profitability in wholesale distribution because employee compensation costs—salaries, commissions and benefits—represent 60 to 70 percent of total operating expenses. As I note in an earlier column, distributors are at the forefront of using technology to reduce repetitive, low value-added activities such as order processing, billing, inventory control, delivery route scheduling and warehouse management.   (See The productivity imperative for wholesale distribution) 

The table below compares “output per hour” in wholesale with the non-farm business sector, which includes all for-profit business sectors in the U.S. economy. Productivity growth throughout the economy began accelerating in the mid-1990s. Yet productivity growth in wholesale exceeded the overall business sector by 1.6 percentage points in the past fifteen years and by 2.5 percentage points since 2001. Note that output is adjusted for price changes, eliminating the effect of product inflation. 

AVERAGE ANNUAL GROWTH IN LABOR PRODUCTIVITY, 1991-2005

Other studies of labor productivity, using different metrics, also show that the wholesale industry has made a disproportionately large contribution to the nation’s productivity. McKinsey Global Institute concluded that the wholesale sector contributed 28 percent of the productivity increase from 1995 to 1999. A study by economists at the Department of Commerce found that wholesale trade contributed a similar proportion of the nation’s productivity growth over the longer period from 1989 to 2001. To put these results in perspective, the wholesale industry accounted for only six percent of U.S. gross domestic product during the periods studied.

Unfortunately, these studies do not identify which sub-sectors of the wholesale industry contributed to productivity growth. Therefore, we mathematically decomposed productivity growth into the exact percentage point contributions of 19 major sub-sectors within wholesale distribution during the 2001 to 2005 period. This process, called growth accounting, allows us to identify how much of the 5.8 percent growth in labor productivity came from each sub-sector.

The results of our analyses are shown below. Four sub-sectors accounted for nearly 70 percent of the 5.8 percent growth in labor productivity from 2001 to 2005. These four sub-sectors accounted for only 43 percent of the wholesale industry’s sales during this period.

CONTRIBUTION TO TOTAL PRODUCTIVITY GROWTH
IN WHOLESALE, 2001-2005

Data limitations prevent us from peering below this admittedly aggregated view of the industry. However, the sub-sectors making the largest contribution to productivity growth have some common characteristics:

• Faster industry growth - Growth attracts outside financial capital, enabling investments in an IT infrastructure that can exploit latent scale economies. Early, successful innovators can capture an increasing share of the market by offering different services or lower costs than less technology intensive competitors. Even after adjusting for product inflation (pharmaceuticals) and deflation (computer hardware and software; electronics), three of the top four industries are growing quickly. 
• Competitive intensity - More-intense competition encourages distributors to innovate and seek new ways to cut costs or use IT more effectively. This effect appears to be even more powerful as a distribution industry consolidates and competition shifts to a national level instead of geographically separate, regional markets. The largest publicly traded distributors operate in the top contributing sub-sectors.
• Product characteristics - Certain products allow physical distribution efficiencies. For example, less bulky products or products with a higher value relative to shipping costs provide greater opportunities to automate warehouse picking.
• Supply chain technology standards - In each of the top contributing industries, manufacturers and distributors have agreed on common standards for product identification. As a result, distributors can invest in technologies such as warehouse management systems with an automatic product identification system, such as a machine-readable bar code or a radio frequency identification (RFID) tag.

Note that total industry size did not guarantee a meaningful contribution to productivity improvement. Grocery and food wholesaling, which represented 11 percent of total revenues, actually had a slightly negative contribution to the wholesale industry’s productivity growth. Although these wholesalers are information technology intensive, they face shrinking capacity utilization as larger retailers bypass the traditional channel.  Wal-Mart’s leading share and the growth of large supermarkets are triggering an intense shakeout among the remaining smaller stores that used to purchase through wholesale distribution. Real (inflation-adjusted) revenues of grocery wholesalers have been essentially flat since 2001.

Nevertheless, the factors driving productivity growth in the top industries are likely to continue. These productivity gains will probably spread to other sectors as distributors continue making investments in information technology.