The U.S. floorcovering industry--2006.

Helms, Marilyn M. ; Baxter, Joseph T.

CASE DESCRIPTION

The primary subject matter of this case is a study of the U.S. carpet and floorcovering industry. Secondary issues include consolidation of mature industries, global pressures, mergers and acquisitions, and rising raw material and fuel costs. The case permits in-depth discussion of the various externalities facing this changing industry including internationalization and consolidation pressures as well as shifting customer preferences away from carpet and toward hard surface flooring. It is designed for senior-level classes in strategic planning and business policy. It is expected to require two to three hours of outside preparation by students.

CASE SYNOPSIS

Dalton, Georgia is the carpet capital of the world and is home to the area's leading floor covering and carpet producers. The old world industry attracted the interest of Warren Buffet prompting him to purchase Shaw Industries, Inc. in 2001. Shaw and their key competitor, Mohawk Industries, Inc. has a rich history of growth through acquisitions. The industry giants have consolidated much of the formerly fragmented flooring industry they helped establish. Each is a full-line flooring producer manufacturing carpet, rugs, ceramic tile, laminate flooring, wood flooring vinyl, and other surfaces for commercial and residential customers and both continue to battle for the number one position in the U.S. The industry has experienced recent fiscal growth from the U.S. housing market boom and higher product sales prices exceeding analysts' expectations. However, rising fuel prices, competition from low-price Asian imports and actions by competitors continue to challenge the industry. Small suppliers exiting the industry have caused raw material prices to rise. Changes also include a shifting product mix driven by consumer preferences toward laminate, wood and ceramic tile flooring and away from carpet and vinyl products. The rug segment is growing along with hard surface flooring. Even with wood or laminate floors, consumers decorate with area and scatter rugs. The industry is changing and the leaders must consider additional ways to grow. Interviews with industry analysts, trade associations, and consultants provide additional insights.

INTRODUCTION

Carpet industry executives throughout Dalton, Georgia home of the world's leading floor covering and carpet producers reviewed industry challenges as they prepared their strategic plans for 2006 and beyond. The leading firms had a rich history of growth through acquisitions, consolidating much of the formerly fragmented flooring industry they helped establish. While the entire industry experienced recent fiscal growth from the U.S. housing market boom, this market had slowed in 2006. Also, while higher product sales prices exceed analysts' expectations, the rising fuel prices, competition from low-price Asian imports and actions by competitors continued to challenge the industry. Raw materials were also more expensive since several small suppliers left the industry. Executives pondered consumer's future floorcovering preferences. Recently customers seemed to choose laminate, wood and ceramic tile flooring along with area rugs instead of carpet or vinyl products. Clearly, the industry was changing and the executives wondered what future strategies should be.

INDUSTRY CHALLENGES

Rising Costs--Fuel, Raw Material, and Employee Health Care

Increasing oil and energy prices, raw materials and other supply shortages, a record number of lower-priced Asian imports, escalating health insurance costs for employees, and the falling U.S. dollar relative to other currencies, particularly the Euro, has carpet and floorcovering executives worried. While industry consolidation and vertical expansion had boosted profitability levels, rising fuel prices made 2006 and beyond more uncertain. The ability to obtain raw materials on a just-in-time basis is critical. The principal raw materials include nylon, polyester and polypropylene resins, fibers, and carpet backings, which are used exclusively in the carpet and rug business--talc, clay, nepheline syenite and various glazes, including grit (ground glass), zircon and stains, which are used in ceramic tile business.

With a large U.S. workforce, rising employee health care costs continue to affect the industry. It is more challenging to offset these rising costs with lower selling general and administrative costs or through lower production costs.

Growth Through Acquisitions

Analysts question whether the mature industry can maintain the recent rapid acquisition rate. Mohawk Industries, Inc. and Shaw, Inc., the industry leaders, continue to acquire smaller competitors and suppliers. Shaw acquired SI, Inc. (formerly Synthetic Industries, Inc. a market of non-woven products and carpet backing) and Honeywell in 2005. These backward vertical integrations added carpet backing and a source of carpet fiber to Shaw's range of products. Mohawk, too, continued its consolidation of the carpet industry and diversification, purchasing Unilin, Inc. in 2005 in a deal valued at $2.6 billion. Unilin, a Belgian-based laminate floor covering manufacturer with 2004 revenues of $1 billion and employing 2,400 in Europe and the U.S., gave Mohawk a stronger presence in the laminate flooring market along with an expanded range of flooring products and a larger European customer base. The large acquisition came just three years after Mohawk bought Dal-Tile, the largest U.S. ceramic tile maker.

Changing Product Preferences

Carpet manufacturers have morphed and matured into full-line flooring companies offering a range of hard surface categories to supplement their tufted carpeting products. Laminate flooring products is the most successful recent hard surface product. Ceramic flooring has more stock keeping units, and though popular, is more difficult to distribute throughout the US. Hardwood is a smaller category but has room to expand.

The industry is bi-modal with large conglomerates offering a full range of floorcovering products and at the other extreme, a number of niche players that compete on price or differentiation. Industry sales are 67 percent for residential flooring purchases and 33 percent commercial. Some 75 percent of the flooring sold is for replacement purchases (remodeling) and the remaining 25 percent for new construction.

While the hard surface manufacturers remain more fragmented, fewer than 35 carpet manufacturers remain. Most leaders agree size is the key to success in this rapidly consolidating industry. The industry has been boosted by a strong U.S. housing market. Laminate sales comprised only 5 percent of the US floor covering market but the category rose 24 percent in 2004 and is projected to be a $5 billion dollar industry in the next five years. Industry-wide, although carpet and rug sales continue to grow at over 9 percent, hard surfaces are growing at double-digit rates with wood flooring growing at 13.4 percent and laminate flooring experienced a 19.6 percent growth.

Ceramic flooring grew 15.3 percent but resilient flooring's growth was only 3.6 percent. The slow growth of resilient or vinyl is due to rising oil prices and a 2005 explosion in a raw material (PVC resin) plant supplying the company's key input. Other small suppliers exiting the industry also caused prices to rise. Price increases were numerous in 2005 due to continuing raw material and energy cost increases. Tufted carpet and rugs, like vinyl, use petroleum products as raw materials. Rising oil prices are seen as a potential and growing threat. As an example, Solutia (the spin-off company of Monsanto) raised the prices on all nylon carpet fiber by 8-12 percent for all shipments on or after October 1, 2005, citing rising fuel prices.

The rise in the rug segment is a result of the growth in hard surface flooring. Even with wood or laminate floors, consumers decorated with area rugs. Carpet tile remains a popular and growing category among designers and architects and its ease of installation and option to replace only a few soiled squares has interested residential customers.

The principal methods of competition within the industry are price, style, quality and service. Price competition and market coverage are important because there is little differentiation among competing manufacturer's product lines. Investments in modernized, advanced manufacturing and data processing equipment, marketing strategy and distribution systems all contributed to the larger firm's ability to compete based on performance, quality, style and service, rather than price alone. Industry sales are seasonal. These results are primarily due to consumer residential spending patterns for floor covering, which historically have decreased during the first two months of each year following the holiday season. Commercial and institutional flooring sales peak in spring and summer, largely due to the remodeling of educational institutions during this period. Carpet's leading economic indicators are consumer confidence, interest rates, and existing and new home sales. The carpet industry leads economic recoveries, experiences volume rebounds, and demand from consumers' previously postponed purchases.

The primary categories of the United States floor covering industry includes carpet and rugs (63 percent), ceramic tile (12 percent), hardwood (10 percent), resilient and rubber (9 percent) and laminate (6 percent). Recent compound average growth rates for all categories, except the resilient and rubber category, meet or exceeded the growth rates (measured in sales dollars) for both the gross domestic product of the United States and housing starts and is 3.0 percent for carpet and rugs, 7.0 percent for ceramic tile, 1.2 percent for resilient and rubber, 20.9 percent for laminate, and 7.9 percent for hardwood. The retail carpet industry remains fragmented and often requires a very high level of service. Flooring continues to represent a major expenditure for homeowners and is only replaced every six to ten years. A consumer with greater product knowledge can make choices that are more informed but this requires a well-trained and knowledgeable sales force. There are also on-going installation considerations that must be coordinated with the purchase, often making flooring a complex purchase. However, there are also favorable trends in the residential market as more people own homes, homes are larger, and there is more interest in home decorating due to popular redecorating, remodeling, and home improvement television programs. The move to shopping at "big-box" home improvement retailers reduces the number of retail locations for purchasing floorcovering.

In general, customers want longer lasting, better-looking floors. Customers are learning to "hate" carpet because many builders and installers use a base or entry-grade carpeting. Use of this product creates disappointments because it does not perform as well as more expensive, heavier weight carpeting that shows fewer wear patterns. If the FHA building standards change to include a better grade of carpet, this could reduce consumer's perceptions that broadloom carpet is "bad." However, consumers agree their next replacement purchases for their carpeting will be for a hard surface product. Customers want a choice of color and design and many are demanding personalization in their flooring. Today's floorcovering shopper is more informed and sophisticated and willing to pay for quality but have higher expectations with a fashions and design focus. They are demanding new textures and styles as well as woven-look fabrics. The move is toward "mass customization" to offer customers a unique product.

Partnerships for branding, labeling, and merchandising are important to the industry as are ties to furniture collections. Designers and collections (Bob Mackie, Laura Ashley, Waverly, Ralph Lauren Home, Martha Stewart, Bernhardt, and Kathy Ireland) have lent their names to rugs and floorcovering products. Cooperative advertising programs often cross promote flooring products.

Globalization

While the large manufacturers have a strong foreign presence, smaller manufacturers find it challenging to develop export products. International trade shows such as the yearly Domotex show in Hanover, Germany, display small and mid-size mills and their products, but according to the American Floorcovering Association, an industry trade organization, participation at two or three shows is necessary to develop sales contacts. Travel costs too are often prohibitive for smaller companies. Industry officials, however, agree the export market is a growing one that companies should consider. U.S. carpet is currently exported to Canada, Mexico, the United Kingdom, Japan, Saudi Arabia and Hong Kong.

Social Responsibility, Recycling, and Reverse Supply Chain Logistics

The industry has been focused on recycling as well as reuse and carpet reclamation to reduce the amount of carpet waste entering landfills and reducing the production impact on both air and water resources. Plants are conserving energy and water and many specifiers are requiring that carpet have a recycled content. In some commercial accounts, customers are using carpet tiles and only replace the soiled tiles periodically. In other cases, institutions will "rent" carpet tiles and the installer will replace as needed, recycling soiled squares. However, difficult business conditions and higher than expected production costs have made recycling somewhat difficult. The industry is also working with the "big box" retailers to recover post-consumer wastes. Substitutes for current products that offer sustainability include both bamboo and cork flooring.

Each market is different in their environmental concerns, according to industry officials. In Europe, for example, buyers are concerned about whether products are made in an environmentally friendly manner and want to know if products are made with recycled material or through other sustainable processes. The entire industry is working to reduce energy and water consumption and has done so since the 1990s according to Werner Braun, president of the Dalton-based Carpet and Rug Institute. By 2010, the industry expects to divert 40 percent of all carpet currently entering landfills to other value recovery options (Jones, December 25, 2005).

International Imports

While the U.S. market remain focused on a higher end, higher style product than anywhere in the world, analysts fear threats from Chinese and other Asian imports within the next three to five years. Vance Bell, Executive Vice President at Shaw Industries, Inc. agree installation and after-sales functions are important in the marketplace. Mac Ryland of Kurt Salmon & Associates Consulting said the floorcovering imports have grown in the last decade. In 1994, imports made up 12 percent of a $13 billion American flooring market. Today, imports make up nearly a quarter of a $23 billion market. For example, some 70 percent of ceramic flooring sold in the U.S. is imported.

With a growing middle class, China is expected to form their own domestic flooring market. As China develops more capacity, the U.S. will no doubt see more imported products. Analysts agree the U.S. market cannot ignore China. Partnerships between American and Chinese floorcovering manufacturers might also occur in the future. Some industry leaders fear collaborating with China though and worry about a possible loss of U.S. customers and loss of trade secrets if they share production techniques and other knowledge with China. The Chinese take advantage of much lower wages and can afford the cost of shipping products to the U.S. and selling them at lower prices than American producers. The Chinese are not currently selling significant tufted broadloom carpet amounts in the U.S. but more tufting machines are being installed in China. Home Depot and other large retailers are also sourcing more products from China (Helm, December 2005).

If China is a competitor in the next decade, according to Jim Bethel, President of J & J Industries, he expects the Dalton region's response to be critical, depending on whether this is pursued as an opportunity or a threat. The Georgia Department of Labor reports some 22,200 residents of the five county area, which includes Dalton, work in floorcovering manufacturing and the prediction is these jobs will become more technology-oriented. Mr. Bethel further agreed the weight and bulk or value density of carpet makes it very expensive to move a long distance and the Chinese would have difficulty servicing an exported product. However, if foreign companies begin production of floorcovering within the U.S., these issues no longer apply. While few imports now originate in China, that could change. The carpet-making equipment industry reports from five to eight percent of their machines are sold to China and the Chinese are buying similar equipment from other countries (Gary, 2006).

Technology and Efficiency

Internally, technology has helped the floorcovering industry prosper and remain in the U.S. rather than move offshore. The industry, unlike other textile manufacturers, is not labor intensive and the tufting and processing machinery is continually automated. The larger carpet mills are vertically integrated--extruding their own yarn, dying the yarn, tufting and finishing it into carpet for the end user.

Distribution systems and a supporting infrastructure add value to all flooring products. Investments for the industry include specialized sales forces, product inventories, and automated distribution systems. With mergers and acquisitions, the industry leaders have worked to combine brand strategies, merge sales forces, and improve efficiency by realigning plants by product type, combining raw material components, reducing overlapping product offerings, and consolidating administrative functions.

THE FLOOR COVERING COMPETITORS

The carpet industry began when a young Dalton, Georgia woman, Catherine Evans Whitener, created a bedspread in a hand-crafted pattern by sewing colorful cotton yarns into unbleached muslin, clipping the ends of the yarn so they would fluff out, and finally, washing the spread in hot water to shrink the fabric and hold the yarns in place. Interest grew and by the 1930s, early entrepreneurial women and their families made the spreads on their front porches. Lower prices, new minimum wage laws, and the development of the mechanized tufting machine gradually made the handcrafted spreads too expensive. The industry began to pull workers into mills in Dalton, Georgia, beginning the rapid growth of the mechanized tufting industry and broadloom carpet production.

In the mid 1950s wool and manmade fibers--polyester, nylon, olefin, rayon, and acrylics--were gradually introduced to replace the cotton fibers. Most manufacturers agreed the single most important development in the industry was the introduction of bulk continuous filament nylon yarns. These yarns provided a quality, durable carpet, similar to wool but more economical to produce. In 1950, only ten percent of all carpet and rug products were tufted, and ninety percent were woven. Almost instantly, man-made fibers, new spinning techniques, and new dyeing equipment, printing processes, tufting equipment, and backing for different end uses appeared. Today tufted products accounted for more than 90 percent of the total production (less than two percent were woven) and 6.7 percent, comprised all other methods, such as knitted, braided, hooked, or needle- punched.

The industry broke the billion dollar sales mark in 1963. Through the years, the North Georgia area has remained the center of the tufted carpet industry and Dalton, Georgia has become known as the tufted "Carpet Capital of the World." The region produced more than 80 percent of the total output of the worldwide industry of over $15 billion.

The big companies have continuously bought smaller ones and the number of carpet makers in the North Georgia (U.S.) area fell from more than 300 firms to three giants - Shaw Industries, Mohawk Industries, and Beaulieu of America, and about 100 small-to-mid sized operations. The local population could not meet the job growth of the 1990's and a wave of immigration has kept the mills running. By 2004, Latino residents made up nearly half the city of Dalton's population according to U.S. Census data.

Shaw and Beaulieu are headquartered in Dalton, while Mohawk is based nearby in Calhoun, GA. Several smaller companies such as the Tandus Group (Dalton, GA), J&J Industries (Dalton, GA) and the Dixie Group (Calhoun, GA) have been able to carve out lucrative niches in the industry. Other competitors in vinyl and laminate flooring include Armstrong and Mannington. The top five manufacturers are profiled by flooring category in Exhibit 1.

MOHAWK INDUSTRIES, INC.

Mohawk is the leading producer and distributor of flooring worldwide including all major flooring categories: carpet, rugs, hardwood, laminate, ceramic tile, and vinyl flooring. They also lead in yarn, ceramic tile, area rugs, and bath mats production. Their net sales increased 13 percent in 2005 to $6.620 billion from $5.880 billion in 2004 and the sales increase resulted primarily from the acquisition of Unilin (the European laminate company), internal growth and price increases. Also for 2005 their sales trends continued with the growth in the commercial and new residential construction business outpacing the residential replacement business. See Exhibit 2 for the composition of top management and the board of directors. The income statement and balance sheet are shown in Exhibits 3 and 4.

Exhibit 2--Officers and Board of Directors

Officers

Jeffrey S. Lorberbaum, Chairman and Chief Executive Officer, Mohawk Industries, Inc.

Herbert M. Thornton, President--Mohawk Group

Frank H. Boykin, Vice President--Finance & CFO

William B. Kilbride, President--Mohawk Home

Christopher Wellborn, President--Dal-Tile

Board of Directors

David L. Kolb, Former Chairman, Mohawk Industries, Inc.

Jeffrey S. Lorberbaum, Chairman & CEO, Mohawk Industries, Inc.

Leo Benatar, Principal in Benatar and Associates

Bruce C. Bruckmann, Managing Director, Bruckmann, Rosser, Sherrill & Co., Inc. (a venture capital firm)

Larry W. McCurdy, Former President Dana Corporation's Automotive Aftermarket Group, (a worldwide manufacturer of motor vehicle parts)

Robert N. Pokelwaldt, Former Chairman & Chief Executive Officer York International Corporation, (a manufacturer of air conditioning and cooling systems)

S.H. "Jack" Sharpe, Executive Vice President, Mohawk Residential Business

John F. Fiedler, Former Chairman & CEO, BorgWarner, Inc.

Phyllis O. Bonanno, President & CEO, International Trade Solutions

Christopher Wellborn, President - Dal-Tile

Source: 2005 Mohawk, Inc. Annual Report

Mohawk designs, manufactures and markets residential and commercial flooring products distributed through authorized Mohawk dealers. In 2005, Mohawk operated under four divisions with its own products, features, and brand names, providing goods for all significant market segments, distribution channels, and price points. Mohawk's family of well-known brands includes: Aladdin, Alexander Smith, American Olean, American Rug Craftsmen, American Weavers, Bigelow, Dal-Tile, Galaxy, Harbinger, Helios, Horizon, Image, Karastan, Lees Carpet, World, WundaWeve, Custom Weave, Mohawk, and Mohawk Home.

Mohawk Carpet Mills had its beginning in 1878 when four brothers from the Shuttleworth family brought 14 second hand looms from England to New York. By 1908, the fledging firm introduced a new carpet. Flooded with orders, the weavers worked five years without changing either the color or the pattern on their looms. In 1920, the Shuttleworth Brothers Company merged with the nearby firm of McCleary, Wallin and Crouse to form Mohawk Carpet Mills, Inc., names for the Mohawk River Valley in upstate New York. Even in the 1920s, mergers were strategic and designed to give the company a competitive edge. In the 1950s Mohawk moved south, constructing manufacturing facilities in Mississippi and South Carolina. During the next fifteen years, Mohawk expanded its offerings through product innovations, market growth, mergers, and acquisitions. Beginning in 1992, a series of strategic mergers and acquisitions redefined not only Mohawk but also the entire floorcovering industry.

Each acquisition expanded Mohawk's presence in the floor-covering industry--Horizon Industries in 1992; American Rug Craftsman and Karastan-Bigelow in 1993; Aladdin Mills in 1994; Galaxy Carpet Mills in 1995; certain assets from Diamond Carpet Mills in 1997; Newmark Rug Company, American Weavers & World Carpets/WundaWeve in 1998; Durkan Patterned Carpets and Image Industries in 1999; Alliance Pad in 2000; Dal-Tile and American Olean in 2001-a move that made Mohawk a leading supplier of ceramic and stone floor covering, Lees Carpets in 2003, Wayne-Tex in 2005 and Unilin in 2005. In early 2006, the firm purchased Propex Fabrics, a major supplier of secondary carpet backing in a backward integration strategy. Through aggressive acquisitions and internal growth, Mohawk's goal is to create a strong, diversified company--the world's largest floor covering supplier, the country's leading recycler of plastic soda bottles (which become polyester carpeting) and one of the country's largest and most efficient distribution and trucking companies. In 2005, they employed more than 34,000 employees, with half of them in Georgia.

According to the 2005 Annual Report, Mohawk sold floor covering and textiles for every room in the home and for every commercial application, hardwood flooring, laminate flooring, ceramic tile flooring, stone and marble flooring, via an exclusive distribution agreement with Congoleum, vinyl sheet flooring, woven bedspreads, tapestries, pillows, throws and window blinds. Mohawk products are in major retailers across the country and the world--from Home Depot to Bloomingdales, from Lowe's to Macy's, from Target and Wal-Mart to specialty boutiques in large cities and small towns. The Unilin acquisition added the European company's wood flooring, shelving, chipboard, and roofing products.

Floorcovering companies have long sought partnerships that would increase their name recognition with the public. Looking to increase its brand presence, Mohawk partnered with Solutia Wear-Dated and 3M Scotchgard[R] in 2006 to bring together three of the most well-known brands in the floorcovering industry. More than 80 products are affected, many switching from other fiber technologies to the Wear-Dated Fiber. A new line of carpets and hardwoods features the new Scotchgard[R] Protector Advanced Repel Technology for stain protection, available only through Mohawk.

Human Resources

Jeffrey S. Lorberbaum is the President, Chairman, and CEO of Mohawk. He was born in 1954 in Dalton and began his professional career with Aladdin Mills in 1976 after completing a B.S. from the University of Denver. In 1994, he was Vice President of operations at the time of Aladdin's merger with Mohawk Industries. In 1995, Lorberbaum was appointed President and was appointed CEO in 2001. In 2004, he assumed the Chair of Mohawk's Board of Directors. Mohawk's management and board are composed of executives from a number of their recently acquired companies.

Technology and Logistics

Backward and forward integration of manufacturing, distribution, and marketing operations provides advantages of scale. Fiber extrusion assets provides over 50 percent of Mohawk's carpet and rug fibers, including nylon, polyester, and olefin. Mohawk controls manufacturing for carpet, rug and carpet cushion products as well as a majority of ceramic tile. Real Time Visibility, their order tracking system, ensures on-time product delivery along with over 1,000 trucks, 300 distribution points, 15 regional warehouses, 20 factory warehouses and 42 satellite warehouses. As an example of information technology advances, Mohawk embraced e-commerce with its contract dealer community. By enabling specifiers (architects, designers) and dealer partners to check available inventory and place orders on-line, their Quick Ship program offered shipment of products within two days. Mohawk opened a new distribution center in Calhoun, Georiga in November 2005, adding 1.3 million square feet of distribution and manufacturing space at a cost of $33 million to increase company logistics efficiency.

Organization and Structure

In 2005, Mohawk Industries realigned its residential and commercial flooring businesses into two strategic business units (SBUs) designed to enhance operations and customer service. Jeff Lorberbaum, Chairman and CEO of Mohawk, said "Through better focus on our different customers, we will improve reliability, innovation, and service. Our intent is to develop a structure that allows Mohawk employees to best utilize their skills, increase responsiveness, and contribute to Mohawk's overall success. For the Residential SBU, Tom Lape will be responsible for sales and marketing functions. Frank Peters will lead carpet and yarn manufacturing, product development and planning. This SBU will also include hard surfaces, customer operations, and other support functions. For the second SBU, Commercial Flooring, Jim McCallum will be head sales and marketing. Jim Prettyman will be responsible for carpet manufacturing, product development and planning. This SBU will also include customer operations as well as other support functions. Operations are responsible for extrusion, distribution, backing, and cushion. Operations will also include engineering, recycling, samples, purchasing, environmental, and other support functions.

Mohawk has two reporting segments, the Mohawk segment and the Dal-Tile segment. The Mohawk segment distributes its product lines through a network of 52 regional distribution centers and satellite warehouses using a fleet of company-operated trucks, common carrier or rail transportation. The segment product lines are sold to independent floor covering retailers, home centers, mass merchandisers, department stores, independent distributors, commercial dealers and commercial end users. The Dal-Tile segment product lines include ceramic tile, porcelain tile and stone products distributed through approximately 244 company-operated sales service centers and regional distribution centers using primarily common carriers and rail transportation. The segment product lines are purchased by tile specialty dealers, tile contractors, floor covering retailers, commercial end users, independent distributors and home centers.

Marketing

Mohawk has promoted its brands through national advertising in both television and print media as well as in the form of cooperative advertising, point-of-sale displays and marketing literature provided to assist in marketing various carpet and ceramic tile styles. Mohawk relies on the substantial brand name recognition of its product lines. The cost of producing display samples is a significant promotional expense and has been partially offset by sales of samples and support from suppliers.

Mohawk has provided a premium level of service, maintaining its own trucking fleet and over 250 local distribution locations. Eighty-five percent of Mohawk's sales are made to independently owned dealers, contractors, and distributors. The balance has been sold to large national chains, home centers, and mass merchants. End-use purchases of Mohawk's products have been broad and varied. Today, residential replacement accounts for over half (56 percent) of their sales with commercial (27 percent) and new residential construction (17 percent) representing other major purchasing categories. According to Mohawk's 2005 Annual Report, this diversity in customer groups brings increased stability of the business and balanced business cycles in each area. Mohawk stayed connected to the retail marketing of their products through various merchandising programs.

SHAW INDUSTRIES, INC.

Shaw's earnings and revenues increased in 2005, according to Warren Buffet, Chairman of the board of Berkshire Hathaway, Shaw's parent company. In 2005, Shaw Industries' pre-tax earnings were $485 million up from $466 million in 2004 and $436 million in 2003. The company's revenues rose to $5.72 billion in 2005, up from $5.17 billion in 2004 and $4.66 billion in 2003 and $4.33 billion in 2002. Buffet also indicated, like other building products companies, Shaw continues to face rising costs for raw materials and energy and has raised prices on many products but these price increases often have lags before they become effective (Jones, March 7, 2006).

The increase in 2005 reflected increases in average net selling prices for carpet and a very small increase in yards of carpet sold. During 2005, sales of rugs also increased over the 2004 level. Pre-tax earnings in 2005 increased $19 million (4%) over 2004. Despite the increases in selling prices, operating margins in 2005 were adversely affected by repeated increases in petroleum-based raw material costs. Increases in production costs have outpaced increases in average net selling prices over the past two years. In addition, product sample costs pertaining to the introduction of new products increased approximately $29 million in 2005 as compared to 2004.

Revenues generated by Shaw Industries in 2004 increased $514 million (11%) over 2003 due to a 9% increase in square yards of carpet sold, higher net selling prices and increased hard surface and rug sales. In addition, sales in 2004 include two businesses acquired by Shaw in 2003 (Georgia Tufters and the North Georgia operations of the Dixie Group). These acquisitions contributed sales of $240 million in 2004 and $50 million in 2003. Pre-tax earnings in 2004 totaled $466 million, an increase of $30 million (7%) over 2003. Raw material price increases came faster than sales price increases could keep up, resulting in a decline in gross margins during 2004 as compared to 2003. Shaw's biggest news for the start of 2006 was spending $20 million to convert a yarn facility in South Pittsburg, Tennessee closed three years ago due to reduced demand for spun nylon yarn into the company's first engineered hardwood flooring plant. Formerly the company sold wood flooring purchased from a third party. This plant conversion represents the company's first entry into hardwood manufacturing (Shaw only manufactured laminated "wood-look" flooring before). Shaw could have entered this market through acquisitions but decided to start a plant themselves. The company was pressured to enter this segment given Mohawk's increased hard surface production (Jones, March 8, 2006).

Shaw got its start in 1946 as Star Dye Company, a small business that dyed tufted scatter rugs. Numerous events transformed Shaw into the world's largest carpet manufacturer. The philosophy guiding those events has not changed much through the years. "Our business is about meeting customers, figuring out what they need, and supplying that need," said Robert E. (Bob) Shaw, the only CEO Shaw has ever known. "That's been our commitment from the beginning." Clarence Shaw, father of Chairman and CEO Robert E. (Bob) Shaw and former Chairman J.C. (Bud) Shaw, bought Star Dye Company in 1946. In 1958, Bob Shaw became CEO of the company, which is jointly owned by the two brothers.

In 1967, J.C. Shaw organized a holding company to acquire Philadelphia Carpet Company, which originated in 1846. The holding company added Star Finishing to the fold one year later, marking Shaw's first move into carpet manufacturing. The holding company went public as Shaw Industries, Inc. in 1971 with approximately $43 million in sales and 900 employees. In 1985, Shaw made its first appearance on the Fortune 500 with more than $500 million in sales and close to 5,000 employees.

With a goal of differentiation and adding value, in 1972 Shaw purchased a yarn plant, acquired a continuous dye plant in 1973, created a trucking subsidiary to improve shipments and expand direct sales to retailers 1982, and established regional U.S. distribution centers and modernized plants and equipment in the early 1980s. Other tactics allowed Shaw to quickly respond to breakthroughs including stain resistant carpet, decrease their fuel, water, and electricity consumption, and recycle manufacturing waste. In 1992, Shaw acquired Amoco's production facility for polypropylene fibers. This added another source of raw materials. In 1993, they began producing the popular Berber styles and began the rug division followed by the hard surfaces division in 1998 with the launch of ceramics.

The desire to be the industry's low-cost provider was also a determining factor in Shaw's decisions, namely the acquisitions that brought such respected names as Cabin Crafts and Sutton under the Shaw umbrella. It also played a role in one of the largest and most significant moves in the company's history: the merger of Shaw and Queen Carpets in 1998. Queen's own legacy started when Harry and Helen Saul, parents of Shaw's current president Julian Saul, expanded their part time business into the full-time venture, Queen Chenilles. The year was 1946, the same year Clarence Shaw started Star Dye.

On January 4, 2001, Shaw began a new chapter with the completion of its sale to Berkshire Hathaway Inc., for $2 billion. Berkshire Hathaway has always been known for buying and holding businesses that had a dominant market share, had strong management teams, and were considered undervalued in the stock market. With the move, Shaw was no longer a public company. In 2001, Shaw began work on their new laminate plant in Georgia. In 2002, Berkshire Hathaway acquired the rest of Shaw owned primarily by CEO Bob Shaw and President Julian Saul for $354.6 million in stock. Bob Shaw, when asked about the Berkshire Hathaway sale commented, "Now we can make better five-year decisions. With a public company, you make 90-day decisions. And we don't have to put up with Wall Street." Mr. Shaw continued, "Business was great when Buffet bought the company, now it is even better in spite of a barrage of price increases that added more costs for the company. After all, when you walk on carpet you're basically stepping on processed oil."

Shaw continues to grow by acquisition and in 2003 acquired Georgia Tufters and the North Georgia operations of the Dixie Group. Shaw Industries, Inc. purchased the U.S. Nylon Carpet Fibers Business from Honeywell International in fall 2005. (Honeywell had swapped assets with BASF and sold all their American fiber production facilities). This acquisition moved Shaw further into raw material production (backward vertical integration) (www.floordaily.net). Mr. Shaw agrees, "the industry went through rapid change 20 years ago. During an era of great consolidation, Shaw was the primary consolidator. We went from being one of 20 or 30 companies of similar size, none of us having more than three or four percent of the industry, to the point where in soft flooring (carpet) we had about 45 percent of the industry. That was our go-go period, when we went from revenues of a couple hundred million to about $2 billion." Mr. Shaw attributed his size growth to the purchase of the top three competitors at the time in the mid 1980's - Cabin Crafts, E & B Carpet, and Salem. "It was the maturing of the carpet industry," and "we are on the leading edge of that," he said. Shaw used credit to purchase the competitors. Shaw did admit mistakes including the company's ill-fated move into the retail business. "Manufacturers and retail are two entirely different entities, and one was in conflict with the other," he said. "We found ourselves in competition with some of our customers. Even Home Depot wouldn't do business with us as long as we were in retail."

Today Shaw is a full-service flooring company with approximately 30,192 employees. . Shaw's residential carpet brands include Philadelphia Carpets, Cabin Crafts Carpets, Queen Carpets, Shaw Mark Carpets, Sutton Carpets, Tuftex, Home Foundations (sold through home builders), Kathy Ireland Shades of America, Couture by Sutton, Expressive Designs (wool and wool-blends), and Inside Out. Additional residential brands include Shaw Living rug designs, Shaw Ceramics, Shaw Laminates, and Shaw Hardwoods. Their commercial brands are Philadelphia Commercial Carpets and Queen Commercial. They sell flooring for specified commercial and contract applications throughout the world. Shaw Contract Group remains the leading flooring provider to the commercial market including health care, education, corporate office, government, and retail sectors. Other contract brands are Patcraft Commercial, Designweave, Shaw Hospitality, Design Origins, and Commercial Hard Surfaces.

BEAULIEU, INC.

Roger De Clerck, founded Beaulieu Belgium, and Mieke and Carl Bouckaert established their U.S. operations, Beaulieu of America, in 1978 as the first producer of polypropylene oriental rugs. As the company grew the Bouckaert brothers invested in yarn extrusion in 1981 becoming the first manufacturer in the carpet and rug industry to produce their own yarn. With continued growth, the company diversified into tufting carpet in 1984, establishing Beaulieu Commercial in Chatsworth, Georgia. In 1987, the firm's U.S. extrusion capacity increased with the addition of a facility in Bridgeport, Alabama, which produces nylon polymers and nylon yarns. In 1990, Beaulieu continued its vertical integration with the addition of another facility, also in Bridgeport, Alabama, for the extrusion of polypropylene staple fiber; polypropylene slit film, and weaving of primary and secondary backing. Like their competitors, the growth of carpet and rug manufacturing drives the expansion in yarn extrusion and polymer capacity.

From the first carpet manufactured in 1984 to the acquisition of Conquest Carpet Mills, Interloom, Coronet Industries, Grass More and D&W Carpets, as well as the addition of Murray Fabrics, Beaulieu of America is the world's third largest carpet producer behind Mohawk and Shaw. Recent additions include Marglen Industries, Columbus Carpet Mills, and Peerless Carpet Corporation. Beaulieu of America also looks outside the U.S. borders for growth opportunities. In 1980, Beaulieu Canada was founded. The 1990 purchase of Coronet yielded Coronet Canada, the second largest manufacturer in Canada. Overseas production expanded in 1995 when Beaulieu acquired an Australian Manufacturer, Sterling Carpet Mills, creating Beaulieu Australia.

In 1998, Beaulieu acquired Peerless Carpet Corporation, then the number one carpet producer in Canada. In 2002, Beaulieu of America decided to concentrate strictly on high quality, affordable broadloom carpet, and sold its rugs and hard surfaces divisions. Their residential brands include Beaulieu & Coronet, Laura Ashley, and Hollytex while their three commercial and design brands are BOLYU, Cambridge, and Aqua, which serve the office, hospitality, retail, and institutional, educational and healthcare environments. The company is privately owned and no financial data is available.

THE ANALYSTS' VIEW

Dave Foster, Host of Floor Radio and the companion website (http://www.floordaily.net), when interviewed in late 2005 about the recent industry consolidation commented, "I've just returned from the NeoCon East Trade show in Baltimore, MD, a key trade show for all commercial floor covering with buyer representatives from the GSA (Government Service Administration). I talked with small manufacturers at the show and they are concentrating in the specialty areas where the large companies (Shaw and Mohawk) are not interested. Their products are not mainstream but are specialty or architectural products. If the major companies acquired these smaller manufacturers, it would only be to offer a broader width to their product line but these acquisitions would not represent a major addition." When asked about the reason for the mergers in this industry, Dave Foster replied, "Mohawk and Shaw have had strong logistical operations. When customers have placed orders, they have known they will get the products very soon, given the numerous warehouse locations. Even the B-to-B segment's growth had supported the logistical investments."

"Customers are accustomed to receiving carpet as fast as possible, so it is easy for Shaw and Mohawk to put other flooring products, like laminate, on the same truck and ship the products together. Also the direct shipping makes the price more attractive to the retailer," said Foster. "In the past, laminate flooring had been sold through wholesalers. The second reason for the mergers is a hedge strategy. Over the last ten years, the market share of carpet fell and was replaced by other flooring options," replied Foster. He continued, "The industry decided to be more than just carpet companies. With their logistical assets, they deliver more products to the same destination. Twenty years ago most carpet went through distributors. The major companies did not want to pay a profit margin to distributors for something they could do better. Mohawk decided the industry needed consolidation and bought "major players" in the industry.

Dave Foster is positive about the future role of small mills. "Lots of small mills have done well. Dixie Industries, Inc., for example sold their tufting and yarn operations and re-invented themselves to concentrate on higher end commercial and residential customers." "While dealers have liked the Shaw and Mohawk products, they wanted to offer other supplier's products as well," Foster continued, "Even though dealers purchase 80 percent of their products from either Shaw or Mohawk." "Retailers want flexibility and customers want choices. In the last five to eight years, there has been a concentration of various levels of dealer involvement in the industry."

In Dave Foster's radio interview with Keith Hughes, Director of Equity Research at Sun Trust Robinson Humphreys, Keith discussed the industry's movement of manufacturing facilities abroad. Keith mentioned the key question all firms considered whether the labor savings would be worth the investment. He added, quality standards are lower initially and shipment times averaged three to four months from Asia. In addition, inventory carrying costs increased with the longer delivery time. He agreed both domestic manufacturers and retailers asked these questions but noted manufacturing in Vietnam has recently been cheaper than manufacturing in China.

Wanda Ellis, President of the American Floorcovering Alliance commented, "with the current competition it has been tough to find sources of economical yarn for production since all the yarn is petroleum based. Ellis quoted Tim Booth of the British Wool Marketing Board who agreed, "the industry needs to develop a situation to move from petroleum based yarns and use a blend of fibers to make the nylon yarn go further." Europe is flooded with cheaper imported floorcovering from China. Unless a firm is a member of the EU, import duties and tariffs are assessed on imports. Ellis summarized by agreeing the US needed better trade laws and enforcement of those laws with China. When asked what the smaller carpet and flooring companies thought about being an acquisition target, Ellis agreed, "most would like to be acquired because it has become so difficult to find a niche for their products and a source for raw materials." Finding raw materials is complicated by Shaw's latest purchase of Honeywell's nylon group.

While many floorcovering products use raw materials derived from oil, the high-energy prices affect every level of the flooring supply chain in a multitude of ways. Companies are forced to allocate more funds to run their operations but the bigger expenses come from shipping and receiving products. The cost of gasoline forces many to absorb the expenses or to add a surcharge to cover the extra costs. Another major problem is the growing number of price hikes. Having so many increases has caused havoc at the retail level as dealers find themselves adjusting their prices rather than simply selling or marketing. To help counter the impact of higher oil prices on raw materials, mills and fiber suppliers are developing new fibers including Shaw's ClearTouch and Mohawk's Smartstrand, both made from polyester derivatives. With lower production costs and recent innovations, the yarns could effectively compete with nylon and polypropylene in terms of durability, softness, coloring, and styling.

The floor covering industry is sensitive to changes in general economic conditions, such as consumer confidence and income, corporate and government spending, interest rate levels and demand for housing. Yet, industry analysts like Keith Hughes report adding flooring products does not increased the value of a residential home like additions to kitchens or bathrooms do. Hughes also reports the increase in raw material prices and other macro-environmental variables slow floorcovering replacement business.

The Carpet and Rug Institute (CRI), lobbies for the industry and offers educational programs about carpet cleaning and installation. They work to counter misinformation about dust-mite and asthma/allergy issues linked to wall-to-wall carpet. Carpet is often blamed for sick building syndrome. While the assumptions are not true, some consumers still believe carpet contains formaldehyde. Internationally, Japanese customers fear ticks and leeches live in carpet. They will only use wood flooring. CRI has programs in place to certify installers as well as to test vacuum cleaners. The training and education programs work to foster a more professional image for installers. Since most customers do not install floorcoverings themselves, this is important. In addition CRI's educational programs stress the benefits of carpet including noise reduction, temperature control (carpet is warmer than hard surfaces) and protection against falls (ideal for the elderly). Their web site provides further customer education and information about carpet and other floorcoverings.

 What are the pros and cons of the industry leaders maintaining
 their rapid acquisition rate of competitors and consolidation of
 the carpet industry?

 Will the recent acquisitions guarantee Shaw and Mohawk a strong
 position for further expansion within the flooring category? Should
 they consider other growth avenues like joint ventures,
 partnerships, or internal growth?

 Are the top firms expanding too quickly? If so, what challenges
 face management?

 How will smaller companies be able to carve out a lucrative niche
 in this industry?

 Do these firms represent a threat or an opportunity to Shaw and
 Mohawk and why? What are the pros and cons of diversifying outside
 the floorcovering industry?

 How will raw material and energy price increases and the need to
 remain environmentally responsible continue to affect the industry?

 Will sales of laminate and other hard surfaces continue to grow?

 What effect will low-cost imports, particularly from Asia, have on
 the industry?

REFERENCES

"Carpet Maker Looks to Europe," Atlanta Journal Constitution, July 5, 2005 at http://www.ajc.com/business/content/business/0705/05bizmohawk.html.

Gary, Bob, Jr. "Is Carpet Next on China's List?" Chattanooga Times Free Press, Monday, January 9, 137(26), A1 & A5.

Helm, Darius (2005). "Top 15 Specified Carpet Manufacturers" Floor Focus, 14(5), June, p. 25-49.

Helm, Darius (2005) "Review 2005: Price Pressures and Surging International Trade Dominate the Industry This Year," December, Floor Focus, 25-31.

Jones, Jamie (2005). "Mohawk Acquisition to Boost Company," The Daily Citizen, Friday, A1, A3.

Jones, Jamie (2005) "Industry looks to 2006," The Daily Citizen, Sunday, December 25, 12A.

Jones, Jamie (2006) "Earnings, Revenues Up for Shaw Industries in 2005," The Daily Citizen, Tuesday, March 7, 1A.

Jones, Jamie (2006) "Shaw to Build Hardwood Flooring Plant in Tennessee," The Daily Citizen, Wednesday, March 8, A1 & A3.

"Mohawk Realigns Residential and Commercial Flooring Units, August 16, 2005, at: http://www.floordaily.net/newlayout/template.asp?fid=6041.

Oliver, Charles (2005) "American Products Have an Edge on the Overseas Competition," The Daily Citizen, Friday, March 25, A3.

Pare, Mike (2005) "Investors React Favorably to Mohawk's Venture into Laminates," Chattanooga Times Free Press, July 5, 2005, D1.

Patton, Randall L. (2004). Shaw Industries: A History, The University of Georgia Press.

"Scoring Flooring Industry Stats for 2004" Floor Covering News, July 11/18. 2005, Volume 20, Number 9. p. 1-18.

Carpet Industry History

http://www.daltonchamber.org

Competitors

http://www.shawfloors.com

http://www.jjindustries.com

http://www.armstrong.com

http://www.beaulieu-usa.com

http://www.beaulieucommercial.com

http://www.mannington.com

http://www.interfaceinc.com

http://www.mohawk-flooring.com

http://www.mohawkind.com

http://www.cafloorcoverings.com

http://www.berkshirehathaway.com

Trade Associations and Marketers

http://www.carpet-rug.org/

http://www.americanfloor.org/

http://www.britishwool.org.uk

http://www.floordaily.net

http://www.merchandisemart.com/ neoconeast.html

http://www.britishwool.org

Cluster Analysis

http://www.isc.hbs.edu/MetaStudy2002Bib.pdf

Marilyn M. Helms, Dalton State College

Joseph T. Baxter, Dalton State College

Exhibit 1: Top 5 Manufacturers Flooring Sales by Category
(2004 data)--(in Millions of Dollars)

 Total U.S. Ceramic
 Flooring Carpets Floor
Company Sales & Rugs Tile

Mohawk 5,217 3,779 1,207
Shaw 4,630 4,346 54
Armstrong 1,645 0 4
Beaulieu of America 1,115 1,115 0
Mannington 746 137 10

 Wood Laminate Resilient
Company Flooring Flooring Flooring

Mohawk 90 40 101
Shaw 30 200 0
Armstrong 807 108 713
Beaulieu of America 0 0 0
Mannington 148 65 371

Source: Floor Focus, May 2005, p. 26.

Data compiled by Market Insights/Torcivia and Floor Focus Magazine.

Exhibit 3--Income Statement 2001-2005, Mohawk Industries, Inc

 For the Years Ended December 31,

 2005 2004 2003

 (In thousands,
 except per
 share data)

Statement of
earnings data:

Net sales $ 6,620,099 5,880,372 4,999,381
Cost of sales (a) 4,896,965 4,259,531 3,605,579
Gross profit 1,723,134 1,620,841 1,393,802

Selling, general and
 administrative
 expenses 1,095,862 985,251 851,773
Operating income 627,272 635,590 542,029

Interest expense (b) 66,791 53,392 55,575
Other expense
 (income), net 3,460 4,809 (1,980)
 70,251 58,201 53,595
Earnings before
 income taxes 557,021 577,389 488,434

 For the Years Ended December 31,

 2002 (c) 2001

 (In thousands, except per
 share data)

Statement of
earnings data:

Net sales 4,516,957 3,441,267
Cost of sales (a) 3,247,865 2,583,669
Gross profit 1,269,092 857,598

Selling, general and
 administrative
 expenses 747,027 530,441
Operating income 522,065 327,157

Interest expense (b) 68,972 29,787
Other expense
 (income), net 9,464 5,954
 78,436 35,741
Earnings before
 income taxes 443,629 291,416

Exhibit 3--Income Statement 2001-2005, Mohawk Industries, Inc

 For the Years Ended December 31,

 2005 2004

Income taxes 198,826 208,767
Net earnings $ 358,195 368,622

Basic earnings per share $ 5.35 5.53
Weighted-average common
 shares outstanding 66,932 66,682
Diluted earnings per share $ 5.30 5.46
Weighted-average common and
 dilutive potential common
 shares outstanding 67,644 67,557

Balance sheet data:
Working capital $ 1,228,573 968,923
Total assets 7,991,523 4,403,118
Long-term debt (including
 current portion) 3,308,370 891,341
Stockholders' equity 3,027,120 2,666,337

 For the Years Ended December 31,

 2003 2002 (c)

 (In thousands, except per
 share data)

Income taxes 178,285 159,140
Net earnings 310,149 284,489

Basic earnings per share 4.68 4.46
Weighted-average common
 shares outstanding 66,251 63,723
Diluted earnings per share 4.62 4.39
Weighted-average common and
 dilutive potential common
 shares outstanding 67,121 64,861

Balance sheet data:
Working capital 592,310 640,846
Total assets 4,163,575 3,596,743
Long-term debt (including
 current portion) 1,012,413 820,427
Stockholders' equity 2,297,801 1,982,879

 For the Years Ended December 31,

 2001

 (In thousands, except per
 share data)

Income taxes 102,824
Net earnings 188,592

Basic earnings per share 3.60
Weighted-average common
 shares outstanding 52,418
Diluted earnings per share 3.55
Weighted-average common and
 dilutive potential common
 shares outstanding 53,141

Balance sheet data:
Working capital 449,361
Total assets 1,768,485
Long-term debt (including
 current portion) 308,433
Stockholders' equity 948,551

(Source 2005 Mohawk Annual Report)

Exhibit 4 Mohawk Industries Inc. and Subsidiaries

Consolidated Balance Sheets; December 31, 2005 and 2004
(In thousands, except per share data)

ASSETS 2005 2004

Current assets:
Cash and cash equivalents $ 134,585
Receivables 848,666 660,650
 Inventories 1,166,913 1,017,983
 Prepaid expenses and other assets 140,789 49,381
 Deferred income taxes 49,534 55,311
 Total current assets 2,340,487 1,783,325
Property, plant and equipment, net 1,810,728 905,332
Goodwill 2,621,963 1,377,349
Tradenames 622,094 272,280
Other intangible assets 552,003 50,366
Other assets 44,248 14,466
 $ 7,991,523 4,403,118

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Current portion of long-term
 debt $ 113,809 191,341
 Accounts payable and accrued
 expenses 998,105 623,061
 Total current liabilities 1,111,914 814,402
Deferred income taxes 625,887 191,761
Long-term debt, less current
 portion 3,194,561 700,000
Other long-term liabilities. 32,041 30,618
Total liabilities 4,964,403 1,736,781
Stockholders' equity:
 Preferred stock, $.01 par
 value; 60 shares
 authorized; no shares
 issued -- --
Common stock, $.01 par value;
 150,000 shares
 authorized; 78,478
 and 77,514 shares issued
 in 2005 and 2004,
 respectively 785 775
 Additional paid-in capital 1,123,991 1,058,537
Retained earnings. 2,268,578 1,910,383
 Accumulated other
 comprehensive loss (47,433) (2,441)
 Less treasury stock at cost;
 10,981 and 10,755 shares
 in 2005 3,345,921 2,967,254
 And 2004, respectively 318,801 300,917
Total stockholders' equity 3,027,120 2,666,337
 $ 7,991,523 4,403,118

(Source 2005 Mohawk Annual Report)