Driving the Future of MRO Solutions. As the market leader, Grainger remains committed to making sizable investments to drive tomorrow's innovative customer solutions. These investments strengthen and add to the Company's strategic assets.

As Grainger looks to the new millennium, its efforts are guided by two major growth initiatives:

• Create focused businesses to serve customers' needs and find new growth opportunities within existing businesses
• Develop and embrace new technologies that strengthen the Company's current capabilities and help drive the future of the MRO marketplace

Grainger Industrial Supply. Grainger Industrial Supply is the U.S. leader in branch-based MRO distribution. Its network of 349 branches and Grainger.com Web site offer an unmatched combination of product assortment, rapid availability, and ease of service. In 1998, the business experienced strong financial performance despite the launch of several future growth initiatives and infrastructure projects.

Product Assortment: As part of its marketing efforts, Grainger encourages customer purchases across multiple product categories. Initiatives in 1998 included devoting more space to merchandising with a new branch layout that introduces customers to a broad range of products as they browse, while increasing impulse purchases.

Another key 1998 initiative was the introduction of several attractively priced, high-quality private label programs. Westward tools and LumaPro lighting products were secured through the Company's global sourcing business. The Company plans to aggressively add other attractively priced private label programs in the future.

Rapid Availability: Grainger's industry expertise allows it to build market share by enhancing product availability in unique markets. For example, at Boston's "Big Dig" construction project, the business introduced a mobile branch, complete with wireless computer links to Grainger's order entry systems. In Manhattan, the Company replaced large branches with a number of small branches in convenient locations. Frequent replenishment of these small branches maintains Grainger's commitment to availability while leveraging its investment in inventory.

In 1998, Grainger Industrial Supply incorporated many enhanced design features in new branches that provide tangible benefits to its customers. Expanded display areas allow customers to interact with a wide array of products. Wide aisles, low display fixtures, and automatic doors help increase the customers' view of the service areas and ease navigation through the showroom. These features have contributed to higher display revenues per square foot and have increased customer satisfaction.

Ease of Service: The Internet is an important growth engine for Grainger Industrial Supply. Access to Grainger 24 hours a day, 7 days a week through Grainger.com is a major convenience for many customers and a competitive advantage for this business. Enhancements in 1998 to Grainger's Internet offering included more products, better search capabilities, and the ability to accept credit cards.

Other Initiatives: Additional efforts to build market share in 1998 included important changes to Grainger's marketing programs. To achieve maximum results, promotions now integrate all marketing resources - sales calls, phone sales, branch merchandising, direct marketing, and advertising. Grainger Parts, the Company's after-sales replacement parts business, is now an integral part of every promotion. Results in 1998 far outpaced previous years' promotions.

Grainger Industrial Supply's cost savings program allows the Company to offer customers even better prices while maintaining attractive margins. Category by category, Grainger and its suppliers identified and seized opportunities to reduce supply chain costs. Savings in 1998 were significant and should continue into the future.

In 1998, Grainger Industrial Supply began to transition its legacy systems to an enterprise resource planning system based on SAP's R/3. The switch to a single, integrated enterprise system will allow the business to make changes quickly as requirements evolve. Roll-out to all Grainger Industrial Supply facilities is scheduled to be completed in 1999.

Acklands-Grainger Inc. A weakness in the Canadian lumber, mining, and oil markets, combined with a weak Canadian dollar, represented a challenge to Acklands-Grainger in 1998.

Acklands-Grainger's experience and reputation as a long-term player in Canada positions the business for growth as the Canadian economy rebounds.

Accordingly, in 1998, Grainger continued to invest in Acklands-Grainger. In eastern Canada, branches were opened in Burlington, Kingston, North Bay, and Windsor, Ontario; Longueuil, Quebec; New Glasgow, Nova Scotia; and Saint John, New Brunswick. In July, Acklands-Grainger opened a new distribution center for private label Westward and Profast'ners products.

Building upon Grainger Industrial Supply's solid supplier relationships, Acklands-Grainger launched several new product lines in 1998, including lighting, motors, compressors, and HVAC. Also in 1998, the business introduced a French language catalog to further penetrate the French-speaking market.

Grainger, S.A. de C.V. Sales in Mexico increased significantly in 1998. Grainger's broad assortment of products, rapid availability, and simple ordering process is filling a need that has been largely unmet in Mexico. Grainger's growth strategy -- which included a significant market awareness and penetration campaign, product additions, and increased capacity -- produced strong results in 1998.

The efforts of 66 sales representatives, along with direct marketing, public relations, and advertising, placed Grainger number one among MRO suppliers in customer awareness. In Monterrey, companies rated Grainger as their first choice for miscellaneous MRO purchases.

Both to drive and accommodate growth, Grainger doubled its branch capacity in Monterrey to 80,000 square feet. At year-end, over 60,000 products were available to customers, an increase of 54% over 1997.

Grainger Custom Solutions. In 1998, Grainger formed a separate business to serve large customers that are looking to distributors to manage entire MRO product categories. Many companies are looking for some of the benefits of integrated supply, but are not ready for a total outsourcing solution or on-site management services.

Grainger Custom Solutions offers customers a complete solution in six major product categories, along with access to Grainger Industrial Supply's broad product line. Customers are guaranteed specific cost reductions, with mutual incentives for both them and Grainger when targets are exceeded.

In 1998, the business opened two call centers, located in Gurnee, Illinois, and Taylor, Michigan. During the year, over 20% of customers were transitioned to these call centers, with the remaining 80% scheduled for transition by June 1999.

Grainger Custom Solutions' low-cost logistics platform includes distribution centers in Morton Grove, Illinois; Dallas, Texas; Fresno, California; and Dearborn, Michigan. Immediate product needs are fulfilled from Grainger Industrial Supply's logistics system. Grainger Custom Solutions uses SAP's R/3 enterprise resource planning system, installed during the fourth quarter of 1998.

Grainger Custom Solutions focuses its people, systems, assets, products, and services on the needs of this important and large customer segment. At the same time, the formation of this new business allows Grainger Industrial Supply to focus on its broad-line speed and convenience mission.

Grainger Integrated Supply. Grainger Integrated Supply provides on-site materials management services to large companies looking for a complete outsourcing solution. This includes supply chain management, storerooms, and purchasing operations. The business' mission is to free its clients to focus on their businesses, while Grainger Integrated Supply provides a comprehensive low-cost, high-service MRO solution.

In 1998, Grainger Integrated Supply revenues grew over 50% to $81 million. Growth drivers included new sites as well as expanded responsibilities at existing sites. Revenues currently under contracts ranging from two to eight years total $290 million.

To maximize future growth, the business began targeting high-tech industries in 1998 - complementing Grainger Industrial Supply's traditional focus on heavy manufacturing businesses.

The business implemented its new SAP R/3 enterprise resource planning system in 1998. Improved information capabilities and more effective site linkages will benefit all customers. The system gives Grainger Integrated Supply the ability to view real-time inventory information across all customer locations, providing a key competitive advantage in the marketplace.

Grainger Consulting Services. Many companies realize the significant opportunity to improve the way they manage indirect materials and drive costs out of their business. Grainger Consulting Services helps companies capitalize on these opportunities and facilitate change.

In 1998, Grainger Consulting Services served over 90 client locations in a variety of industries including manufacturing, health care, transportation, services, property management, education, and utilities.

In addition to consulting, this business offers implementation resources. In 1998, Grainger Consulting Services added an inventory database development and standardization service. This is a powerful resource for clients implementing enterprise asset management systems. It also signed a Complementary Service Agreement with PSDI, developer of MAXIMO, a leading enterprise asset management software provider. This relationship brings both parties' customers more complete solutions and opens up new market and client opportunities.

Lab Safety Supply. Lab Safety Supply had a strong year in 1998. Double-digit growth was driven by new products, new geography, and new media. More than 15,000 new products were added to non-safety related product categories. These categories account for over 50% of revenues.

Targeted catalog offerings now include:

In addition to strong sales growth, focused efforts in catalog production, order fulfillment, and circulation management resulted in profit improvements. The transition to a new catalog management system, completed in 1998, has improved the feed into print and electronic media. Also implemented in 1998, new predictive modeling techniques allow the business to more efficiently target the most productive customers, eliminating mailings to non-performing accounts.

Other 1998 initiatives included new inventory and warehousing methods that reduce costs and increase customer satisfaction.

Developing and Embracing New Technologies

Grainger is uniquely positioned to benefit from the forecasted expansion in business-to-business Internet commerce based upon its product information content, relationships with the world's leading manufacturers and distributors, a customer base of more than two million businesses, and the most trusted name in MRO. In 1995, Grainger saw the benefit that the Internet could provide to its customers. Grainger now enjoys a sizeable competitive lead in bringing innovative solutions to the market. Grainger's commitment to this unprecedented opportunity is backed by strong investments in people and technology. In 1998, the Company invested over $14 million to leverage its head-start advantage and increase its lead in bringing new Internet capabilities to market.

Grainger Internet Commerce. To further advance the Company's Internet leadership, all of Grainger's Internet activities are handled by a single organization. This leverages specialized Internet technology and marketing skills.

Grainger.com. In 1998, Grainger.com was once again honored as one of the world's top ten business-to-business Internet sites by Advertising Age's Business Marketing Magazine. During the year, Grainger invested heavily to expand its already successful Internet presence. New functionality for Grainger.com included the introduction of CasterMatch, another in Grainger's MatchMakers series, and a more powerful search capability. Grainger.com began accepting credit card purchases in November. In 1999, Grainger.com will transition from Grainger Industrial Supply's Web site to an integrated site for all Grainger-branded businesses.

OrderZone.com. In 1998, Grainger applied its Internet expertise to create a new multi-distributor Web site that brings an innovative Internet solution to customers from one-person businesses to Fortune 500 companies. The new business, "OrderZone.com," is scheduled for a second quarter 1999 launch. In this indirect supply digital marketplace, customers register once to place orders across a number of leading complementary distributors. Products can be searched across the entire offering, a single order can be placed, and customers receive a single invoice.

The initial distributor partners include Cintas Corporation (uniforms), Corporate Express, Inc. (office products and computer supplies), Grainger Industrial Supply (MRO products), Lab Safety Supply (safety products), Marshall Industries (electronic components), and VWR Scientific Products (laboratory supplies).

Large Company E-Commerce. Grainger is also addressing the unique electronic commerce needs of large companies. In addition to the capabilities found in OrderZone.com, large companies require greater supplier choice, tighter integration with their own systems, and adherence to their purchasing procedures. Several solutions are emerging through collaboration with a number of software companies, and Grainger is again positioning itself for success as this market develops.

Grainger's Internet leadership was showcased in September 1998, when Grainger teamed with SAP and Requisite Technology, Inc. to demonstrate electronic Web-based purchasing through an SAP client system directly from Grainger utilizing Requisite's BugsEye search software. The demonstration was showcased at SAP's SAPPHIRE Conference in Los Angeles, attended by 14,000 professionals.

Product Information. Grainger's skills in compiling, manipulating, and displaying product information created the industry's leading MRO catalog, CD-ROM and Web site. These same skills apply to Internet commerce, which requires accurate, consistent, and timely product information to satisfy customers' procurement needs.

In 1998, Grainger launched a major initiative to take product information management to a new level. Grainger formed an alliance with Requisite, a leader in electronic cataloging and content services for electronic commerce. This will enhance Grainger's information quality and search capabilities, allowing Grainger employees and customers to rapidly find the items they need to solve MRO problems.