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How To Stop Worrying And Love The Next Recession

Companies that managed the last recession best are planning for the next one now.
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THERE IS A STORY -- NO DOUBT AN apocryphal one -- about John Maynard Keynes, the great British economist, who found himself on a train one day near the end of his distinguished career. A conductor approached, collecting tickets. Keynes searched for his in vain. Finally, the conductor told him not to worry, just send in the ticket when he found it. Keynes looked up with some irritation. "The problem," he said, "is not where my ticket is. The problem is, where am I going?"

These days, there is no shortage of economists telling us where we are going, and few of them seem to think we're going into a recession at any point in the near future. The Reagan Administration predicts that the U.S. gross national product will increase 4% in 1986, up from 2.3% in 1985. Private economists generally agree, give or take a percentage point.

Unfortunately, such numbers are almost meaningless to anyone who runs a company, as most economists will readily concede. "You really can't take GNP as an indicator of sales growth or, for that matter, anything," says Allen Sinai, chief economist at Shearson Lehman Bros. and (next to Jeane Dixon) probably the most quoted prognosticator in the country. "GNP forecasts may inspire policymakers to do things like increase or decrease the supply of money but, aside from that, they're pretty empty."

There's another problem with such rosy predictions. Empty or not, they tend to hide a simple, if regrettable, truth: sooner or later, a recession is inevitable. The only unknowns are when and how bad.

So what, you might ask, can economists tell us about the future of the economy? Surely, there must be some trends that are significant for people building companies, some clues as to how they should be preparing for what lies ahead. Can't economists at least enlighten us about those?

Well, no.

Not that the trends don't exist. It's just that economists can't seem to agree on what they are, or what they mean. "The unique thing about this period is that you can find bankers and economists to support almost any economic scenario you can come up with," says Dean Treptow, president of Brown Deer Bank, in Brown Deer, Wis., and a shrewd observer of such phenomena. "I've never seen such a wide diversity of economic forecasts as we're seeing right now. It's almost chaotic."

Take inflation. Some forecasters see inflation rising to 6% or 7% in the coming months, pushed up by a weaker dollar and growth in the money supply. Others say, no, inflation will definitely hold steady at about 3%. Still others contend that the thing we have to worry about now is deflation, thanks to excessive industrial capacity across much of the economy.

Or what about the dollar? Can't we at least expect some relief when it finally weakens against foreign currencies? Absolutely, say some economists: a falling dollar will stimulate exports and help American companies compete against imports. Baloney, say others: it will have little effect, if any, because foreign companies have used the past few years to prepare themselves for such competition, improving the quality of their goods.

Consumer installment debt? A real sword of Damocles, say some economists, noting that debt as a percentage of disposable income is currently at an all-time high (close to 20%). A red herring, say others, pointing out that much of that debt takes the form of credit-card balances, which many people pay off every month.

The effect of Gramm-Rudman? It will cure the deficit problem once and for all, assert some. No, say others, it will require a massive, across-the-board reduction in government spending, with catastrophic effects on the economy. No, it will force an equally devastating tax increase. No, it's unconstitutional and, therefore, irrelevant. You pays your money and you takes your choice.

We could go on and on, listing fundamental disagreements about major issues, until you might begin to wonder whether we know anything about the economy at all. The answer to that question is yes. We do know, for example, that the current recovery -- which began in November of 1982 -- has already lasted longer than the recovery of 1954-57, but not quite as long as the recovery of 1970-73. We know as well that, as of last November, the percentage of American adults employed (60.7%) was at an all-time high for any expansionary period; then again, so was the percentage of American adults unemployed (6.9%) for any expansionary period. We also know that consumers appear to be exceptionally bullish about the future: after declining for several months, the University of Michigan's Survey of Consumer Attitudes, a 33-year-old composite index, shot up to 93.9 in December, very near its historic peak.

And there's one other thing we know. We know, or at least we can be reasonably sure, that the forecasters won't warn us about the next recession until it's too late. "It has been a long time -- like since the Peloponnesian War -- since any significant number of forecasts have predicted recession until after it had actually begun," notes Albert T. Sommers, senior fellow and economic counselor of The Conference Board, a New York City-based business group.

That's disturbing news -- or it should be -- to all those who are waiting for the official announcement before getting their businesses in shape to withstand the onslaught of the next recession. It's even more disturbing when you consider that, from one perspective, the next recession may already have begun. Amid the celebration of the present recovery, we tend to lose sight of the fact that there have been minislumps all over the country during the past three years. Texas, for example, has been reeling from the effects of the worldwide oil glut; thousands of companies -- and not just energy companies -- have been forced out of business. Silicon Valley has been similarly shaken by the troubles in the microcomputer industry. And parts of the Midwest have yet to show any signs of recovering from the last recession.

Of course, some company owners don't worry about the possibility that a recession might hit their corner of the world. They figure that they have such a hot product or service as to make them recession-proof. They should talk to Michael G. Berolzheimer, a San Francisco venture capitalist.

Berolzheimer learned about the perils of overoptimism more than a decade ago, when he was president and chief executive officer of a family business called Duraflame Inc., which produced and marketed fire logs made from sawdust and wax. In the fall of 1974, his company was growing so fast that neither he nor his managers could conceive that sales might significantly weaken, even in a recession. They thought, hey, people will always want to sit around a blazing fire.

So they cranked out fire logs by the truckload and, boy, did they pay for it. By the end of 1974, sales of Duraflame's products had ground to a halt. "We wound up with about a half year's supply in inventory," recalls Berolzheimer, a 46-year-old Harvard M.B.A. "We didn't realize that the product was as vulnerable as it was, which means we weren't asking enough hard questions." Duraflame survived the slump, but not without a lot of red ink. The experience taught Berolzheimer a lesson he will never forget.

That lesson, in a nutshell, is "Be prepared." This does not mean playing Chicken Little, always acting as if the sky were falling; that approach can be as disastrous, in its own way, as ignoring the possibility of falling skies altogether. Rather, "being prepared" means organizing your business so that you can recognize trouble when it arises, and respond to it swiftly and effectively. The question is, How?

IT WOULD BE NICE TO be able to offer a simple answer to that question -- a single, all-purpose, fool-proof strategy for coping with recession -- but unfortunately, there isn't one. After all, businesses face different sorts of risks. Each company has its own products and its own customers, and operates in its own part of the country and its own segment of the market, so specific responses will, of necessity, vary greatly.

Nevertheless, if you look at companies that are smart about such matters -- and that have managed past downturns better than most companies -- you'll find that they do three things in common. First, they monitor their markets like hawks, so that they can be quick to spot any weakness that appears. Second, they build as much flexibility as possible into their operations, so that they can react when they need to. Third, they have a plan of action in place, and they're prepared to put it to work at the first sign of trouble.

Establishing an early warning system is particularly important, given the general unreliability, and ultimate irrelevance, of economic forecasts. Moreover, there are now tools available for this purpose that didn't exist in presious recessions. They are called computers. Ten -- or even five -- years ago, it was hard to find a smaller company that used a computer to monitor its market. These days, it's hard to find one that doesn't. And while applications vary according to the needs of the particular business, some sort of computerized early warning system is in place at almost every company that is serious about staying on top of its marketplace.

Thomas E. Wolfe Co., for example, a San Francisco-based manufacturer of trousers and skirts, has installed an inventory-management system that runs off of two IBM Personal Computers. The system allows CEO Jack Wolfman and his managers to keep track of everything from fabric purchases to unshipped orders to production and shipping schedules. Wolfman says it not only lets them keep inventory to a minimum, it also tells them exactly where they stand at any moment, and helps them detect trouble early.

At Marelco Power Systems Inc., in Howell, Mich., president Peter Burgher uses his computer specifically to focus on the future. Among other things, it allows him to track orders for the electrical transformers his company makes. If orders look skimpy a few months down the road, Burgher can take action while there is still time.

This is not to suggest that companies are, or should be, relying exclusively on computers. The best method for reading a market is still what it has always been: staying in close touch with customers.

Consider Semline Inc., a printer and book manufacturer located in Braintree, Mass., whose management prides itself on knowing its customers' businesses as well as the customers do. About 70% of the company's sales volume comes from printing and binding books for such large publishing houses as Prentice-Hall Inc. and McGraw-Hill Book Co. CEO John Collins and his top financial and marketing people make it their business to study every customer's annual reports, 10-Ks, and anything else they can lay their hands on. Semline's officers also meet regularly with production and marketing people at each of the companies they work with, and develop their own informal grapevines, which will feed them flash reports on important developments. This intelligence gathering takes time, notes Collins, 39, but it has enabled the $30-million company to see further into the future than most of its competitors. "Unless you spend time on market research, you can get into awfully deep yogurt," he says.

Market research gets more complicated if you have more customers to keep track of, but the principle is the same. Wolfman at Thomas E. Wolfe, for instance, sells to some 300 retail stores -- more than he and his 14 salespeople can keep close tabs on. Instead, they talk regularly ("at least once a week," says Wolfman) with buyers and managers at 15 to 20 representative accounts around the country, ranging from small specialty shops to major department stores. "These are our target core accounts," explains Wolfman, a former general merchandise manager at Levi Strauss & Co. "They're the guys who we feel give us the best and most accurate information." The target customers keep Wolfman informed about retail shoppers' response to his current line; they offer suggestions about new styles to consider; and they give him early warnings of moves by domestic and foreign competitors. "We feel the pulse of what's happening and where the opportunities are," he says.

Of course, it doesn't do much good to have an early warning system if you can't react to the information you get, especially when that information warns of a sudden, dramatic downturn in business. For that reason, well-managed companies take care to maintain as much flexibility as possible, which often means running lean. Marelco's Burgher, for one, makes sure that the transformer company is lean by monitoring the relationship between his direct costs (those associated with producing and selling his products) and his indirect costs (for administration and everything else). A 24-year veteran of, and former partner with, the Big Eight accounting firm of Arthur Young & Co., he tries to keep the ratio at or near 5-to-1, which he considers a good indication that the 40-employee company is operating efficiently. If the ratio goes to, say, 4-to-1, Burgher takes that as a sign that "things are sliding out of control and I'm cutting into my profit margin."

Ratios aside, flexibility demands control of costs, especially such fixed costs as debt service. After all, if you are saddled with massive loan payments, you won't have much room for maneuvering when business goes bad. For that reason, Nathaniel Howe, president of Hartford-based Quamco Inc., has been focusing squarely on retiring the debt with which he and his partners financed the leveraged buyout of the company, comprised of six former divsions of Litton Industries Inc., in late 1984. The hefty loan payments, says Howe, constitute far and away the largest cash drain on the company, which manufactures metalworking tools and industrial products. With that in mind, he has been trimming inventories and doing a variety of other things to accelerate cash flow. "We're feeding our banks as fast as we can," Howe says. As a result, Quamco's credit terms "are substantially better than they were when we bought the businesses in 1984."

The need for flexibility also means keeping close watch on cash flow. Charles River Data Systems Inc., a computer maker located in Framingham, Mass., for example, could qualify for attractive volume discounts from software vendors by making large initial payments. But chief financial officer Graham Briggs prefers to limit the cash outlays, and the risks. In a volatile market, he points out, "flexibility can be an awfully good substitute for foresight."

Some companies take caution a step further, looking not only at their suppliers but also at their customers. The owner of one Boston-area distribution company has recently been tightening up on the credit standards he uses on customers. The reason: he doesn't want to be stuck with difficult collections when the economy weakens. "Most businessmen are afraid to lose business," he says, "but they don't realize the costs of doing business and how hard it is to make up for a bad debt." He tells his salespeople to be more careful with new accounts, and he asks slowpaying customers to pay in cash. "When you can't collect $100,000," he explains, "that can be 25% or 30% of your profits for a whole year."

OBVIOUSLY, A COMPANY needs time to build in such flexibility. It's too late to start repaying loans, shortening contracts, or tightening credit standards after business turns sour. The truth is that a company in a bad market has limited options: you can cut costs, or you can try to increase sales. The more pressure there is to cut costs, the fewer resources you can apply toward boosting sales. If you haven't prepared adequately, you will probably be forced to scramble just to stay afloat. You may even be tempted to scale back your marketing efforts, cut your prices, or do a variety of other things that, in all likelihood, will only make the situation worse. Conversely, a company that has prepared well for a downturn, building in flexibility, is able to respond to trouble by cranking up its marketing efforts. And that, in fact, is precisely what the best-managed companies do.

A case in point is Semline, the book printing company, whose marketing efforts brought it through the recession of 1981 and '82 virtually unscathed. Long before the recession hit, CEO Collins and his top managers had detected softness in the market for softcover text- and trade books. In response, Semline's salespeople were asked to drum up new business -- jobs printing computer manuals, for example -- and were offered incentive bonuses of an extra 5% to 10% for cracking new accounts. As a result, Semline's sales grew a healthy 15% during the recession. "We didn't say, 'My God, how do we retrench?" says Collins. "We went on the offensive."

Similarly, a marketing offensive helped Marelco Power Systems to survive the last recession, which arrived soon after Burgher bought the Michigan company in 1980. Especially hard hit were the state's auto suppliers and machine tool makers, which constituted most of Marelco's market. "We lost about 98% of our sales," he recalls. Burgher responded by eliminating his own salary and slashing his payroll, and by putting together a network of about 200 independent sales representatives around the country.The latter began turning up new customers for Marelco, including makers of robotics equipment. Meanwhile, Burgher continued to invest in new products, even with business in the doldrums.

Since then, the company's sales have been growing. Nevertheless, when Burgher spotted new signs of weakness last January, he went right to work preparing for the next recession -- replacing his least effective sales reps, and stepping up his own travel schedule so that he can call on more customers himself. In addition, he has, for the first time, begun to sell some lower-price products through electrical distributors. By adding new products and selling through a new distribution channel, says Burgher, "we're hoping to get some sales stability, so we can cushion the impact of a recession."

As the experiences of Semline and Marelco suggest, it is often vital that a company respond quickly to any signs of weakness in its market. That's true no matter what industry you are in. Last summer, for example, business began to slacken at Aahs!, a specialty retailing chain based in Santa Monica, Calif. Founder Jim Greenwood and his newly hired general manager, Hank Toles, might have been tempted to watch sales for a couple of months and hope for the best. Instead, they immediately did a top-to-bottom evaluation of the company, whereupon they closed two money-losing stores and initiated big changes at the remaining four.

Among other things, they began a new education program to teach the company's approximately 100 employees about the economics of retailing. Each month, employees get a store-by-store rundown on performance and are coached on the steps they can take to boost sales and improve the bottom line. In addition, Aahs! adjusted its merchandise mix of upscale cards and gifts, deemphasizing what it considered to be the very trendy products, adding less expensive (and less volatile) items.The idea, says Toles, is to build both a more loyal clientele and a more stable business.

So far, the company's quick response appears to be paying off. During the last three months of 1985, the gross profit margin was almost 3% ahead of projections. "Anybody can look like a hero when times are good," says Toles, now chief financial and administrative officer. "But the secret of good management is figuring out how to make money when markets are weaker."

As important as it is to react swiftly to changing market conditions, however, it is even more important to know how to respond. Otherwise, you're liable to do the wrong thing -- such as cutting prices when they don't need to be cut.

That, indeed, was one obvious option open to John McCormack in early 1985, when business began to fall off at Visible Changes Inc., his $12-million chain of haircutting salons based in Houston. An investor in oil and gas, McCormack had been expecting problems, and responded quickly with an aggressive television advertising campaign aimed at stimulating volume in his 15 salons. Over a three-month period, the company spent $250,000 on hundreds of spots, which generated more than 20,000 first-time customers. In hopes of luring them back again, McCormack handed out thousands of discount coupons, good for $2.50 off the price of a $19 haircut. To his surprise, he found that, while many of the people came back, less than 1.5% brought their coupons.

The experiment gave McCormack new insights into his customers -- and, not co-incidentally, into his company's strengths. Most important, he says, it showed him that people who come to our salons aren't interested in $5 haircuts." Armed with this knowledge, McCormack proceeded to develop an innovative system for stimulating salon traffic based on style, not price. Each of the company's 275 haircutters is now required to learn at least one new haircut every six weeks. In addition, they are encouraged to build their own clientele. Haircutters who are requested more than 50% of the time, for example, can charge an extra $2 per cut, which they can keep. What's more, they qualify for special bonuses. And haircutters requested more than 75% of the time receive additional bonuses.

The program has worked like a charm. During 1985, some 70% of the company's haircutters were requested more than 50% of the time, versus about 40% the year before. Meanwhile, Visible Changes has not only survived in a dreadful economy, it actually grew 12% last year, at a time when scores of salons offering cheaper haircuts were going out of business.

"We've taught our people the importance of responding to customers," explains McCormack, a 40-year-old native of Queens, N.Y. "And we learned to listen to the economy and to read the market. We found that our customers didn't want us to cut prices. They wanted us to give them the latest look."

SO WHAT CAN A COMPANY DO TO prepare for the next recession? Well, judging from the experiences of other companies -- companies that have done well in past recessions -- ther are at least three things it can do. It can monitor its market. It can stay flexible. And it can get ready to respond whenever trouble appears.

When you think about it, that's more or less the way any well-managed company goes about its business, regardless of the imminence of recession. After all, a recession is just one of many events that can threaten the health -- or even the existence -- of a smaller company, and they all demand alertness, flexibility, and a quick, intelligent response. The difference is that fate may spare some companies from those other perils, but sooner or later every company has to deal with the effects of a business downturn.

In the final analysis, preparing for that downturn means knowing your business backward and forward: what it takes to cover your overhead, how your market is changing, what's happening with your customers and suppliers, where your flanks may be weak, what opportunities are opening up, how things look down the road. For some companies, the wise strategy will be a defensive one -- assuming the worst and charting a relatively safe, conservative course. For others, the opposite may be true.

In any case, now is the time to figure out the right strategy, while the economy is still expanding and the economists are talking growth. The truth is that, if you wait until the downturn actually arrives, it may be too late.

Last updated: Apr 1, 1986




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