Unprepared people get hurt in an economic downturn. But if you have a plan, you can come out stronger than ever
Someone once observed that there are no bad predictions; there's only bad timing. Regular readers of this magazine may recall that three years ago I predicted the economy was headed toward a full-scale, across-the-board recession like nothing we'd seen since the early 1980s.
OK, so I was three years early.
These days you don't need the Hubble telescope to see the recession coming. It's not here yet, at least not as we go to press, but I doubt it's more than a few months away. My guess is that by next fall we'll all be dealing with the effects of a general downturn in economic activity. That will be very bad for some companies--and it can be very good for others.
Listen, everyone doesn't get hurt in a recession. I don't want to sound like a cheerleader for bad times, but change creates opportunities, and moving from boom to bust is a big change indeed. Some companies automatically get a boost because of the nature of the industry they're in--collection agencies, for example, or makers and sellers of automotive replacement parts. But even if you're not in a business that usually does well in a recession, it could still turn out to be the best thing that ever happened to your company, provided you've done your homework. The people who get into trouble during a downturn are invariably the ones who go into it unprepared.
How do they get into trouble? In the first place, by thinking the recession won't affect them. That's a real danger if you've never been through one before. There's a natural tendency to approach your first recession in a state of denial. I know I did. You tell yourself that you're too smart to get hurt, or that your company's in a unique niche, or that you could use a breather anyway, or whatever. You just don't want to think about all the bad things that might or might not happen 8, 9, or 10 months down the line.
But when you're drowning in slow accounts receivable and you have to start laying people off, it's too late to come up with a contingency plan. You need one now, and it has to begin with a clear understanding of what you're going to face when the recession hits.
Recessions are not mysterious. They're periods during which the economy gets smaller. Business activity goes down. People buy less and worry more. Everybody looks for ways to save money and conserve cash. The big fear is that you won't be able to pay your bills--and that, as a result, your company will fail.
To do well in such an environment, you have to turn the situation to your advantage. That means mobilizing your entire organization to focus on cash flow and then using the cash you have to maintain and expand your customer base.
There are actually four steps involved. Let's take them one at a time.
Figure out how to become the low-cost provider
The first step is to determine in advance how you could compete on price if you had to.
In a recession everybody competes on price. Why? Because customer attitudes change. During periods of economic growth, customers look for service, reliability, and fair prices and are very loyal to suppliers who provide all three. But when the economy goes south, customers get scared like everybody else. They aren't satisfied with a fair price anymore; they want your lowest possible price. If they don't like what you offer, they look elsewhere.
So you need a plan whereby you'll be able to reduce your prices and yet maintain your profitability. In my storage business, for example, I compete on quality and service, not price, but I could change my strategy overnight if I had to. Our costs are already substantially below the industry average. We figured out a long time ago that we could save a lot of money by building warehouses with very high ceilings, allowing us to store more boxes per square foot than our competitors do. So there's room to cut prices if necessary, assuming we can find ways to save money in other areas of the business.
Understand, I'm not saying I'll be happy to do it. I'd greatly prefer to help my customers reduce their costs in other ways--by giving them something extra for their money or by showing them how to get more bang for their buck. But in a recession, a real recession, you may not have a choice. You may find that without cutting prices, you simply can't compete. In that case, you'd better have a plan to reduce prices profitably or you won't survive.
Watch for the signs, and move fast when you see them
A recession is no time for procrastination. You have to be ahead of the curve or you'll lose whatever advantage you gain by being prepared.
That's especially true when you're dealing with customers. You can't wait for them to tell you your prices are too high. By then you've already become part of the problem. You need to approach them first, right when they're beginning to panic. You need to say, "I know times are hard, and we've figured out how we can save you some money." You can become a hero to your customers--but only if your timing is right.
So when exactly should you move? As soon as you see clear indications that the recession has started. I'm not talking about looking at official statistics or waiting for an announcement on the evening news. If you're paying attention, you'll know the slide has begun long before it surfaces in the media. More to the point, you'll know it's happening in your market. You'll see the signs, not only in your business but among your friends and acquaintances.
What you should look for are changes in both psychology and behavior. Recessions happen when people spend less, but often they spend less because they expect bad times. Anticipating slower sales, companies stop hiring. Projects are put on hold. People don't pay their bills as quickly as they used to. Everyone becomes more conscious of cash.
So I keep my eyes open for any clues that a change is occurring. I notice, for example, when sophisticated people I know start checking prices or cutting back on their purchases. I listen to the gossip among business associates. Most of the time they tell me how unbelievably great they're doing. When they start saying that business is just "good" or "OK," I take it as a bad sign.
Another one is a sudden increase in the number of requests for financial information that businesses are getting from their lenders. You know something's up when the banks stop beating the bushes for new customers and focus instead on the loan covenants of the companies in their portfolios.
But mainly I look at the signs in my own businesses. There are four key indicators I watch closely.
First, I keep track of service requests from current customers as a way of monitoring how they're doing. When their business is good, they move a lot of boxes in and out of our warehouse. I want to know right away if the box traffic slows down, and I want to find out why.
Second, I track the number of unsolicited inquiries we receive from potential customers looking to save money. A significant increase could mean that more people are beginning to feel squeezed.
Third, I watch the pool of job applicants. Like most businesses, we have a hard time finding certain types of employees--part-time truck drivers, for example. When the recession comes, we'll see a sharp rise in applications for those jobs from people with experience and long-term employment records, because other companies will have begun cutting back.
But maybe the best indicator of an oncoming recession is a slowdown in receivables as people start to conserve cash. It can happen very gradually. With everything else going on, it's easy to miss. Then one day you wake up and discover your collection time has increased 10%--from, say, 32 days to 35.
That increase alone doesn't prove a recession has started. You may just have grown sloppy. I'd look at the accumulation of evidence before doing anything drastic. I wouldn't cut prices, for example, until all the indicators are pointing in the same direction and you feel certain the economy has crossed the line.
But that doesn't mean you can ignore a slowdown in receivables. On the contrary, you have to jump on it immediately. You have to hire more collectors, speed up billing, do everything you can to get the number of days back down. And I wouldn't stop at 32 days if you think a recession is coming. I'd work the collection time all the way down to 29 days. Why? Because cash is king in a recession. You're going to need all you can get.
Mobilize your people to save jobs
Fear usually breeds bad morale, and recessions are scary times for employees. You can use the crisis to bring people together, however, by letting them know up front that you're committed to preserving their jobs and that they can help. How? By finding ways to cut costs.
And you do have to cut costs. If you're going to reduce prices, maintain profits, and conserve cash, you need to look at every expense, both shortand long-term, and decide what can go. There's only one category I'd put offlimits: sales-and-marketing expenses. I wouldn't touch them at all, for reasons I'll explain below, but everything else needs to be scrutinized closely.
Of course, you probably think you watch expenses as it is. I tell myself the same thing. It's baloney. Every company I know suffers from creeping expenses, and the condition gets worse during periods of prolonged economic expansion. When the recession comes, you have to separate the luxuries from the true necessities, and you can't do it alone.
For example, we hold two big parties for employees every year. They're good for morale, but together they cost as much as one annual salary. I'd rather suspend the parties--and save a job--while the recession lasts, but I'll probably let the employees decide.
We also spend a lot of money on season tickets to professional sports games. We use them to reward employees and entertain customers. There are other ways to do both and to cut our overhead in the process.
In addition, we can sharpen our buying. Maybe we should consider switching telephone carriers or refinancing our leasing arrangements. Maybe we should look for a better deal on insurance. There's a myriad of possibilities--things we should no doubt have been doing all along but tend to let slide when business is good. In a recession you need to put cost cutting back on the front burner and get your people involved. For one thing, they're likely to come up with ideas you'd never think of. More important, you'll be sending a strong message that you aren't going to abandon them in tough times.
Go out and sell
It's ironic to me that going into a downturn, most companies cut first the one type of expense they shouldn't cut at all: advertising. A recession is the best time to advertise. You'll never have a better chance to expand your business. Why? Because everybody is asking the same questions you are. "How can I save money?" "How can I survive?" People are willing to listen to anyone who can help them come up with an answer. They're open as never before.
If you've set yourself up as the low-cost provider; if you've moved quickly at the start of the recession; if you've stayed on top of your receivables, mobilized your people, reduced your expenses; in other words, if you've done all the other things I've talked about here, you'll be in an ideal position to add new customers--provided they know what you have to offer. To take advantage of the opportunity, you need to put every spare cent you have into getting out the message.
At the same time, you have to confront another challenge. I'm talking about deciding whether or not to add capacity, increase inventory, and do whatever else is required to make sure you can take care of those new customers once you get them.
It's a real dilemma. You take a risk when you tie up cash in assets you may not need during the hard times ahead. If you guess wrong, you could find yourself with a lot of slow inventory or excess capacity at the same time you're engaged in a desperate struggle to raise cash to cover your expenses. On the other hand, you also take a risk if you try to grow without having the ability to meet the demand you generate.
I'm facing that choice right now. We're building a new warehouse, which I expect will be filled within a year or so. In April I'll have to decide whether or not to start construction on a second warehouse. If we grow as I anticipate, we're going to need the additional space, and it's much cheaper for us to build our own storage facility than it is to buy or lease someone else's.
Then again, I don't want to be caught short of cash in a recession, especially if it's accompanied by serious price deflation--which is certainly possible. Believe me, I'll be watching the signs like a hawk.
Of course, there's a chance I'm wrong and we won't have a recession after all. I was wrong three years ago. What happened? We left prices where they were, and the company grew like crazy.
Having a plan doesn't mean that you implement all parts of it at once. I'm not suggesting that anyone start cutting prices before it's necessary. On the contrary, I believe strongly in keeping gross margins as high as possible for as long as possible. It will kill me if I'm forced to cut mine by three or four percentage points. I won't sleep nights until we get our overhead expenses low enough to make up the difference.
But we don't have to cross that bridge yet, and maybe we never will. In the meantime there are many other things we can do to get prepared, most of which we should be doing anyway. You should do them, too, whether or not you believe my prediction. At worst, you'll wind up with a stronger, more profitable company in three years.
Then you can tell me I was wrong again.
Norm Brodsky is a veteran entrepreneur whose six businesses include an Inc. 100 company and a three-time Inc. 500 company. This column was coauthored by Bo Burlingham.