Business tactics for confronting economic recession and planning for recovery.

Author:Pearce, John A., II
 
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ABSTRACT

A primary economic indicator declared that the US was in recession as of February 2001. Managers' responses during this downturn should be influenced by the cyclical nature of their industry and by the extent to which the roll of the recession is effecting their competitive environments. Depending on their situation, managers may find value in seven success tactics that benefited adopters during the decline phase of the last recession. They may also wish to take advantages of recovery tactics that can help to position their firms for the end of the recession when new competitive dynamics come into play. This article explores the logic of these tactics and provides prominent examples drawn from corporate successes.

THE UNITED STATES IS IN A MANUFACTURING RECESSION

Of the three major indicators of a recession, the first to reflect a downturn in the economy is monthly index of the National Association of Purchasing Management. A precursor to the more encompassing measures of the Gross National Product and the Leading Economic Indicators, the index recorded it thirteenth consecutive sub-50 monthly report in September 2001; the NAPM defines as its recessionary threshold as two consecutive sub-50 months.

Because the manufacturing sector constitutes about 20% of the overall economy, the numbers indicate that its weakness is so severe that it can pull the national economy into a downturn. Other economic signs suggest that a severe downturn, if not a nationwide recession, has arrived. US worker productivity, a measure of living standards, fell at an annual rate of 0.3% in the second quarter of 2001, after showing the biggest drop in eight years in the first quarter. Unit labor costs jumped 6.3% for the quarter, the biggest increase since 1990. Factory orders declined in the first two quarters of 2001, unemployment levels reached a nine-year high, and the overall economy is growing at an anemic rate of only 1.2%. April 2001 also marked three quarters of consecutive declines in corporate profits, the longest stretch since the Asian currency crisis of 1997-1998. With the economy of the US slowed further by the terrorist attack of September 11, 2001, recession seems even more likely.

This article looks at recent recessions in an attempt to identify the tactics that executives have used--often in emerging entrepreneurial companies--to minimize negative impacts on their firms' performances. This topic is important because entrepreneurs have the same needs to forecast the future direction of the economy as do executives of larger firms, but they characteristically lack the resources to undertake extensive monitoring and interpretation of economic trends. Unable to afford specialized in-house economic talent, entrepreneurial executives often need to do their own economic forecasting. The insights presented in this article are intended to provide these entrepreneurs with research and experience based information that can improve their ability to cope with economic downturns.

We begin with an overview of how downturns affect industries, before turning to eight tactics that have reduced the severity of the decline phase of a recessionary period on business profitability. The focus then turns to success tactics that have directed some highly successful company turnarounds during the recovery phase of the economy. The paper concludes with guidelines for entrepreneurial executives to consider in preparing for economic downturns.

HOW VULNERABLE IS AN INDUSTRY?

A recession does not arrive at every location throughout the country at the same time. In fact, some locations often go largely unaffected. Similarly, some industries are hit first; others are hit harder. Therefore, even when national statistics show that a broad-based slowdown is occurring, entrepreneurial executives need to assess the extent to which their own industry is affected. The principal predictor of likely impact is the cyclicality of the industry.

Cyclical Industries

The performance of a cyclical industry coincides with the phases of the business cycle. Therefore, in a recession a cyclical industry is characterized by stable or falling prices, a decrease in corporate spending, a decline in real earnings, excess production capabilities, and high unemployment. The economy produces less than its capacity. Examples of cyclical industries include jewelry and precious metals, automakers, apparel and other textile products, red meat, paper and paperboard mills, computer manufacturing, homebuilders, real estate sales, hotels, airlines, media, and electronics.

In the 1990-1991 recession, automobile manufacturers and the suppliers that served them were among the hardest hit. Net income slipped 78% at Ford and 81% at Chrysler. To minimize losses, the carmakers reduced costs by closing plants, squeezing suppliers, and using special discounts to entice buyers.

Another major recession victim was the real estate industry, and as a result, the commercial banking industry. Real estate lending was the biggest single category of business for commercial banks and became the major source of financial weakness for the banking industry during the recession. Comprising approximately 25% of the industry's loans, the commercial real estate market became the largest problem-loan category in banking history.

Major airlines also suffered from the decrease in consumer spending and turned to price wars to maintain passenger volume. In early 1991, American Airlines cut fares on all of its routes, both domestic and foreign, escalating a round of discounts in the industry designed to lure travelers back into the air after months of slow traffic due to the recession and the Persian Gulf War. Delta air followed suit by cutting one-way and round-trip fares for business travelers. United Airlines also began offering coupons good for discounts on designated flights.

Despite a recession, some cyclical firms can increase their sales. These firms entice buyers by using discounts, or offering limited services for a reduced price. For example, although the U.S. hotel industry lost 2.7 billion in 1991, there were many hotel success stories, particularly among limited service hotels, defined as those without restaurants (Faust, 1992).

Counter-Cyclical Industries

An industry that typically does well during a recession is a counter-cyclical industry. It is characterized by an increase in earnings, a rise in employment, an increase in consumer spending, and full utilization of its production facilities. Counter-cyclical industries typically perform well in a recession because they provide the consumer with cost savings on a necessity product. Therefore, generic products and discount warehouses improve their profit performance as consumers seek to save money on necessary purchases.

Noncyclical Industries

A noncyclical industry does not follow any cycle. Its performance is unrelated to the state of...

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