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Norbert J. Ore is a bit mystified by the current manufacturing slump. It seems to have crept up on managers, he points out, despite "the far better tools we have today" for deciding when good times are giving way to bad. "I thought we were better at these things," he says.
Ore is puzzled despite his vantage point from the lead car of the nation's economic roller coaster. In addition to his job as group director of strategic sourcing and procurement of Georgia-Pacific in Atlanta, he is also chair of the National Association of Purchasing Management's survey committee, which issues the bellwether Purchasing Managers Index. And he won't be the only one scratching his head if the manufacturing slump triggers a recession in the general economy: thanks to the decade-long economic boom in the U.S., 70% of today's CEO's have never led companies through a downturn. Moreover, navigating through the rough seas will be complicated by what analysts see as the distinctive aspects of this downturn.
Of course, all U.S. economic contractions share certain characteristics. The principal one is the condition that defines a recession: two consecutive quarters of decline in the country's gross domestic product (GDP). Beyond that, all downturns see companies lower their inventories, cut back production, and trim overhead costs. Unemployment goes up, overtime pay goes down, and families trim spending. But within that framework of recurring traits, all the post-World War II recessions in the U.S. have had unique characteristics. In the 1970s, for example, it was "stagflation"—high inflation accompanied by high unemployment. The most recent downturn that had the coincident impacts of the Gulf War, the collapse of real estate values, and unprecedented layoffs of white-collar workers.
| It's the more exposed business units—the ones farther from the core—that get hammered in a downturn. |
| —Chris Zook |
Why this disturbance is different
Many experts expect the current downturn—and recession, if it comes to that—to be different from others in more ways than ever. Their reasoning, taken collectively, focuses on three factors:
1. Low unemployment with little or no inflation. This is precisely the opposite situation from the one with which many of today's corporate and government leaders are familiar. You have to go all the way back to the 1920s to find the most recent precedent, says Brian Wesbury, chief economist for Chicago investment bankers Griffin, Kubik, Stephens & Thompson. "Back then, the Fed boosted interest rates in a deflationary environment, which squeezed the money supply and caused a lack of liquidity in capital markets. Last year, they did the same thing, buying into the [stock-market] bubble idea and trying to fix it."
2. Increasingly impatient investors. Companies face the prospect of weathering this downturn with harsher-than-ever requirements of investors. "I'll tell you what's different from other slowdowns," says Chris Zook, Boston-based director of worldwide strategy practice for consultants Bain & Company. "Profitable growth is more scarce than ever." A Bain study indicates that only about one company in 10 now registers real annual growth of more than 5%. In the 1960s and '70s, nearly three-quarters of companies surpassed that growth rate each year. Investors' patience with such weak performance—measured by the average period a stock is held—has steadily declined, Zook observes. "It's gone from eight years in the 1950s and '60s to just over a year today." The top reason for that precipitous decline "is the huge widening gap between projected and actual financial performance. Shareholders dump stocks because most companies miss their earnings targets."
3. A reverse wealth effect. The wealth effect is thought to trigger more purchasing of higher-priced goods by investors who feel flush with investment gains—even if they're only paper gains. Today, a reverse wealth effect has taken hold as debate rages about how much the recent stock-market declines are contributing to the downturn, and whether they will significantly impede recovery. One proponent of market-collapse influence, Morgan Stanley chief economist Stephen Roach, argues, "This downturn results from the popping of the biggest equity bubble in U.S. history, and it has ended up infecting our entire economy." Investors came to perceive gains in the stock market as a form of permanent savings, [resulting in a] plunge of the real savings rate almost to zero." In other words, consumers have been on a record buying spree; now they have few things left to buy and no funds with which to buy them.
Expert opinion is divided, however, over the issue of whether technology has fundamentally altered the economy. Wesbury posits that today's "incredible technologies" have not merely "propelled the economy," they've actually expanded its capacity to grow much faster without creating inflation. "What I see is a high-tech boom underlying deflation, producing an incredible, perhaps unprecedented, growth environment." But Roach disagrees: "I don't buy that for a second," he says flatly. Such a view is simply a reflection of the "new economy mantra," which carries with it the attendant imperative to "add cost and scale to the enterprise."
Ore weighs in on the debate by noting that in the old economy, "a company's 15% annual growth was phenomenal. In the high-tech economy, we've seen companies growing 60% or more. At those rates, the question in a slowdown is, How fast can we slam on the brakes?" Not very fast, it seems. "Sure, the technology is better and the manufacturing methods are better, but it seems we're not any better today at sales and operations planning." In a booming economy, sales forecasters become steadily more optimistic in assessing future demand. "They're human," says Ore. "It's our own form of irrational exuberance." When the inevitable drop in demand occurs, "you've got a huge gap between projected and actual sales—and a classic inventory recession."
Steering your company
So what can you do to avoid or at least steer your company out of the downturn doldrums? The answers depend, in part, on where you come down on the preceding debate about technology's influence on the economy.
Turn your moves in an inflationary economy on their head. If Wesbury is correct in perceiving the current situation as a deflationary downturn, you may want to trim inventories to their lowest possible levels and avoid taking on debt. "The real interest rate today is extremely high," he says, well above that of the 1970s, when nominal interest rates reaching the mid-teens were at times exceeded by the inflation rate.
Trim your sails. Even if you believe that today's economy is fundamentally different from the old one, it's safer to deal with current conditions as they present themselves. Roach senses that corporate leaders "are still feeling blindsided" by the rapidity of the decline. Reject the corresponding hope that recovery will be equally rapid, he counsels, and "rethink the whole approach to managing costs" instead.
Beware of—or exploit—disruptive technologies. Technological advances incorporated into production machinery are dramatically lowering equipment costs and, therefore, the costs of entering new markets. Wesbury notes that established companies—with their huge capital outlays in more expensive, but now technologically eclipsed equipment—"have a hard time competing with new entrants who today come into a market for a fraction of the outlay required only a few years ago."
Tend to your core as never before. Bain's Zook believes that companies focusing on a well-defined core business—as opposed to those that stray into ventures "far from their core"—will fare best during a downturn and perhaps be able to seize new growth opportunities. "It's the more exposed business units—the ones farther from the core—that get hammered in a downturn," he says.
Think of the new economy as being the old economy with a new technology. The widespread perception that the emergence of the Internet has changed the rules of business success is today proving flat wrong, asserts Harvard Business School professor Michael E. Porter in a recent Harvard Business Review article. "The old economy of established companies and the new economy of dot-coms are merging," he writes. But they'll do this by taking different strategic paths: "Dot-coms need to create strategies that involve new, hybrid value chains, bringing together virtual and physical activities in unique configurations." The established company, meanwhile, should stop imitating start up rivals and instead "tailor Internet applications to ... overall strategy in ways that extend its competitive advantages."
The first serious slowdown in a decade "speaks to the need to drive with one foot on the gas and another on the brakes," says Norbert Ore. The new economy's ability to scale unprecedented heights warrants our respect. But at the same time, we need to be mindful of its ability to turn sharply downward. In spite of all that may be different about this economy, says Brian Wesbury, "You may have to just take a step back and say 'Well, the business cycle lives after all.'"
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