Building a Future in Hard Times

How businesses can turn needed cutbacks into innovation, productivity and profit.

By Jon Frandsen, Senior Editor, Kiplinger.com

May 20, 2009

Just how bad is it? Think of it this way: What passes for good news these days is that the economy appears to be getting worse more slowly. But what is confounding businesses is not how awful the economy is -- after all, recessions are a part of the business cycle -- but how the economy may be changing and what those changes portend for years to come.

The problem, of course, is the specter that this recession might be something much bigger than a typical cyclical downturn, and that is reinforced every time another corporation goes into Chapter 11 or disappears. To avoid using the "D" word, some economists have created new labels, calling the period a "reset" or referring to it as "the Great Recession," for example. But whatever you call it, the consumer is probably not coming back with a wide-open wallet and fistful of credit cards anytime soon.

Americans are shell-shocked and frightened, in a way they haven't been since the 1930s. Household net worth has taken its deepest plunge since the Federal Reserve began keeping such records in 1952. Unemployment is at a 25-year high and headed higher. As a result, consumers are cutting debt and socking away cash at rates not seen in years.

Many economists and analysts believe these will become long-term habits. Consumers will eventually start spending more, of course, but they will also keep saving, rely less on credit and stop using their homes as bottomless piggy banks. Wachovia estimates that the new savings habit could lower consumer spending by $400 billion-$600 billion per year, equating to "a onetime reduction in GDP of 3%-4%."

How do businesses adjust for this shift in their planning? Honestly, they'd like to know the answer.

In a PrimeAdvantage survey of CFOs for small to mid-size manufacturers, 93% of respondents listed "an inability to measure customer demand" among their top three external concerns, with 76% putting that worry in the No. 1 spot. A survey of CFOs of larger U.S. companies in all sectors had similar findings.

In much the same way as consumers are responding to the sudden economic jolt and uncertainty by digging in, businesses, especially smaller ones, are slashing costs and scaling back investments.

"We cut hard and we cut deep because we didn't know what the hell was going on (last fall) or what we were getting into," says Robert Haaverson, CEO of Imanami, a business software firm in Livermore, Calif. "We had orders that disappeared and orders delayed."

Haaverson, like many other business chiefs, says acting quickly to slash costs and conserve cash has not only kept the company afloat in these rocky times, but has left it in a position to move aggressively as opportunities emerge.

But many other firms are still flailing, and the worst is yet to come. PNC Financial Services Group's annual survey of small and medium-size businesses, taken in the first quarter and released in April, showed that 90% plan to cut or eliminate business expenses in 2009. Despite massive layoffs already, 23% of those firms plan to pink-slip even more workers.

Why are such draconian steps continuing? Only 26% of those surveyed expect an increase in sales in the next six months, the lowest level reported by PNC since it started the survey in 2003.

The weak housing market has been a millstone around the neck of the economy: Eighty-eight percent of those surveyed (10 points more than a year ago) believe housing prices will remain stalled or even drop in their areas, according to the PNC report. "House price expectations are an important factor in consumer spending, so the findings imply an overall expectation for weak consumer spending for the rest of 2009," says Stuart Hoffman, PNC's chief economist.

Bill Dunkelberg, chief economist for the National Federation of Independent Businesses, acknowledges that the economy is undergoing significant change. But what many economists fear most about this downturn -- increased savings and extended restraint of consumer spending -- may prove to be a long-needed benefit, Dunkelberg believes.

"That money in savings shows up on the investment side and funds business expansion," he says. He sees a big change coming in the mix of consumer spending and investment, but "if an economy consumes everything it makes, there's no growth."

Many economists also fear that today's high unemployment, which is only expected to climb over the rest of the year, spells the permanent loss of millions of jobs. That would further dampen the recovery by reducing the purchasing power of the workforce. Dunkelberg sees a positive side to that for business.

First, employers are now able to find better workers more cheaply than they have been for years. The percentage of firms that report having trouble getting good labor was 25% in 2000. Now it's 3%. Second, if jobs are lost permanently, "it's because productivity is improving. Businesses are doing more with less," he says.

Anecdotal evidence certainly bears that out. Many businesses are clearly using this period of retrenching to find ways to not only get lean, but to stay lean.

Ilya Bodner, founder and owner of Initial Underwriting Group, which arranges loans for businesses and keeps clients updated about loan products, has cut his workforce, switching to an automated voice marketing system that allows him to make hundreds of calls a day from his Columbus, Ohio, office without staff. "I'm now able to reach more clients, while still allowing those with further questions to speak with someone at IUG directly…it frees up my other employees to spend their time on more important activities," Bodner says, noting that he saves $15,000 a month in labor costs.

M5 Networks, a New York firm that provides VoIP phone services for business, made cuts as a business strategy. "We cut some jobs to preserve profitability, and put more money in the company in equity and debt to make sure we had a buffer," recounts CEO Dan Hoffman. The company expects to grow this year, despite the downturn, and is investing in technology and training staff to improve efficiency and prepare for expansion. "Productivity takes a leap forward in a recession," Hoffman says. "There's been so much technology created in the last few years that has yet to be absorbed. Businesses are stampeding to use it now."

Next: More Case Studies in Survival (coming May 27).

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