The Economy:
Bad Business Environment or A New Baseline?
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By Edward D. Hess,
Distinguished Executive in Residence and
Adjunct Professor of Management, Goizueta Graduate School of Business
Emory University
Atlanta, Georgia
edward_hess@bus.emory.edu
Bad Business Environment
This is the toughest business environment in decades. On the plus side, we have low inflation, low interest rates, and plentiful labor. On the negative side, business profits are disappointing, consumer and business debts are high, the stock market has lost over $8 trillion of value and is still historically overvalued, our budget and trade deficits are growing, investors have lost trust in the financial system, and uncertainty abounds regarding Iraq and the War on Terrorism.
We are experiencing the worst three-year stock market period since the Great Depression, even though the Federal Reserve has kept the consumer economy growing through low interest (mortgage) rates. Industrial overcapacity still exists in most industries and corporate spending and investment is weak. All of this raises some fundamental questions:
- When will corporations start making investments again?
- Should the Fed reduce interest rates further?
- How will we finance our growing budget deficit?
- Lastly, how should you manage your business in this environment?
Corporate Spending Again?
The economy is not going to get better until corporations start making capital investments again. When will that occur? When their profits increase substantially. How can that happen? Well, most companies have already been managing the cost-expense side of their business so increased profits most likely will occur when top line growth occurs. How do you grow the revenue in a low growth, excess capacity, saturated market environment? By taking someone else's market share via acquisitions or by lower relative pricing (devalue the dollar and export). Because both acquisitions and devaluation are hard to do, most likely, we will see another round of cost cutting and layoffs to further reduce expenses.
What we are beginning to understand is that there are limits to growth. As industries continue to consolidate, the bigger you become the harder it is to continue to grow at the same rate. To grow a $50 million dollar company 20% a year is easier than growing a $50 billion dollar company 20% a year. As a result, everyone looks for operating efficiencies and productivity increases as well as acquisition of new market opportunities. There is no silver bullet; for corporations to increase spending, profits must increase. There is no easy way for that to occur.
Further Interest Rate Cuts?
The Fed has already lowered interest rates to modern lows and the economy is still anemic. Lowered interest rates so far have fueled consumer spending, high consumer debt, real-estate refinancings, and a false sense of consumer wealth to ameliorate consumer stock market and retirement plan losses.
Would even lower interest rates spur more consumer spending or more corporate investment? Consumers have their limits on debt carry, and we may have reached that limit. It is unlikely that lower rates will be the spark to restart the economy from either consumer or corporate perspectives.
Rather, the Fed and government policy should motivate corporate investment and entrepreneurial job creation. Maybe we need to consider investment tax credits, R&D credits, and job creation credits along with more liberal ordinary tax loss provisions for investors in entrepreneurial ventures. Job growth will come from new ventures, not the big companies.
Financing of Our Budget Deficit?
Yes, our budget deficit is back. In the 80's and 90's, we financed our budget deficits by attracting foreign capital to our government-backed interest rate instruments. But today our interest rates are lower than or marginally equal to other industrialized nations. Deficits are financed by borrowing or by taxes. Where is the money going to come from to finance the deficit? Tax increases or borrowings? Borrowings! And if we have to compete for capital in global capital markets, we will have to raise interest rates.
If we have to raise interest rates to finance the deficit, what happens to the stock market? Without substantial corporate profits increases, the stock market will fall ever further and our downward spiral will continue.
How Should You Manage Your Business In This Environment?
I foresee 2003 as another tough year economically. Corporations will take more steps to reduce expenses (more layoffs) and more industry consolidations and restructurings will take place.
What should you do in this environment?
- Change your mentality and frame of reference. Building and growing a business is a long-term venture. Forget the 90's. It was a once in a generation aberration. Forget about easy money and realistically redefine your wealth needs and measures of success. Redefine success; growth is good but a good stable business is good, too. Adjust your long-term investment return expectations to no greater than historical returns; be liquid and flexible; and be proactive each day.
- Success for the next few years is staying in business. So manage your costs and risks. Focus, focus, focus on your key profitable customers.
- As industries consolidate, the bigger and bigger companies will leave certain market segments or under-serve them. Analyze your competition and be a corporate guerrilla attacking the big guys where you can win big without big losses. Market segmentation and customer acquisition service are key.
- There are billions of dollars in private equity capital looking to invest in good growth business and good management teams. Consider whether you should access that capital (and all the pros and cons of such a move) and acquire some competitors.
The Current Bad Economic Environment Just May Be A New Baseline.
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Copyright © 2002
