We are in the second longest expansion of the U.S. economy (eight years and 11 months). Strong fundamentals continue to fuel growth as “slow and steady” wins the day. However, recessions are part of every economic cycle.
So, when does the other shoe drop? Economists in late 2017 predicted a recession in 2019. Today, most forecasts are pushed to 2020, though trade policies and import tariffs could have a negative impact. For business owners, planning now can be “recession-proof” tomorrow.
David J. Solomon is managing principal for Solomon Coyle LLC in Alexandria, Va. The management consulting firm serves small to mid-sized service-related businesses ($25 to $50 million on average). Formed in 2004, the firm has assisted design and interiors, a market that rises and falls based on the strength of the construction industry. For Solomon, conducting smart and thorough business planning while keeping an eye on economic indicators will put business owners on solid footing when the next downturn arrives.
“In smaller companies, business planning isn’t always as thorough as one would want,” Solomon said. “When things are going well, owners may feel they are too busy to set aside time to plan. But if you neglect planning, it will make the inevitable recessionary times especially difficult.”
Solomon added that, during the good times, business euphoria can mask vulnerabilities, putting companies at more financial risk. Maximum financial opportunity lies in the rough times. Planning can help locate opportunity prior to a recession. It’s one part of “recession-proofing” one’s business. The first step is being aware of the economy around you and the barometers that track it.
The external clues to the economy’s health
The National Bureau of Economic Research (NBER), a private nonprofit research organization based in Cambridge, Mass., defines recession as “a significant decline in economic activity spread across the economy, lasting more than two quarters which is 6 months, normally visible in real gross domestic product (GDP), real income, employment, industrial production and wholesale-retail sales.”
Solomon follows data provided by both commercial and governmental agencies. Such data includes following GDP growth, the unemployment rate, interest rate projections, and private and public construction activity as captured by the U.S. Census Bureau. He also finds the American Institute of Architects’ (AIA) Architectural Billing Index to be especially useful. While Solomon Coyle focuses on office construction, the index also captures industrial and institutional sectors.
“The Architectural Billing Index is very interesting to us,” Solomon said. “It compares billing activity month to month. We look to see if billings are higher or lower and by how much. Is there a consistent pattern? One month of fewer planned design projects may not be indicative of a trend, but several months in a row might.”
The billing index score indicates likely construction activity looking out nine months on average from billing. As ELECTRICAL CONTRACTOR does in its yearly construction forecast, Solomon suggests following economic prognosticators such as Dodge Data and Analytics, ConstructConnect, Moody Analytics and Wells Fargo.
Another source of information is The Conference Board, which provides a number of indexes including consumer confidence, employment trends, leading economics, CEO confidence and help wanted status. The board tracks U.S. labor and global economic health.
“What happens across the globe is out of your control, but follow what’s happening,” Solomon said. “Be cognizant on what world economies may influence ours.”
Real estate management company Jones Lang LaSalle’s (JLL) property clocks look at sector health through vacancy, demand and construction and rental rates.
“We focus on the office sector, but there are also clocks for industrial, retail, multifamily and others,” Solomon said.
If rental space looks tight, it could indicate an opportunity for developers for new construction or renovation.
“The JLL clocks are just another way to sense if business is slowing or the economy cooling in different parts of the country or overall,” Solomon said. “For instance, Houston took a hit when energy prices bottomed out, yet rental rates and low vacancy rates remain healthy in San Francisco, Dallas and Seattle, and other cities.”
Know your business
Good planning allows you to prepare for a recession. Being equipped to adjust helps you avoid being reactive. There are actions you can take now to help you when business slows.
“Take time for scenario planning,” Solomon said. “It’s more than an exercise; it’s strategic, especially when economic storm clouds are on the horizon. Define your business’ strategy so you can set better goals. Can you spend the capital? Running out of capital is how businesses go out of business during a recession. If a recession hits, would you be better to focus on your core business, or would diversification truly help? Maybe a new extension or channel strategy.”
If diversification is on the table, you need to ask questions. Will it provide value and growth? Can you afford to diversify? What would that mean in terms of training costs, bringing in new talent? The move should be a good fit, not a quick fix. Maybe it’s part of a “go/no go” strategy based on business metrics at a given time. Solomon suggested setting both achievable goals and stretch goals.
“Say you are a $10 million contractor who gets the occasional bigger project that puts you temporarily at maybe $12 to $14 million,” he said. “What would you need to do to be a consistent earner at that higher level? That plan is a push or stretch goal. Is it realistic? You may need to add one or two sales people. You are looking ahead but also factoring in recessionary times as you figure out if this kind of growth can be sustained. Also, maintain sales and marketing in slow times. Your current customers need to know you are there for them and potential customers will discover you.”
Hour to hour
To set prices, business owners determine that sweet spot of what they charge and overhead cost to ensure they recover expenses and make a profit. That’s a cost model needed in good times and bad. Solomon found businesses are challenged when they don’t have models to follow.
“We find it useful to look at average hourly cost,” he said. “It’s more vivid. Factor in direct labor and overhead. That might include vehicles (fuel, mileage, repair and maintenance), office staff, warehouse personnel, work crews, supervisors, and designers (hourly pay including benefits). Looking at costs hourly is a model we follow.”
Solomon calls this “knowing your data.” Other key performance indicators (KPI) include income statements (total sales, gross profit, installed margin, core expenses, operating profit, and net profit before taxes), balance sheets (current ratio, debt to net worth, return on assets, and return on equity), and productivity (sales per employee and compensation as percentage of sales).
Handling customer-focused cash flow is important, as well, especially during a recession. Solomon recommended practices such as revisiting sales terms and conditions, running a credit check every six months before extending terms, and requiring 100 percent prepayment on ancillary orders.
Economic outlook revisited
While economic performance month to month has shown volatility, economic forecasters’ long view has been positive.
“Recession short-term risk is very low and even lower than what I presented at the 2018 Dodge Construction Outlook conference last November in Chicago,” said Cristian deRitis, senior director, Moody’s Analytics Inc. “Forecasting is always a bit of conjecture, but the economy’s fundamentals remain strong. The risk of a recession now looks very low for 2019, presuming the tax cuts are passed [they have], which will provide some stimulus, and employment stays strong.”
Bettering the full employment figure of 4.5 percent (3.9 as of April 2018) implies wages should be picking up as more employers need to compete for workers. The 4.5 figure reflects a state of employment with no inflationary pressure.
“Once you employ everyone you can, its gets harder to employ more,” he said. “So you can raise wages (which could help accelerate the slow wage growth) or maybe steal employees from someone else. Wages become competitive.”
While the recent tax cuts are expected to have a positive effect furthering the sails of this recovery, deRitis said it will depend on how the money makes its way back into economy from those that have benefited from the cuts. Do companies invest more and hire more people? With increased dividends translate to shareholders spending more money?
A major infrastructure program in 2018 is unlikely but could surface in 2019. An allotted $10 billion for infrastructure spending was included in the 2018 omnibus bill, but that amount falls far short from President Donald Trump’s envisioned $200 billion kick-start to major infrastructure investment.
“The immediate benefits of tax cuts offer maybe a 6- to 12-month boost to the economy before higher interest rates have some effect,” deRitis said. “Infrastructure spending could provide that second lift. The Fed has taken a preemptive approach, modestly hiking up rates to avoid high inflation. Our economy can digest these hikes right now.”
While the next recession is expected to be garden variety (deRitis estimated an eight- to nine-month duration), he added there are always winners and losers.
“The pain is different across industries and how you go into recession makes a difference,” he said. “The next go around won’t likely come from a crash in residential housing. So that area, while affected, may not be hit hardest.”
Ultimately, good business planning is the best way to stay in front of a recession. Solomon’s rule of thumb for success is a 20 percent strategy for the future and 80 percent toward operational excellence and profitability.