Post-Bubble Economy Management
For Heavy Duty Distributors
By Bill Wade and Bruce Merrifield
Admit it. The current recovery that expert,
establishment economists have been forecasting has few clothes. Consensus
economic forecasts quoted by the media have been consistently and
significantly wrong to the optimistic side for the last 2 years … why
should we expect their 2.5 to 3.5% growth forecasts for the next 5
quarters to be accurate? And these numbers do not even factor in the
unique dislocations in the heavy truck business resulting from recent EPA
fuel efficiency regulations and major common carrier bankruptcies.
While the experts were missing the recession of 2001
completely, they also under-reported the following major economic
anomalies:
1.
The US stock markets have lost roughly half of their value, $7.5
trillion, since March 2000 and the trend is still negative after a record
31 months. In spite of the “things are in good shape” cheerleading from
Wall Street analysts and government administrators, could we be in a
“secular bear market” like the one from ’66 to ’82 (when stocks declined
12% over 17 years in constant dollars)?
2.
The total interest-bearing debt in the US for consumers,
corporations and governments has grown past $32 trillion, or almost 3
times the underlying economy. Credit market defaults and risk premiums are
now rising which suggests credit crunches ahead. Credit crunches are
especially damaging to distributors due to their historic dependence on
inventory and accounts receivable financing.
3.
During all past recessions consumers have stopped spending and
started saving which helps to reduce imports. For the first time ever,
debt-fueled consumer spending increased during our corporate capital
expenditure downturn. Our balance of trade deficit has exploded and now
the dollar’s value is starting to erode because of too much dollar supply
and not enough demand.
4.
For the first time since 1915, when the Fed started being an active
business cycle player, stock markets have not revived 6 months before a
“recovery” like the one started in Q4 ’01. In spite of big interest rate
reductions, double-digit money growth and timely government tax cuts, both
the economy and the markets have responded poorly.
5.
The current “productivity capacity gap” for the US economy is
assuring higher unemployment rates ahead. US productivity has been
improving 2.5% per year and the labor force is growing 1% for a total
productive capacity rate increase of 3.5%. The economy’s growth for the
last 7 quarters has averaged about 2% and now is in a stall. Over-time
wages disappeared for the average American worker. Even the
ever-optimistic average economist is forecasting a rise to 6.3%
unemployment by Q1 ‘03. Where will the demand stimulation come from to get
the entire planet growing at 3.5% or better for a few quarters to create
some over-time, new jobs and new corporate investment?
Where has been the discussion about how to
unwind the inter-related bubbles for the: money supply, stock market,
phony corporate profit reporting, appreciation of the US dollar, all debt
bubbles and excess global production capacity investment. They all
inflated together in a reinforcing spiral since ’94; shouldn’t they now
all rewind in a negative spiral?
Let’s face it! We haven’t had a post-bubble economy
like this in the US since ’29. Because economists and central banks
worldwide have been using models developed since WW2 that have been tuned
to control price inflation since 1980; they are still trying to take each
new data point and fit it into the consumer-led business cycles that we
have had since WW2.
Considering the elephantine anomalies above, maybe
it’s time to consider the growing minority view that we are currently in
the third year of perhaps a six-year, Japan-lite process of having to work
off the excesses caused by all of the inter-related bubbles that have
fueled each other since ’94.
How About Consumer Spending?
When the Federal Reserve interest rate hikes and the
stratospheric stock values finally did in the 18-year-old bull market,
huge interest rate deductions temporarily salvaged half the stock market
bubble and further inflated most debt bubbles. The inter-related mortgage
debt explosions, housing valuation bubbles and auto sales bubbles have all
seen notably, huge growth in the past 12 – 20 months.
If consumers don’t get scared by declining stock
markets, rising unemployment, wage freezes, and accumulating “for sale”
signs in the neighborhood, and start saving out of their paychecks (the
old fashion way), the lenders will stop the borrow-and-spend game.
Lending requirements are already starting to
tighten; interest rates for the least creditworthy have started to rise
and loans are being foreclosed … causing credit crunches and slower
economic growth. No matter what scenario you pick, there will still be
record levels of debt to be serviced as an overhang to a “not growing fast
enough” global economy, which will cause both good and bad deflation of
all asset categories.
What Should Heavy Duty Distributors Do?
First, we will have to be our own horse-sensible,
foreword-looking economists. If we are heading into a synchronized
asset-deflation that will eventually cut across all classes of assets
(including your own inventory), shouldn’t we consider some of the
following always-smart measures?
Pay down debt. In inflationary times, like
the ‘70’s, borrowers of fixed interest debt prospered at the lenders’
expense. In deflationary times, borrowers can get killed even at low
interest rates. If a distributor, for example, is currently borrowing at
4% to finance inventory with a debt capacity that is deflating at 2% per
year, and the company has no profits from which to deduct the interest,
the after tax cost to net worth is significant.
Debt levels, moreover, could still be rising to
finance interest costs, operating losses and more empty volume that
requires more assets. The hits could get worse if interest rates reflect
good deflation that is supplemented by fire sale, bad deflation, because
credit crunches are forcing competitors to dump product on the way to
bankruptcy.
Reducing debt is, however, easier said than done.
Most Heavy Duty specialists should know how to:
Identify and deal with big-volume, high trade
credit customers … for which margins are thin, profits are really
non-existent and the customers themselves are bankruptcy candidates in a
prolonged post bubble economy. There are lots of huge volume large fleets,
but in analyzing these customers, keep saying, “volume is vanity, profit
is sanity” to get over sales-volume, ego needs.
Don’t rent out your balance sheet to unprofitable,
risky customers.
Buy some commodity inventory in smaller quantities
… when possible, to increase turns and fill-rates more than the gross
margin drops from paying a higher price. Take advantage of the real reason
that well-connected local heavy-duty specialists exist (and manufacturers
that want to buy market share with better turn-earn economic offerings).
This frees up cash, improves asset productivity and
gives customers better fill rates. For this measure, keep saying, “buy the
lowest total procurement cost at a higher price.”
Identify the bottom 50% of all stocked items that
are 1% of the sales … and perhaps 10%+ of inventory and deal with them
on a profit losing, but cash flow positive way. Apply losses to tax-loss
carry-backs to get even more cash into the business. This is type of
housekeeping should have been done both preventatively and remedially on
an annual basis, but small cash-trap investments have been accumulating at
most heavy duty distributors for years.
If this is a big opportunity, it should be done with
your banker’s complete understanding and blessing; otherwise, they might
get anxious about reported losses for tax purposes even though cash and
debt-service capability is rising.
Think About The Business You “Know”
Most distributors might not realize the
effects of the following dramatically successful ways to reduce debt while
boosting profitability, productivity and morale:
-
Downsize and upgrade the customer portfolio
based on estimated and even forecasted profit contributions. Most
heavy-duty distributors are unknowingly spending about 50% of their
operational activity and costs on serving sales volume that actually
generate net losses.
If a typical WD would just rank its customers by estimated profit before
interest and taxes and use the report to implement some profit improvement
plays, both profits and personnel productivity would explode while
inventory and receivables needs would shrink.
- Help all employees be part of the solutions
for productivity, profitability and balance sheet liquidity improvement,
instead of part of the deadweight problem. It starts with their education
about the ABC’s of distributor finance and how they can be responsible for
getting much better total pay and job satisfaction faster.
Although it sounds like a huge undertaking, there are affordable solutions
that will deliver immediate positive cash flow and morale-upgrade
benefits. Going to a “high commitment culture” will also play
well in contrast to the average worker’s impression of the big, corrupt
capitalists in the news. There still can be integrity, control and pride
within small business America jobs.
- Reduce distribution capacity and competitive intensity
on a local market basis. Here’s a lesson from the past. In 1984, the
Houston market was in the first half of about a 6-year, oil-bust
depression. During the late ‘70’s a number of distribution chains in a
particular industry had opened up enough new locations in Houston to more
than double the number of competitive players.
One local CEO competitor sent letters to fellow CEO’s who owned Houston
locations stating that because there was too much capacity he was either a
seller to or buyer of anyone else who saw the same long-term, big glut, no
demand problem. Most of the other CEO’s contacted the client, win-win
rationalization deals resulted and losses were minimized.
- Sell over-appreciated commercial property.
In some markets, commercial property has also become an inflated asset
bubble. In Boston, a sharp real estate operator has just put 50+
properties on the market with an asking price of about $650 Million.
Perhaps they have noticed two key trends. A) Commercial vacancy rates in
the Boston area have risen from 8% to 25% in just the past 12 months. B)
Lots of investors’ money has flowed out of index and money market funds
into real estate investment trusts (REITs) for their high yields. Why not
sell high to funds that are required to invest new proceeds into real
estate. Individual investors are always the last buyers of whatever is hot
right at the top!
This summary is certainly not intended to scare
anyone … its pretty tough to scare anyone who has been in this business
long! Hopefully, however, it will offer a lot of food for thought with
each manager coming to his own revolutionary conclusions, but the economic
dislocations that are all around us demand major rethinking of our
unspoken assumptions and actions.
Plenty of distributors have already made one or two
rounds of typical financial cuts with the expectation that things would
pick up again like they always have, at least since WW2. They haven’t yet
and they may not for some time. If it looks like business conditions are
going to be underwater for longer than we can hold our normal financial
breath, shouldn’t we be looking into more radical solutions like growing
gills or signing up all of the employees to be part of customer
profitability centric solutions?
About the Authors:
Bill Wade has been in the automotive and heavy truck aftermarket on
both the manufacturer and distributor sides for over thirty years. He has
written and spoken extensively on the effects of distribution
consolidation and buying groups. He recently formed Wade&Partners,
a marketing services company specializing in issues such as unexpected
growth opportunities, strategic development, startup or turnaround
counsel, brand building and restoration.
D. Bruce Merrifield
is one of the foremost authorities on independent distribution, high
performance service management and the effects of e-commerce on
traditional distribution channels. As head of Merrifield Consulting
Group, he has authored several books and over a hundred articles for
trade publications and various associations on maximizing supplier /
distributor effectiveness.
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