Published June 2004

Economic upswing calls
for cost containment

Just a few years ago it was impossible to pick up a newspaper or watch a television news program without colliding with the phrase “sea change.” The reference to Shakespeare’s “The Tempest” had long ago fallen into disuse, but in the 1990s, “sea change” suddenly reappeared and spread quickly. It seemed to be everywhere. “Sea change” here, “sea change” there, from public opinion polls to football; everything had to be undergoing a sea change.

Now, just when the economy goes through a real sea change, the phrase disappears.

But, no matter what we call it, there is no doubt now that after nearly four years of doldrums, our economy is expanding solidly. And although most of our businesses will be carried along with the flow, along with the increases in sales, most of us will also see sharp increases in costs. After several years of stunted growth and persistent downward pressure on prices, we are now seeing increases in the prices of both raw materials and finished goods.

Fortunately, we are still in the early stages of the economic recovery, and while a few businesses have already been clobbered, most of us still have time to get ready.

It is really just a matter of a balanced business plan, or business model, if you prefer that term. From a management skills standpoint, it is as simple as switching from offense to defense. In an economic expansion, profits come as much from cost containment — defense — as from sales growth.

Cost containment in these times involves mentally taking apart your business and looking at how it will be affected by changes in five key areas:

• Interest rates. There has been upward pressure on rates in recent months, and the Federal Reserve has alerted us to the likelihood of higher interest rates. If you have a bank loan, you can expect your costs to go up, and you should figure out how much the increases will affect your bottom line. When calculating this, your anticipated borrowing levels should be set higher, too, to reflect the additional cash needed for both sales growth and the increases in other costs.
• Wages. Employment is expanding rapidly and this will be translated promptly into higher wages. You will find that job candidates have competing offers (or believe they could get them), and you will have to offer more money to get them in the door. When calculating the effect of this on profits, be sure to include the effects on your existing work force. You will not be able to raise wages for new, incoming workers without adjusting wage levels for your current work force — at least not for long.
• People. In addition to needing more people because of increasing sales, you are going to have to replace more people because they will leave you. During an economic downturn, workers generally are more cautious about seeking new horizons and, consequently, more willing to set aside any discontents with their current job. That will change rapidly, and as the economy improves many firms will see sharply increased turnover rates. Losing experienced workers is painful by itself, but bringing in replacements at the same time as new, expansion hires can challenge management’s ability to sustain the business “culture” — its goals, style and what it is all about. It is important that you plan for this, offsetting this challenge with a combination of financial incentives and, more importantly, management time and effort focused on this issue.
• Materials. For the past few years there has been a persistent downward pressure on materials prices. Those days are over, and it is time to meet the new reality: upward pressure on materials prices. Beyond the effect of cost increases, this is a good time, in fact your last good time, to go over all of your raw materials, from basic components to final containers. It wouldn’t hurt to build up some inventory of critical items and, also, to start developing backup plans and alternative sources.
• Rents. The economic recovery will push rents upward, especially in the Pacific Northwest, where we have suffered a longer and deeper downturn than the rest of the country. Smart managers will recognize that this would be a good time to renegotiate leases and lock in costs — but only if the facility fits your business plan after you have adjusted it for increases in sales, interest rates, wages, turnover and materials.

In an upturn, the important thing to remember is to think defense on costs. The improving economy may offer some great opportunities for you in terms of sales growth and market share. But in an upturn, thinking defense on costs can translate those opportunities into solid profits and long-term success. That’s making a sea change work for you.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.

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