E-zine #21

Not All "Risks" Are Financial -- Even During A Recession

The French philosopher Jean-Paul Sartre once stated that “Not to decide is to decide.” It’s doubtful that Sartre had business ventures in mind when he made this observation, but his words accurately describe the choice carwashers face when deciding whether or not to make an investment in enhancing their operations. Businesses that postpone investments aren’t avoiding making a decision – instead, they are deciding not to invest; and like all decisions, this one has consequences -- good, bad or in-between.

Professor Panka J. Ghemawat has studied the effects of investment decisions on businesses during recessions. He points out that although some business owners believe they are avoiding risk when they decide to put off an investment, this is only half true. Taking a pass on an investment in your business doesn’t eliminate your risk, according to Ghemawat, it simply transfers your exposure from a financial to a competitive risk.

The Risk of Investing and Not Investing

In an article published by MIT Sloan Management Review, Ghemawat explains that financial risk is the chance that the money a business invests in new equipment or other improvement won’t be recouped through increased profits. Competitive risk is the chance that by not investing in an enhancement, a business will become less successful than its competitors at meeting the needs of customers or controlling costs, and will end up losing market share.

Under normal circumstances, a business achieves a balance between financial and competitive risks, weighing the cost of an investment against the odds that it will boost productivity or enhance marketability enough to increase profits, then evaluating how a decision not to invest in improvements will impact the company’s competitive position in the marketplace.

However, during recessions, some companies over-emphasize the financial risk of investing in themselves in the mistaken belief that they are saving money and building cash reserves to get them through the tough times, according to Ghemawat. In reality, avoiding the competitive risks of investing in a tough economy may well have the opposite effect on businesses.

For example, by failing to invest in new technology a business may miss out on efficiencies that drive down labor and other operating costs, allowing it to operate more efficiently and (ironically) weather the impact of a recession better. During the 1980s, Wal-Mart was able to offer deep discounts, yet still operate more profitably than its larger rivals Sears and Kmart. This is largely due to the fact that during the recessionary 1970s, when Sears and Kmart were focused on minimizing financial risks, Wal-Mart was investing heavily in technology, leasing the IBM 370/135 that allowed it to maintain inventory control much more efficiently than its less technology-driven competitors. Click here to learn how SiteWatch® can help you control costs.

Some Of Your Competitors Continue To Move

The important thing to keep in mind when making business decisions during a recession is that regardless of how challenging the economic picture may seem, the market continues to grow and some of your competitors are looking ahead and developing new ways to address the needs of the customers you are both trying to reach.

Some of these competitors may be new; FedEx, Southwest Airlines, Microsoft, Apple Computer, and Hewlett-Packard were all started during recessions or depressions. Some of them might be existing companies that are busily reinventing themselves during the economic downturn. Apple introduced the iPOD during the recession following the 9/11 attacks. McDonalds revolutionized the quick serve food industry by rolling out its first drive-through window and breakfast food (Egg McMuffin) during the depths of the 1970s recession, the same decade that CitiBank turned the banking world on its head by introducing the Automated Teller Machine (ATM). Click here to learn how the SiteWatch® Xpress Pay Terminal® with FastPass® and ARM can provide you with new ways to reach customers.

Even during tough times, or perhaps especially during tough times, businesses that circle the wagons and avoid investing in themselves run the risk of being leapfrogged by rivals just as the nation’s largest and second largest retailers (Sears and Kmart) were by Wal-Mart in the 1970s.

Consider the case of the Joseph Schlitz Brewing Company. For many years, Schlitz was the number two brewer of beer in the US, trailing only Anheuser-Busch. Then the recessionary 1970s hit, and Schlitz cut its advertising. Meanwhile, Miller, which began the decade as the nation’s seventh largest brewery, invested heavily in developing and promoting a new product category called “Lite Beer.” By 1982, Miller was the second largest brewery and Schlitz had ceased to exist as an independent company.

When The Chips Are Down

In his MIT article, Ghemawat describes how US semiconductor chip makers lost their leadership role to Japan as a result of their overly cautious investment strategy in the 1970s. At the start of the ’70s, US chip makers outsold their Japanese rivals by more than two-to-one. By 1982, US share of the chip market had fallen to 51% compared to 35% for the Japanese. Seven years later these positions were reversed, with the Japanese holding over half the market and the American just over one-third.

Although several factors contributed to this reversal of fortune, Ghemawat maintains that the decision by US firms to pull back on investing in themselves during the recession of the 1970s played a major role. This is evident in the fact that the Japanese led the way with the new 16K DRAMS (Dynamic Random Access Memories) at the end of the decade, after the Americans had cut back on developing this technology. When the recession ended and computer makers like IBM needed large volumes of 16K DRAMS, the Japanese were able to meet the demand, while their cost-cutting American rivals were not.

“What would have happened if US manufacturers had invested more heavily in 16K DRAMS in 1975 and 1976? Although we can never be certain, (one industry expert) guesses that US DRAM manufacturers would have been able to hang on to 95% of their initial market share,” writes Ghemawat.

As the experience of US chip makers illustrates, one of the major benefits of continuing to invest in your business during a recession is that it puts you in a better position to meet the surge in customer demand that is likely to occur when the economy rebounds. This is why, though theme park attendance is down, Walt Disney is investing $1 billion in a makeover for its California Adventure Park in Anaheim.

A study conducted by McGraw Hill found that business-to-business companies that maintained or increased advertising during a recession enjoyed a 275% growth in sales in the three years following the recession, compared to a 19% increase for those that cut advertising. During the 1990-91 recession, Nike tripled its advertising spending. When the downturn ended, Nike’s profits were nine times higher than they were before the recession began.

The lesson learned by Nike, Miller, Japanese chip makers and countless other successful businesses is that even during recessions, the market remains dynamic, competitive and rich with opportunities. The carwash that recognizes this market vibrancy and continues to make investments in its own future, is not only in a better position to survive the recession, but is also more likely to emerge from it stronger than ever.