Monday, Nov. 09, 1998
The Coming Storm
By S.C. GWYNNE
Take a good look at George Feldenkreis, entrepreneur, and you can see the curiously split personality of the American economy as it wobbles toward the end of its seven-year boom.
On the one hand, Feldenkreis owns a splendid company in Miami called Supreme International, a leading supplier of men's and boys' casual sportswear to such stores as Macy's, Sears and Target. Supreme has lived up to its name in the 1990s: revenues have increased more than tenfold, to an estimated $220 million this year. The company has been on an acquisition binge. Even better, Supreme continues to roll merrily along as though dark clouds were not gathering over the economies of half the world.
On the other hand, Feldenkreis also owns a company called Carfel, which makes automatic-transmission repair kits and sells them in economies that are no longer booming--like those of Latin America and Asia--exporting more than 50% of its products. Carfel is beginning to take a dive. "Our sales have been dropping tremendously in Latin America," says Feldenkreis, pointing specifically to Venezuela and Colombia, where business is off 15%. He describes the company as "weathering" a bad situation. The situation has got so bad, in fact, that the company is rethinking its place in the automotive world, spending more money to try to diversify and develop new products.
In his own way, Feldenkreis brackets the bipolar condition of the American economy: Supreme International, driven by homegrown demand, perks along, while Carfel, at the mercy of foreign markets, falls on hard times. And Feldenkreis' dilemma is the dilemma of many owners and managers skittering along the edge of what may be an economic precipice: Which company points to the real future in the U.S.? Should domestic managers ignore international warning flags and proceed full steam ahead with plans for new hiring, marketing and capital investments? Or should they batten down and abandon plans for growth until the worst has passed?
WHICH BRAND OF ASIAN FLU?
The answers to those questions, like everything else about this increasingly interdependent global economy, are spectacularly unclear. There is no longer any dispute about whether the U.S. stock market had a bout of the Asian flu in recent months. But even if stock markets continue to bounce back as they did for much of October, the question remains whether the rest of the U.S. economy--and Europe's, for that matter--is about to be sucked into the Asian vortex. If so, that could well guarantee an American recession. And even if the economy shrinks slightly--a condition we are learning to call a "growth recession"--the result would be a drop in the rate of economic growth.
The dilemma is even thornier because a whole subset of American companies--an extremely large subset--remains blissfully unaffected by what is happening overseas. Like Feldenkreis' Supreme International, such companies are driven almost entirely by domestic sales. Privately owned EMP Manufacturing, a maker of screws, bolts and other fasteners in Chesterfield Township, Mich., about 25 miles north of Detroit, does $4 million in sales a year, mostly to the automotive industry. EMP is basking in several years of record-breaking sales. "I don't think it's affected the Big Three at all," says general manager Steve Novak, who notes that forecasts for next year's car sales are for the same near record numbers the industry achieved last year. Not only is Novak not planning any layoffs; he is buying two new high-speed presses and installing a new sorting machine to improve quality and efficiency. In Detroit at the Chene Trombley Market, a convenience store across Interstate 94 from the huge General Motors plant where Cadillacs are made, the outlook is equally rosy. Says manager Aram Yasso of the GM workers who make up most of his clientele: "It doesn't seem like they have a concern in the world right now. They have been working an hour overtime every day and a full shift every other Saturday for about five years."
But an outright global recession, economists concede, is still a real possibility. "The risks of a deeper, wider, more prolonged downturn have escalated," the International Monetary Fund reported in its most recent global forecast; the Commerce Department said last month that in August the trade deficit ballooned $2.2 billion, to $16.8 billion. Warning signs abound that this involves more than just collapsing Asian and Latin American markets. After years of low unemployment, a number of major U.S. companies have responded to their earnings troubles with year-end job cuts, among them Merrill Lynch (3,400), Raytheon (14,000), LSI Logic (1,200) and Atlantic Richfield (900). For all of 1998, firings could hit 625,000, their high point for the decade.
The layoffs, plus Wall Street's tortured gyrations, have driven consumer confidence to a 20-month low, according to the University of Michigan's closely watched survey. The farm sector is already in a recession, pushed there by falling commodity prices that have been deeply affected by the turmoil in Asia. This in turn has affected machinery producers such as Case and Cummins Engine, whose profits fell steeply in the third quarter of the year. Then there is the so-called wealth effect. Fed Chairman Alan Greenspan warned of the dangers of removing more than $1.5 trillion in business and consumer wealth because of the market drop. Said the chairman: "We're bound to see a major impact in personal-consumption expenditures and housing."
At the Oct. 9 meeting of the Business Council, a gathering of mostly FORTUNE 500 execs, the mood might have best been described as resolute, reflecting a determination to make the best of what most of the attendees regard as a fast-approaching worldwide recession. A survey of 75 of the council's 300 CEOs showed that 95% expected the global downturn to have some negative effect on their earnings. More telling, 64% were planning cost-cutting measures that included less hiring, and 57% expected to reduce capital spending significantly. Yet there was a buoyant sense that the U.S. would ride it out. "I don't think the economy is capable of having a deep downturn now if monetary and fiscal policies remain sound," says John Snow, chairman and CEO of transport giant CSX Corp., echoing the sentiments of many of his peers. "There is not a huge stock of inventories to work off. We've gone to a just-in-time type of economy. A quarter or two of shallow recession or reduced growth is all I see, and when that is finished, I think you will see that the rest of the world is starting to recover." Says Atlantic Richfield chairman and CEO Michael Bowlin: "You can create scenarios that go either way. You can create scenarios where Asia will muddle through. You can create equally plausible scenarios where we will have a meltdown. My guess is that we will see continuing recession in Asia, very low growth in the U.S. and Europe, and I think Latin America depends very much on Brazil. It's likely we are going to have very low growth."
WHISTLING PAST CEMETERIES
How managers are coping with uncertainty is a function of which aspect of that bipolar world they are inspecting. At embattled Carfel, Feldenkreis is trying to hold the line on layoffs. "That is the easiest solution, but it is not the long-term solution," he says. "It takes a very long time to train people. We don't operate many plants, so our biggest asset is our people."
Over at his healthy garmentmaker, Supreme International, "there's been no cancellation of orders," says Feldenkreis, "and there has been no notice that the situation is getting worse at the retail level. We are not projecting a slowdown in our sales." The domestic retailers to which Supreme International sells do not seem alarmed. If anything, the Asian debacle is working to their advantage: Feldenkreis, who buys 85% of his clothing and raw materials from Asia, says the crisis there has actually reduced his costs. Absent traditional warning signs, what is he supposed to do?
Feldenkreis' solution: in spite of his rosy sales projections, he is taking no chances. He is "restricting purchases," meaning he is cutting his inventory to the bone. "When you're in a situation like this, you buy only what the customer has ordered," he says. "You have less of your money tied up." He is also more cautious about his borrowings--one of the most important precautions any business can take. "People who are worried that we may have a recession need to reduce or eliminate their debts," says economist Allen Sinai of Primark Decision Economics. "In a recession your income may drop and your ability to repay debt will be greatly diminished."
Elsewhere in the country, companies are following the same general pattern. At Griffith Rubber Mills in Portland, Ore., president Scot Laney can read the immediate future of his company written in empty shipping containers. He watches cargo ships steam into the harbor laden with products from Asia. These containers would normally return to Asia full of American products. But now those goods are too expensive in Asia, so the containers stack up on the dock, harbingers of a recession. "It hasn't got to our level yet," says Laney. "But it will. We know it's coming."
Griffith makes the sealant rubber that Daimler-Benz, Volvo, Mack Trucks and other truckmakers use around windshields and under hoods. Laney sees a domino effect: if U.S. companies can't ship their products to Asia, Brazil, Russia or other places in economic turmoil, they won't need trucks to get their products to port. That's why Laney is scaling back, even though orders for new trucks increased in 1998. "We're not spending money on new equipment," he says. And after two years in which Griffith built two new plants and invested some $3.5 million in new manufacturing capacity, the company is considering a layoff of some of the 450 people who work at its 11 locations. "This is the soft underbelly of the world economy," says Laney. "Recessions that occur far away affect us. We have all learned to be good exporters. I think we're all going to suffer."
Companies in a number of industries are also engaged in what might appear to be counterintuitive economics: reining in budgets in the face of big revenue gains. Dixon Ticonderoga Co., based in Heathrow, Fla., a 203-year-old maker of pens, pencils, chalks, watercolors, highlighters and other types of markers, is slashing its marketing budget in spite of a hefty 14% increase in sales last year. "We have to hunker down here," says company president and CEO Gino N. Pala. "We have to watch things closely. I don't think we've felt the worst of the economic crunch yet. I think the damage has already been done, but we've got to work through it." He says that he intends to keep his staffing "flat" in the new year and that the company will have to do a better job in purchasing to keep its costs under control.
PROS AND CONS OF CAUTION
Layoffs and firings seem to be the handiest solution for other companies too. "Companies no longer wait to ride out the tough spells," says John Challenger, CEO of Challenger, Gray & Christmas, a Chicago outplacement firm. "They practice just-in-time firings." At chipmaker National Semiconductor, managers voice the optimism of those who feel they have reached the bottom. "We've taken fairly severe actions," says chief financial officer Don Macleod, pointing out that the company cut 1,400 employees in April through attrition and layoffs--10% of its work force --even before posting a loss for the quarter. "Our business has been impacted, but we're moving forward. Our current view is that things are stable. They're no longer going down."
At Atlas Asia-Pacific, which distributes paint and automotive oil in Asia, management used a combination of work-force reduction and other strategies to save itself from diving markets overseas. Atlas, of Burlingame, Calif., suffered a catastrophic 65% drop in sales this year. The downturn led the company to lay off four of its 16 employees and to slash its travel budget from $450,000 to $75,000. With the help of its suppliers, Atlas cut the cost of its products in order to keep its struggling customers. "It's been the most difficult time in our history, and we've been around for 25 years," says vice president Joseph Ryan. "We sacrificed margin to maintain market share. I had my bankers call us stupid and dumb. But we're the only ones in the market now. I actually feel the worst is over. I can see rock bottom."
Another problem that companies face--and one that managers must solve quickly--is the phenomenon of Asian companies' flooding world markets with cheap products made even cheaper by Asia's falling currencies and by a desperate need to find new markets. The Pharmed Group of Miami, with $65 million in sales and 140 employees, has watched as its sales of latex gloves were hammered by this new competition. The company used to ship 2 million gloves a month to South American customers. Now, says president Jorge de Cespedes, "the Asians are dumping their products on our customers at such a low price that we cannot compete. We're shipping a container of a million latex gloves about every other month." The company has shuttered two offices in Latin America and has temporarily shelved plans for expansion. De Cespedes says he sees signs of a slowdown domestically and in exports. "You sense it from something as simple as accounts receivable," he says. On average it used to take 38 days for customers to send the checks to pay for the products they ordered. Recently the wait has increased to 45 days.
In Brooklyn, N.Y., however, entrepreneur Tim McCarthy is ignoring the economic uncertainties and plunging ahead with expansion of his start-up Great Harbor Design Center. McCarthy's company, founded in July 1997, makes synthetic stone from recycled glass and concrete. He is planning to make large equipment purchases in December and to start full production in February. He says he's not bothered much by what is going on around him. "I'd always assumed we would be dealing in a very volatile market," he says. "I knew there was going to be a downturn. I just didn't know it was going to be as large as it was in Asia." McCarthy, who says he factored a market crash into his plans from the start, may have hit upon the boldest approach to the new global economy: Damn the torpedoes! Full speed ahead!
--Reported by William Dowell/New York, Laird Harrison/Oakland, Calif., Michael McBride/Detroit, Tim Roche/Pensacola and Adam Zagorin/Washington
With reporting by William Dowell/New York, Laird Harrison/Oakland, Calif., Michael McBride/Detroit, Tim Roche/Pensacola and Adam Zagorin/Washington