Perspectives On An Economic Downturn

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Well, I Guess It’s a Recession: Perspectives on an economic downturn.

Posted 11.26.2001
It has been a while — ten years actually — since we endured the last recession back in ’90/91. But business cycles are pretty much immutable. What goes up must come down. “Regression to the mean,” they call it in statistics.Two things have me especially concerned about our current situation. First, the economic rubber band is stretched tight after ten years of prosperity and growth. Second, this might be the first global recession since the early 70s.

Maybe our customers have enough net worth that there won’t be much impact on their spending. Maybe a kid’s ability to nag his parents into shelling out bucks for new shorts is more powerful than any concern over the family cash flow. Maybe people find money for fun things when everything looks bad. Maybe, but maybe not.

September 11 has had an negative impact on consumer confidence and our nation’s psyche that difficult to quantify. It’s accelerated the decline of an already shaky economy. Any doubt about whether we were headed toward recession ended that awful day. The question is: how deep and how long will it be?

Obviously, I don’t know the answer to that. But since the surf industry is based on products that aren’t necessities (although we try to make the consumer feel they are), retailers and suppliers should be examining their business models and making adjustments now to deal with the impact of an economic downturn.

Maybe a short history lesson, a look at some current economic statistics, and a few conversations with people in the trenches will give us all some insight on what we can expect in the months to come.

A History Lesson

In 1990, the economy started off pretty well. Gross Domestic Product (GDP) grew at a 5.1-percent rate during the first quarter. That declined to 0.9 percent in the second quarter and fell further to a negative-0.7 percent in the third. Fourth quarter GDP fell at a 3.2-percent rate.

For the year, we ended up with a real GDP growth rate of 1.2 percent. In 1991, it was a negative 0.6 percent. Officially, the 1990 recession started in July 1990 and ended in March 1991 — eight months later. A recession, by the way, is technically defined as a decline in GDP for two consecutive quarters, so they can’t get much shorter than that one was.

Iraq invaded Kuwait on August 2, 1990. The air war began January 17, 1991. The ground war followed on February 23 and lasted four days before President Bush declared a cease-fire. The first U.S. troops began to leave on March 8. We declared victory and went home.

Our current conflict began September 11. I’m sure none of us knows how long it will last or what exactly success will look like, but it’s not going to be as definitive as the Gulf War.

I’m told that the ’90/91 recession and the year or two that followed it was a tough time for the surf industry. Surfing was in the pits, and we had to reinvent ourselves. Of course, not all of the surf industry’s malaise back then was related to the economy. But the fact that a major change in fashion trends coincided with a recession meant the surf industry was hit hard.

Yet that was a relatively mild recession, because there was economic strength in much of the rest of the world. The last time Europe, Asia, and the U.S. all experienced economic weakness at the same time was during the 1973 to 1975 recession. It lasted sixteen months. Once again, I’m not certain of anything, but it’s possible that we may be facing that kind of global recession this time around.

The Current Situation

Parts of Asia haven’t gotten over the 1997 currency crisis, and Japan seems poised for its fourth recession in ten years. Germany and Britain, along with other parts of Europe, teeter on the edge of recession as well.

From a healthy 5.6-percent rate of growth in 2000’s second quarter, GDP in the U.S. has fallen each quarter. It ended the second quarter of this year with 0.2 percent growth. My guess is that the number we get at the end of October for the third quarter will be negative.

September retail sales were reported October 12. They showed a drop of 2.4 percent — the biggest in nine years. Economists had expected a drop of 0.7 percent. The September employment report showed the country lost 199,000 jobs during the month. That’s the largest decline in ten years. Most of the fallout from the attack isn’t reflected yet. September was the twelfth month of declining industrial production. That ties a record that goes back to right after World War II.

But there’s also a bit of good economic news. Consumer spending had been holding up fairly well, though it had finally weakened a bit even before September 11. Housing has also held up well — probably due to declining interest rates.

The Federal Reserve has cut the discount rate from six to two percent this year. It was last that low in 1958. Typically, it takes six to nine months for the benefit of rate cuts to work its way through the economy. The first rate cut was in January and the most recent in October, so clearly we haven’t seen most of that impact yet.

Finally, the stock market looks like it may have put in a bottom after the worse bear market since the depression, and the market always turns around before the economy.

Among the public companies in the surf market, it was Quiksilver that made me first say to myself, “Okay, we’re having a recession.” That was back on September 6, the first day of the Action Sports Retailer show in San Diego. Quiksilver held an analyst’s conference call to announce that third quarter earnings were in line with expectations, but that fourth quarter earnings would be lower than projected. This was due to weaker than expected retail orders and too much inventory that would have to be closed out at reduced prices.

Quiksilver said that diluted earnings per share for fiscal year 2002 would be in the range of $1.50 to $1.55. The consensus analysts’ forecast had been for $1.85 per share.

Of course, Quik’s situation was hardly unique among surf-related manufacturers — they were just first to announce. On September 25, Vans beat analysts estimates for its first quarter ended September 1, but expected its second quarter to be flat or down five percent due to the impact of September 11. For fiscal 2002, Vans said its earnings per share would be near the level of a year ago on a forecast revenue increase of roughly ten percent.

Pacific Sunwear, on October 11, warned that its third and fourth quarter earnings would miss analysts’ consensus estimates, citing lower consumer confidence and spending. It now sees third quarter earnings of 25 to 27 cents per share, compared with a mean analysts estimate of 33 cents. It sees fourth-quarter earnings as being between 33 and 37 cents, compared with the previous mean analysts’ expectation of 41 cents.

But let’s not look at Quik, Vans, and PacSun as though they were unusual or had done something wrong. Tommy Hilfiger, Nautica, Kenneth Cole, Jones Apparel, VF Corp, Coach, Polo Ralph Lauren, Liz Claiborne, and Columbia have all either cut their earnings estimates or had them cut by the analysts — or both. Recession and terrorism are hitting pretty much everybody who sells apparel.

What Are They Doing About It?

Steve Price at Killer Dana has been reacting to the possibility of a recession for months now. By August, he’d already backed off on some of his projections and orders. He’s booking less going into spring, and scheduling it for delivery a little further out. He’s forecasting November and December sales will be off eight to ten percent from last year (which he described as being an incredible year), and is planning to be off ten percent through spring.

There were a few slow days after September 11, but overall September and October sales are up 25 percent for Price. Customers, he says, “Aren’t afraid to spend, but are paying more attention to what they get for their money.” He’s stocked up on a lot of rubber this fall, and it seems to be paying off for him. The best-selling wetsuit has been those around the relatively low 150-dollar pricepoint. Price says this is due to both consumer caution about spending, but also the good quality of even lower pricepoint wetsuits.

Killer Dana, it seems to me, has done two things that will get it through hard times. First, it started planning when the storm clouds were first on the horizon — not when the floods came. Second, it has brand recognition and a market position that should keep it a shopping choice for its committed customers.

Jay Wilson, vice president of marketing at Vans, reports that the brand’s high-end and signature products are still experiencing good sell through and demand. West Coast sales, he says, have been harder hit than East Coast sales since September 11. Vans’ core customers are doing fine. “It’s the mainstream retailers who are affecting our business,” he reports. They’ve had some order cancellations and some shipping postponements.

In response, “Vans has reallocated dollars from branding to the store level,” says Wilson. The company is doing more demos at skateparks. It’s revved up the rep force to spend more time with the customers and it’s making more shop calls to find out how they’re doing and to help fill in product. “We’ve got ten people calling shops one to two hours a day,” he says.

Vans has put a hold on new advertising or promotional commitments, and expects to maintain that through the middle or end of November.

Dave Juan, one of the owners of Unsound Surf on Long Island, New York must be one of the guys Vans is calling more regularly. He’s now cut his orders for spring by 30 percent — though he wasn’t worried about a recession until September 11. “Sales were impacted, but are recovering,” he says.

He’s getting lots of calls from reps trying to get him to change his mind. Product is coming early and orders are complete — rather than a bit at a time as has been the case in the past. His interpretation is that brands don’t want to give him the chance to change his mind, and want to get their stuff into his store before the competition. He’s seen some loosening of credit terms and additional discounting. He’s ordered some extra Ocean Minded sandals, citing that brand’s commitment to donate part of its sales to the Red Cross relief effort.

Pat Fraley, president of Counter Culture, says sales aren’t going down, but buyers are more cautious. Some spring orders have been delayed, but he doesn’t see ship dates slipping yet. His perception is that companies with broader distribution are feeling it more than specialty shops. “It seems like most of our retailers are doing the right things,” he says. “They have the right attitude.”

To help those retailers, Counter Culture has changed its pricing structure. “We’re shifting our entire wholesale price structure and pricepoints down two or three dollars,” says Fraley.

Fabrice Le Det, Asia and European sales manager for Reef, says he has some distributors who are very reluctant to travel, but that his international prebooks for spring are still strong and fall product seems to be moving. “The big test,? he says, “will be once the spring line hits the stores beginning in March and we see how the consumer behaves.”

He hasn’t seen many cancellations, though there have been some minor decreases in orders or delivery dates pushed out. Overall, sales are up from last year. He blames any minor softness in international sales on weak economic conditions and competition at the low end, rather than the events of September 11.

Mark Price, who’s handling international distribution for Tavarua apparel, says he’s not sure how much of the domestic retailing slowdown is due to the September 11 attacks, and how much is the result of recession. “The holiday season,” he says, “will be the acid test. It will create opportunities for those left standing.” Strong brands, he thinks, will be stronger next year.

“But what happens,” Price wonders, “when 80 percent of the floor space in specialty shops is taken up by brands that are also distributed nationally in larger stores?”

Hell of a good question. When brands are ubiquitous, how do we keep them special and exciting? A primary method of brand differentiation in the surf industry right now is a consistent and effective marketing program. However, if competition and economic conditions push margins down, how will brands make a buck? Lower margins and higher costs are not typically a recipe for financial success — especially if you’re a small guy. Look what happened to the snowboard industry even without a recession. A recession has the potential to accelerate the same trend in the surf industry.

Do Something!

My wife and I had dinner in an established Seattle restaurant about a week after the attack on the World Trade Center. Business was off about 30 percent, according to our waiter, who predicted: “There’s going to be a bunch of restaurants in Seattle closing down.”

He should be in a position to know. Which ones would close? The ones with either a poor balance sheet or no established clientele — or both. It’s the same situation for businesses around the country — including surf shops.

During a lot of the 90s, low interest rates, high personal expenditures, low inflation and unemployment, and big jumps in net worth meant a high growth rate for retail sales (averaging 6.55 percent annually between 1994 and 2000). That kind of growth and cash flow can cover up a lot of miscues and lack of a competitive advantage.

At the same time, retail competition is tough, to put it mildly. There have been a lot of store closings, but the United States is still over-retailed. All of you surf retailers who have ever had cause to complain about a brand opening your competitor in the next block understand this at a fundamental level. I’m still getting pretty regular e-mails from people who want to open shops and are looking for information.

Just like in the restaurant business, brands and retailers lacking a solid balance sheet and a viable market position are going to be vulnerable in a recession.

You can either sit there and hope, or you can minimize your chances of being a casualty by taking action. Examine your cash flow now. See what a ten-percent decline in revenues would do to your business and adjust your business model right now. I’ve gone out of my way to sound a little economically pessimistic. Hopefully I’m wrong — but plan as though I might be right.

# # #

Jeff Harbaugh helps action-sports companies manage transition in changing markets. Unfortunately, he’s old enough to have lived through several recessions. Reach him at (206) 232-3138 or at jharbaugh@msn.com.



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