As the black clouds of recession gather overhead, surprisingly few firms seem to be taking steps to prepare themselves for the worst. Margaret Coles offers some advice.
Like Christmas with ghastly relatives, recession is a fate to which we are seemingly resigned. Some observers say our conviction that we are due one is bringing it on. Be that as it may, the experiences of the early '90s, when thousands of small and medium-sized companies were forced out of business, should provide valuable lessons in the present gloomy economic climate. At such a time, wise virgins reach for the oil can and wise bosses, if not trimming their wicks, make sure they are prepared.
But how many are doing so? Professor Robert Blackburn, of Kingston University's Small Business Research Centre, says that owners of small firms often suffer from 'fortress enterprise mentality'. 'Even if all the warning signals are screaming that there's trouble ahead, they say they'll survive. They all say they're prepared but they're not as prepared as they should be,' he says.
The most vulnerable businesses are those that are young, small, have grown rapidly and have large amounts of debt. 'The amount of profit you make is not much of an indication,' says Paul Gregg of the Centre for Economic Performance, who co-authored research into the last recession.
Small firms get trapped in a vicious cycle. Most have no strategy and are swept along on a wave of economic growth. They grab short-term finance when they need it and end up heavily borrowed and under-reserved. When a downturn comes, as payments are delayed and bank loans are called in, their cash-flow hits crisis.
To avoid this, Colin Barrow, head of the enterprise group at Cranfield School of Management, advises: 'Reduce dependency on borrowings and increase financing with retained earnings or new shareholder funds. Shareholders are forgiving.
Banks are not.' Now is the time to chase invoices, step up credit control, identify any over-capacity and be strict about expenditure. High fixed costs make a business vulnerable. So does a habit of using up your overdraft facility, paying suppliers as late as possible and being too dependent on getting money in on time.
'Keep your staffing tight,' recommends Barrow. 'Small firms are conspicuously slower than large ones at reducing numbers. But if it's a family business, as many are, I suppose it is difficult to fire Aunt Daphne or your father. If you're in recruiting mode, it might be better to hire someone part-time, or handle new ventures as projects.
'Decide which customers make up the core of your business, and try to keep them happy and firmly in your grasp,' Barrow says. 'Show them that you're seeking to improve your product or service. Ask them what more you can do to help them. Make sure that contracts are up-to-date. Consider offering a loyalty incentive to people who will buy in volume.' It is worth developing a 'sense of common interest' with buyers, says Paul Geroski, professor of economics at the London Business School, especially the dominant ones. 'You could help them to cushion you by suggesting ways of altering what you deliver, to let the buyer alter the package to the consumer.'
'Work harder at marketing - but do it as soon as you hear of a downturn in your sector, because it takes time for work to come in,' adds Blackburn.
Make sure that you are making the best use of your IT system. Firms often duplicate labour-intensive tasks because various functions use different software.
Confidence among small businesses has suffered a serious decline, according to a Sunday Times poll. Over the three months to August, the percentage of bosses at the top end of the sector that expressed optimism plummeted from 57% to 21%.
Among micro firms, it fell from 18% to 12%. Although the view of Angela Baron, a policy adviser at the Institute of Personnel & Development, is unlikely to give comfort - 'if you're not already doing what you should be doing, it's probably too late' - it is not all gloom and doom.
Prudence, cutting down costs and reducing overdraft exposure will help a company to survive but there is a temptation during recession simply to reduce production and hope for better times. This is what most small firms did last time - a 1993 survey by Kingston University showed that only a quarter of the sample planned to make a major investment in the business. Yet elsewhere, a group of medium-sized companies enjoyed 20% growth during the same year.
Colin Perry, managing director of Oldham-based LTE Scientific and chair of the Confederation of British Industries' (CBI) SME council, was hit hard in the last recession. 'It came like a bolt from the blue and our order book evaporated overnight,' he says. His electrical components company was taken over and survived. 'I learnt to run a tight ship,' he says.
Now, the company manufactures a complete product - laboratory equipment - employs 55 people and, last year, invested in a large machine tool and a new computer equipment. 'We export, so we've reduced prices to compensate for the strong pound. We've been very careful and we feel our overheads are low enough,' says Perry. 'We've expanded but we haven't increased costs. We have used leasing only for plant and equipment. We have no overdraft and a substantial amount of spare cash in the bank. If there is a recession, we'll be in a good position to take other firms over.'
Companies that rely on a single product or customer tend to suffer. Those that can be innovative and flexible are more likely to survive. In the recession of the early '80s, a lot of suppliers to the manufacturing sector went to ground. Many emerged from recession to find that most of their customers had disappeared.
But some small firms spotted the start of the service industry boom and reinvented themselves. It is this capacity to adapt and seek new opportunities that marks the successful entrepreneur.
Virgin started small and grew through diversification. John Menzies developed from a newsagents to a distributor.
Within the workforce, redundancy should be the last resort, says Baron: 'You lose innovative capacity and creativity, and demotivate those who are left behind.' Similarly training, usually the first thing to go, may help staff to work in new markets and to position the business for recovery.
Ruthless pruning can be a mistake. If the measures taken are too drastic, they can often kill the business. Last time around, many small companies emerged apparently unscathed but then needed money quickly to expand as orders started to pour in again. They over-extended themselves, obtaining expensive, short-term loans from banks for raw materials and other items.
Overdraft agreements were broken and with tenuous cash-flow, many companies went into receivership because of a single bad debt.
Ernie Reading, managing director of Tensator in Milton Keynes, saw his parent company go into receivership in 1991. 'But we bought ourselves out and turnover has quadrupled in the past seven years,' he says. Tensator makes seatbelt components. It has 215 employees and exports 70% of output.
'In November 1996, we started planning to protect ourselves against the pound rising,' he says. 'We bought currency and took forward options. We expanded our order book. That gave us bigger purchasing power for raw materials, which we bought on the Continent. We bought capital equipment, to increase productivity. We don't want to risk losing customers. My strategy is to be aggressive and do the opposite of what the market is doing.'
It pays to be dispassionate. 'The death rate for small businesses is one in three, so make sure that your passion and enthusiasm are tempered by a cold, hard look at reality,' warns Mark Hastings, policy adviser at the Institute of Management. Where is the business going? What does it need to make it fly? 'Be open with your financial backers. Keep them informed of what the business is doing and what you think the risks are. Everyone thinks they can be the next Richard Branson - that it's about taking risks, being a natural genius - whereas, for most people, it's darned hard work, a lot of study and learning the rules of the game. Invest in your education as a manager. It will pay dividends.'
Roger Rowe is managing director of Alarmtronic in Croydon, which makes fire alarm components. The company went into the last recession with a newly merged company in new premises. 'It taught me not to take anything for granted,' he says. 'I now get a twice weekly print-out of debtors and creditors, and details of cash in the bank.' His survival strategy last time was to hold prices and budget for a 25% drop in turnover; while cutting staff and wages. 'Now I keep a constant eye on the business. I monitor stock levels with a special software program, and I constantly chase money,' he says.
The business budgets for any capital expenditure and buys only when the money is in the bank. 'We're producing a lot more with the same staff levels,' says Rowe. 'We've restored the wage cuts and given people a good increase this year. I talk to staff more now, which includes a production meeting every morning.'
Businesses desperate for cash might find factoring useful, even though it may prove expensive in the long run. The same applies to leaseback. Good deals might be available through local Chambers of Commerce, telephone bills, internet access and healthcare. The chamber, local TEC and Business Links all offer advice, support and networking opportunities.
As Barrow points out, boom and bust is in the UK's psyche. 'Our ups and downs are particularly dramatic, so you've got to be prepared for a plus or minus of 20% in your sales. If you're not, your strategy is probably not sufficiently robust,' he says.
The last word goes to Matthew Farrow, head of the CBI's SME unit. 'Don't be defeatist,' he says. 'While there is some gloomy economic news about, lots of companies are bucking the trend and doing well. Don't assume it's all downhill.'
ADVICE FOR WEATHERING THE STORM
- Keep a close eye on gross profit and availability of cash
- Identify any overcapacity and be strict about expenditure
- Ensure that you have good credit management
- Negotiate with your creditors
- Try to eliminate high fixed costs
- Reduce dependency on borrowings
- Consider your options for managing currency, and seek advice
- Establish where your business is going
- Check whether your prices are sustainable
- Be honest with yourself, your staff and your bank
- Be realistic. Don't put off difficult decisions
- Keep staffing levels tight but don't overdo the pruning
- If redundancies are necessary, make them all at once
- Pay attention to information about your sector
- Seek impartial advice
- Try and get your customers on your side by helping them
- Work harder at marketing
- Make good use of IT
- Learn to be innovative and flexible
- Investigate export markets
- Try to keep up training, especially your own
- Set up a euro account
- Don't be defeatist, and don't panic.
IT MAY BE TOO LATE TO PULL HER SOCKS UP BUT LESSONS HAVE BEEN LEARNT
Sophie Mirman, founder of the Sock Shop, will enter any recession having learnt the value of measured, organic growth.
The story of the Sock Shop was symptomatic of the 1980s business environment.
Formed in 1983, with money from the then government's loan guarantee scheme, it expanded rapidly to 100 shops and floated on the unlisted stock market (USM). By 1990, it had gone into administration, with debts of nearly £20 million.
When I phoned Trotters, Mirman's new company, and asked to speak to her, the voice replied, 'Yes, speaking'. Mirman is clearly determined to keep tight control this time.
'In the '80s, a highly geared company was one going places, and the banks were more than happy to throw money at it,' she says. 'When rates nearly doubled in just over a year, companies that were young and highly geared found it virtually impossible to survive.'
There are two Trotters shops, selling clothes, books and hairdos for children aged from a few months to 10. The first was set up in 1990, and the second in 1991. A mail order business was launched a year ago. 'The company has grown organically, and at a slower rate.
I intend to keep it relatively small,' says Mirman.
She currently has 35 employees, many of whom worked for her at Sock Shop.
'I have no borrowings. The premises are rented but the operation is self-financing. It was such a tough recession in the '80s, it hasn't been forgotten by those of us who lived through it,' she says.
Keeping control entails doing all the buying. 'I spend as much time as I can in the shops, looking at new ideas and how we can improve what we do, seeing what people are buying, and hearing what they're saying,' she says.