Ready to Rumble?

When the U.S. economy goes into a downturn, more Americans, forced out of their old jobs, start businesses. Ultimately, these new businesses help power an economic recovery, providing jobs and putting money in the pockets of consumers. It happened during the last major economic slowdown, in the early 1990s.

Given this history, many economists were prepared for entrepreneurs to lead the country out of the economic slowdown of the early 2000s. But for a time, entrepreneurs didn't respond. In the summer of 2003, John Satagaj, president of the Small Business Legislative Council, said, "I expected us to be in an [entrepreneurial] spurt. I haven't seen it yet."

In the past six months, however, all that has changed. The U.S. economy is predicted to grow by more than 4 percent in 2004. In comparison to previous downturns, this time, many small-business owners waited for the economy to tick upward before making new investments. But now that the economy has started to rebound, small businesses have become more optimistic. A survey released in March by the Business Roundtable, a trade group, found that the number of executives planning to hire outnumbered those planning to slash jobs for the first time in a year and a half. "In the past [few] months, clients have opened their wallets," says Rob Levinson, founder of RL Strategies, a Boston-based marketing firm that works with entrepreneurial companies. And Levinson says, now that an entrepreneurial surge is beginning again, savvy businesspeople are developing strategies to take advantage of it.

Slow Start

Unlike previous recessions, in this downturn, signs of a small-business-led recovery were slow to emerge. According to Heidi Neck, an author of the 2002 "Global Entrepreneurship Monitor (GEM)," a study funded by the Ewing Marion Kaufmann Foundation, the number of Americans planning to start new businesses decreased. And a report released by the outplacement firm Challenger, Gray & Christmas Inc. showed that the percentage of jobless managers who said they were starting new businesses dropped to an average of 6.8 percent in 2003 (down from 9.6 percent in 2002). Compare that to the 1991-92 recession, when roughly 15 percent of jobless managers started companies of their own.

There are several reasons why the surge was slow in coming. Mike Smith, former head of his own PR firm, says the bursting of the tech bubble still inhibited small-business growth in the early 2000s, as the tech crash made VCs gun shy. Fears of global terrorism and the war in Iraq also spooked many entrepreneurs, who worried these events would deter consumers. And, says Erik Pages, former policy director at the National Commission on Entrepreneurship, a group that focuses on public policy and entrepreneurship, people were more reluctant to start businesses because it was harder for them to obtain benefits—primarily health insurance—than during the recession in the early '90s.

Nevertheless, the Commerce Department's GDP and consumer spending figures indicate the economy is growing, if less robustly than in the third quarter of 2003. Powered in part by consumer spending, the U.S. economy grew by 8 percent during the third quarter of 2003 and by 4 percent in the fourth quarter, some of the highest growth rates in five years. Consumer spending in the third quarter of 2003 rose 6.9 percent over the previous quarter—buoyed by a boom in mortgage refinancing and by tax rebates—and by 2.6 percent in the fourth quarter. According to a University of Michigan survey, however, consumer confidence is wavering, having fallen in February 2004.

Despite this, entrepreneurs in the retail sector have been able to slash inventories—in January 2004, orders for goods other than transportation rose, and retail sales overall jumped 0.6 percent—and find the capital needed to hire new workers and expand. Says Satagaj, "Retailers are feeling the best."

And as the government has increased funding for defense and other federal spending, small businesses have been able to take advantage, since the administration has opened more federal contracts to smaller companies. Sequoia Ramsey, president and founder of Realistic Computing Inc., a Baltimore-based computer support firm founded in 2001, has been able to grow her company by relying on government contracts.

Similarly, small businesses have capitalized on the market for homeland security-related products. New Technology Management, a Reston, Virginia-based company with 150 employees, has become a major contractor for the Department of Homeland Security, installing the agency's systems for border surveillance at seaports and land crossings.

Youths are increasingly interested in entrepreneurship. According to the Bureau of Labor Statistics, the number of self-employed Americans between the ages of 20 and 24 is rising, and a recent survey by Junior Achievement Inc., which educates K-12 students about business, shows a plurality of Americans between the ages of 13 and 18 believe owning your own business is more stable than working for a company. Meanwhile, the number of universities offering entrepreneurship classes has risen tenfold in the past two decades.

The 2003 "GEM" shows the number of adults considering starting a company rose year-on-year. In a study of executives of midsize companies released in January by business advisory firm Grant Thornton, more than 80 percent expected the economy to improve in 2004, and more than 90 percent were optimistic about their companies' prospects. Even manufacturing, which entrepreneurs felt could be in terminal decline, seems to be rebounding. In January, the National Association of Manufacturers reported that factories would add nearly 250,000 jobs in 2004.

Still, this surge will be different from past ones, and savvy entrepreneurs are preparing for the changes. In previous recessions, layoffs from larger companies fell heavily on blue-collar workers, some of whom wound up starting their own firms and competing with existing entrepreneurs. This time, the pool of unemployed people contains many more white-collar workers, since the downturn hit professional fields such as IT industries particularly hard. More "of these people [who were] laid off are very skilled," says Paul Taylor, executive director of the Small Business Resource Center in Baltimore. These white-collar workers are more likely to have the education and capital needed to start successful companies. In fact, the "GEM" reports "the more education an American has, the more likely the person will pursue entrepreneurship." As a result, this surge may be the most competitive yet.

With competition tough, wise entrepreneurs are embracing outsourcing. Today it's easier to save money by outsourcing noncore tasks to other American companies, or even to overseas firms. Smart entrepreneurs are figuring out how they can best use outsourcing to compete as the economy recovers—they are putting up jobs for bid on the Internet, developing links to service providers in India and Southeast Asia, and researching other ways outsourcing can improve productivity. "Using the independents has been critical to our growth," says Ken Gaebler, founder of Walker Sands Communications, a small company based in Chicago that outsources computer programming to a company in the Ukraine and data processing to a firm in India. "Everyone I know is growing this way. It allows us to use people on a just-in-time basis and to bring in [exactly] the right person for the job," says Gaebler. "It also allows me to price more competitively. I can charge $60 to $80 an hour for work that competitors charge $200 to $250 an hour for, since they have to pay employees for time when they are not billable, and I don't."

Savvy entrepreneurs are also taking advantage of structural changes that hit larger companies during the downturn. Big "organizations are leaner, but they don't want to hire—so you do services for short-term dollars [for them], and you can make a killing," says Levinson. Indeed, some people laid off from large firms are using the contacts they had at their old firms in their new businesses. They're working as outside contractors for their old firms, which have committed to outsourcing and are unlikely to hire many staff back, even in a better economy. Paul Lorray, for example, worked for MCI/WorldCom, running a call center for 15 years before being laid off last year in the wake of the corporation's scandals. "The first thing that came to my mind when I left was to start my own business," he says. "The WorldCom experience really soured me" on large companies. Lorray decided to start his own firm, staffing it with former MCI/WorldCom co-workers. In July 2002, Lorray founded Argo Customer Solutions, a developer of customer support software applications in Sacramento, California. His firm projects solid sales growth. Says Lorray, "I don't regret for a minute having done this, because I've learned so much."

Other entrepreneurs are preparing for the surge by expanding into export markets; a weaker dollar makes American exports cheaper and U.S. firms more competitive globally. In fact, Leslie Schweitzer, senior trade advisor for the U.S. Chamber of Commerce, says entrepreneurs have been one of the biggest driving forces behind American companies' strong export growth in recent months. Free trade deals recently signed between the United States and Singapore, and proposed deals between the United States and Central America, will only make it easier for small companies to export.

To take advantage of the surge, entrepreneurs are also spending on branding to establish their companies in the minds of consumers who are just beginning to spend again. Entrepreneurs can't be reckless with money as they were in the late '90s-VCs today remain wary of backing any firm that burns its cash quickly. Still, Levinson says, as the economy begins to recover, people become more optimistic and "want to associate themselves with winning companies. If you can market yourself as winning, trumpeting it and boosting your self-image," he adds, consumers will be drawn to your firm. "Eight or nine months ago, I wouldn't have told companies to go out and say things are rosy" in their businesses to attract customers, because it was hard to believe things were going well for anyone. "Now, why keep it a secret if things are going well?" says Levinson. "You should broadcast it."

Joshua Kurlantzick is a writer in Washington, DC.