Definition: Periods during which a business, an industry or the entire economy
expands and contracts
Many business cycles are anything but regular. They vary in
intensity and length. Expansions and contractions of the economy,
also sometimes referred to as booms and busts, are broad economic
events that affect many industries and companies. The United States
economy has experienced approximately 10 of these boom-and-bust
business cycles since 1945. They've varied in length from the
abbreviated six-month contraction that followed the five-year
expansion from 1975 to 1980, to the 106-month expansion that
spanned the 1960s. The characteristics of economic cycles
include:
- Fluctuations tend to affect durable manufactured
goods more than services.
- Wholesale and industrial prices tend to be
affected more than retail prices.
- Short-term interest rates track and amplify the
cycles, moving in an exaggerated manner along with the
economy.
Don't ignore the influences of fortune on your business. Wars,
hurricanes, floods and fires can all have powerful effects on your
business. Wars in particular have a tendency to affect the entire
economy, producing booms in their early years as government
spending mushrooms and followed by the dampening effects of
inflation and, later, recession as the economy cools down.
Some random events can be beneficial to some businesses. A
roofing company, for example, could see a boom in business
immediately after a destructive hailstorm strikes its service area.
It doesn't pay to structure your business around hoping for
disaster, but you should be ready to swing into action when random
events create extra demand for your products and services.
Much effort has been expended trying to develop ways to predict
the turning points of business cycles. Few things are widely agreed
upon, however. For example, falls in stock prices, profit margins
and finally profits are generally seen as precursors of downturns.
However, even experts disagree on the timing of these so-called
leading indicators. It may be weeks or months after a stock market
crash before the economy begins to show signs of receding. Then
again, it may never happen. And there are many other indicators,
such as housing starts, interest rates and price indices, that
economists look to for help tracking and forecasting changes in
business cycles.
The Conference Board Inc., a private, nonprofit New York City
research organization, produces a monthly report that looks at
recent figures on employment, income, prices, costs, inventories
and many other factors. One of the most interesting features of
these reports is the index of leading indicators, which is an
attempt to peek at the near future of the economy. The leading
indicators include average weekly hours worked by manufacturing
employees, unemployment claims, new orders for consumer goods,
building permits, interest rates and an index of consumer
expectations. Unfortunately, because of difficulties in the timely
collection of all this data, it is subject to revision for some
months after a report has been released. Therefore, the "forecasts"
of an upcoming recession are often made after the recession has
arrived.
In general, economic forecasts aren't perfectly reliable.
Neither, of course, are the hunches and intuitions of
entrepreneurs. However, taken together and applied carefully in
view of what you know about your particular industry and company,
economic forecasts can help you to prepare for changes in the
direction of the economy before or soon after these changes
occur.
Business cycles are also affected by seasons of the year,
holidays and other recurring events. Bathing suits and sunscreen,
for example, sell well in spring and summer, poorly in fall and
winter. The opposite is true of coats and gloves. Less well-known
examples include fast-food outlets and other restaurants regularly
suffering sales declines in the winter and boosts in the summer,
especially in northern climes. Don't underestimate the potential
effect of seasonality. Cooler maker Igloo's sales during June, its
busiest month, are 10 times higher than those in its slowest
months.
There are many things you can do to smooth out seasonality--and
you should do some or all of them if you want to grow steadily.
Seasonality is a management challenge; it makes it harder for your
company to grow when you experience wide swings in demand. If
seasonality is causing you problems, think of ways to generate
steady sales. For example, one mail order flower company gets as
much as 40 percent of its revenue from a flower-of-the-month-club
program, which helps smooth out the seasonality of this
business.
One of the best-known examples of the power of seasons on
business is the year-end holiday sales boom that packs half the
year's sales into a few months for many retailers. But the timing
of holidays is even more sensitive than it may appear. Holidays
that don't occur on the same calendar date each year may have
different effects on business, depending on when they actually take
place. Easter is a good example. It may occur during a broad spread
of weeks in March and April. If it's early, retailers in the North
may be hurt because they've displayed swimming suits that don't
appeal to shoppers who are still wearing their winter coats. If
it's late, on the other hand, retailers have to be ready to supply
summer tastes in goods along with their Easter displays.
Highly seasonal businesses must avoid the tempting budgeting
shortcut of taking the projection for first-year sales and dividing
it by 12. If you have wide-ranging changes in cash flow needs, that
kind of budgeting error could sink you. So enter sales and cash
needs on a monthly basis, taking into account the expected effect
of the seasons on each month. Otherwise, planning for cycles is
largely a matter of recognizing that they exist. This may mean not
assuming that the current good times will go on forever. Plan for
tougher times by limiting the costs you add to your business. In
particular, be wary of paying higher recurring expenses such as
rent.
Entrepreneurs tend to take on unnecessary expenses when times
are good, but this can sink you if a recession strikes. Look out
for overly lavish expense accounts, over-reliance on high-priced
professional advisors, products that don't carry their weight, and
even marginal customers you'd be better off without. Trimming these
costs when times are good will help your profits now and may make
the difference between success and failure when the cycle turns the
other way.
Also think twice before adding expenses that may be hard to cut,
or even cost more to cut than they do to keep. Chief among these
costs is people. It can be emotionally as well as financially
painful to lay off workers in the event of an economic downturn.
And the costs for severance pay, unemployment insurance,
outplacement and retraining may also be steep. Remember: Even if
your income statement and balance sheet are strong now, you have to
practice cost containment to be ready for the next recession.