Q&A: Riding The Business Cycle More Wisely

Business expert Peter Navarro says IT solution providers and their clients can be more competitive by better managing the ups and downs of the business cycle, notably via sharper control of inventory and capital outlays such as technology spending. A University of California business professor, Navarro has had his work published in The Wall Street Journal, The New York Times, BusinessWeek and the Harvard Business Review. He outlined his approach, explained in his book The Well Timed Strategy, in an interview with CRN Director Of Editorial Research John Roberts. Here is an excerpt.

CRN: Why do companies need to do a better job of managing the business cycle, and why is it so important for them to know when to act?

NAVARRO: A lot of what people know about strategy focuses on the how and the why. But timing, very often, is as [important] or more important. In terms of inventory-type management, the kind of micro approach to managing inventory is to increase your inventory turnovers as much as possible all of the time. In fact, what you want to do going into or out of a recession is to cut inventory more subtly. When you are coming out of a recession, you want to be building up because you want to be the first on the stock shelves and have the opportunity to sell. Just about any decision across the organizational structure--whether it is marketing, HR, production, M&A, finance, whatever--is sensitive to where you are in the business cycle and the related interest-rate and stock-market cycle.

CRN: You said a key part of managing the business cycle is cutting expenditures ahead of a recession to conserve cash and increasing expenditures at the bottom of a recession to exploit a coming recovery. How does this differ from current business thinking?

NAVARRO: I think the culprit there is a bigger problem of the lack of business cycle literacy among a lot of executives. Those that manage the business cycle well are in the minority. The problem is that understanding basic economics, understanding what economic indicators to look for, is not something that a lot of executives do. That is very costly to companies, particularly in the tech area, because tech has been subject to exuberant views and exaggerations in the business cycle. That is because a lot of tech executives--[Cisco Systems CEO] John Chambers is a classic example--thought their companies were outside the business cycle.

Because of this lack of understanding about basic economics, many [executives] are not prepared to do trim inventory in anticipation of a recession, boost capital expenditures in the middle of a recession and restock inventory in anticipation of a recovery. A lot of companies are very risk-averse, and they just will not do that. But it really is the best way to get the most innovative products on the shelves ahead of your rivals. You can't wait until good times are back. Moreover, recessions tend to be shorter than expansions, so there is a window of opportunity there. If you move three, six or nine months faster than your rivals, then you've got them.

CRN: How can CRN’s readers, as IT solution providers, help their customers better manage the business cycle?

NAVARRO: The average person from your audience actually faces two challenges. The first challenge is the fact that they are in a highly cyclical industry. They have to be as ready as anyone for a recession because their own company will get pulled down whatever happens in the technology industry if a recession occurs. So they need to manage their own companies with an eye toward the economy. At the same time, they can also bring the following message to their customers: 'We can help you manage your company, including your expenditures on technology, using more sophisticated systems that will help you anticipate economic movements and help to exploit them.' It is basically a wake-up call for their customers. The next recession is coming, so how are you going to react to it? How are you going to change your marketing strategies? How are you going to change your HR policies? And of particular importance, how are you going to manage credit and accounts receivable? What you need to be doing, if you smell any whiff of recession, is to accelerate bringing in accounts receivable and tighten up your credit so you are not stuck with a lot of write-off.

The overall message for your readers is that if you and your customers have a business cycle-sensitive management, your companies can be managed better and you can sell your product better. Markets can be segmented according to stages in the business cycle. The sales message and product cycles can be changed according to changes in the business cycle. There are a whole bunch of very interesting things that can be done if people pay attention to changes in the business cycle and the economy.

CRN: What are some indicators that businesses can use to help assess economic conditions?

NAVARRO: One of the things I preach is that executives need to be attentive to economic information on a daily basis, and it does not take a lot of time compared to the payoff. The weekly Economic Cycle Research Institute (ECRI) has two really good indices for businesses to keep their eyes on. The first is the Weekly Leading Index, and the second is the Future Inflation Gauge. Together, they provide executives with a simple but powerful forecasting tool.

In addition, the yield curve, which measures the relationship between short-term and long-term interest rates, has a tremendous amount of information in it. The Federal Reserve determines short-term rates, while long-term rates are basically determined by thousands of savvy investors betting billions of dollars on the direction of the economy. When you get the unusual case of an inverted yield curve, where longer-term rates are actually lower than short-term rates, this is can be a sign of a coming recession. An inverted yield curve has, in fact, predicted five out of the last six recessions. ...

Every day, there is a new economic report that comes out that has meaning and will help you. And if you pay attention to these reports over time, you will get more and more out of them.

CRN: Are the indicators showing that an economic slowdown is coming up in 2006?

NAVARRO: We have had something like 14 or 15 interest-rate hikes, and we are going to have at least one or two more. We are running a big budget deficit, we are at full employment but still not bringing in enough tax revenue, we are running a huge trade deficit, and commodity price inflation is building. Any one of those things could slow down our economy. When you take them all together, there are certainly danger signs.

Can we say absolutely that there will be a recession in 2007? No. But I would watch things real carefully right now, as there could be a downshift by the end of this year. Even if we do not technically fall into a recession, where GDP [gross domestic product] actually declines, a slowdown to a 1 percent or 2 percent GDP growth rate will darn well feel like a recession to most businesses. CRN: Another factor you mentioned in managing the business cycle is better control of the supply chain and inventory. Can you expand on that?

NAVARRO: A well-constructed supply and distribution chain can be its own forecasting tool. I urge your readers not to think of the goal of supply-chain management to always inventory as slow as possible just to tighten, tighten and tighten. In times of recovery, economic recovery and expansion, you actually want to decrease your inventory turnover ratio. But that is not the goal in and of itself. The goal essentially is to move more products into the sales channel at a time when you think demand is going to be moving upward. That way, you can push out your competitors and take advantage of the pent-up demand that gets unleashed. This goes to the point of macro-managing vs. micro-managing your inventory. I think that is a really important distinction, because businesses tend to focus on micro-managing their supply chain, in a sense that they are always trying to squeeze things down, when in fact it is often better to move things up.

CRN: That would create opportunities for IT solution providers in that they could provide the solutions businesses need to manage both macro and micro processes, not just the micro process.

NAVARRO: There is a tremendous opportunity here for IT consultants to go in and teach these companies how to be more business cycle-oriented, how to be more strategic. Systems could be developed and sold to companies that really could do a much better job of making these companies more sensitive to cyclical movement.

CRN: A recurring theme in your book is to pay more attention to economics and the economy. Don’ fly blind, or you could wind up, for example, getting caught with a lot of inventory that ends up being written off.

NAVARRO: Your readers could sit down and think about how they could build a system that would allow their customers to act on this kind of information and build a battle plan. This would entail better economic and business forecasting. A lot of economic information gets trapped in the corporation. It does not move well in a cross-functional discipline. The finance people may be really smart, but the information does not get over to the operations management guys or to the marketers. Developing technologies that facilitate the flow of this strategic forecasting information across units--up and down the organization--would be quite an achievement and quite a business opportunity for your readers.