By Edward Iwata, USA TODAY
February 20th, 2008 | Link to Article |
Millions of U.S. small businesses — especially in the retail, business-services and housing industries — could be vulnerable if a recession strikes on top of the housing slump and credit crunch. A recession isn't official yet. But look at Pearl Paradise, a thriving online jewelry business in Santa Monica, Calif. Jeremy Shepherd, the 34-year-old founder and owner of Pearl Paradise, says the economic slump hit his business last fall.
Shepherd, who speaks the Chinese Mandarin dialect, buys directly from pearl farmers in China and cuts out the middleman. That lets him sell high-quality pearls at lower prices to everyone from college students to investment bankers.
Revenue for his company, which sells pearls wholesale and retail worldwide, had been growing rapidly at 100% or so annually. But in October and November, the usual pre-holiday spike in sales didn't happen. Customers who did buy were purchasing lower-priced pearls.
"It was starting to look bleak," Shepherd says.
He quickly slashed prices 50% on his unsold inventory, and the pearls sold in days. But his projections of $25 million in sales for 2007 fell to $20 million, he says.
To keep his company stable, Shepherd is streamlining costs, combining the firm's several different websites and beefing up his online marketing. He's also delaying the possible launch of a showcase store in Los Angeles.
"We were lucky enough to see it coming early, and we made the right moves to offset any major losses," Shepherd says. "We're taking a pro-active approach. We'll be able to hit it head-on and not have to close our doors or lay off people."
Pearl Paradise and other small businesses are closely watching their financials, their customers' buying habits and other signs of where their companies and the U.S. economy may be heading.
Lacking the financial reserves of bigger companies to weather a long-lasting slump, many little ones could be hurt by emptier shops, weaker sales and cautious consumers unwilling to spend on pricier items and services.
"Small businesses are definitely feeling the pinch," says James Barrood, executive director of Fairleigh Dickenson University's Rothman Institute of Entrepreneurial Studies. "They're cutting back, hunkering down and trying to be more efficient with their operations and their marketing efforts."
Barrood says that small businesses are hammered by a domino effect when big companies, such as builders and developers in the housing sector, suffer losses and cutbacks.
In the housing sector alone, builders and developers hurt by a slump also will hurt roofers, flooring firms, wallpaper companies and other suppliers and vendors, says Bill Conerly of Conerly Consulting, an economics consulting firm near Portland, Ore. Small businesses in travel and leisure, business equipment and supplies and other sectors also are feeling the economic squeeze, Conerly says.
The housing slump and credit crunch are particularly hurting smaller businesses, with 20 or 30 employees, that rely on second mortgages and equity loans to help finance their companies, according to Todd McCracken, president of the National Small Business Association trade group.
Owners of smaller businesses and start-ups "often will use personal equity and equity in their homes as capital," McCracken says. "But it's getting more difficult for businesses to expand or get started."
McCracken says that small businesses — 26 million in the USA alone — often lead the economy out of recessions. "That's difficult to do if they can't get the credit and capital they need to grow," he says.
A recent survey of 1,800 small-business owners by the National Federation of Independent Business trade group shows that an index measuring optimism among the owners dropped in January to its lowest since 1991.
More small-business owners said they expect lower sales and hiring, and they plan to make fewer capital expenditures. Only 5% expect the economy to improve in the coming months.
In a statement, the NFIB said: "The index delivered a recession signal, but it takes more than a quarter to validate. The index has been sliding since it peaked in 2004, typical of an expansion that gets tired, as has the overall level of economic activity. Perhaps the economy will slide, rather than plunge, into a recession."
The NFIB found "no evidence that cash-flow problems have increased dependence on credit from the banking system."
But if the economy worsens, small businesses may have an even tougher time getting bank loans and attractive credit terms.
A recent Federal Reserve survey found that 30% of banks are tightening standards on commercial and industrial loans to small companies so far this year, compared with only 10% in the last quarter of 2007.
"As the prospects of the economy weaken, you will find lenders becoming more cautious," says Keith Leggett, senior economist at the American Bankers Association.
With tighter lending standards, small businesses seeking financing now must have good credit, solid cash flow, more collateral and more cash for down payments up to 50% — compared with 30% in better economic times, Leggett says.
But Leggett and others say that small firms with good credit quality still are able to land financing and grow. Small businesses also should get boosts from the recent rate cuts by the Federal Reserve and from the economic stimulus legislation passed recently by Congress that will put extra dollars into consumers' hands later this year.
Plus, many smaller community banks — having avoided high-risk securities and poor lending practices — haven't been humbled by the housing slump and subprime debacle, and they're still financing small businesses.
Conley, Barrood and others say that smart small businesses are using the slump to streamline their operations, look at potential new markets and improve their marketing. When the economy rebounds, those businesses will be stronger.
Riding out another downturn
Mark Protasiewicz, founder and president of Top Notch Builders in New Jersey, hopes the downturn won't worsen. In the construction field for three decades, he's enjoyed boom years, and he's endured several slumps.
But over the past year or two, the work has slowed a bit, and homes that sold in days now take months to sell at lower prices. Local lumberyards and subcontractors aren't buzzing with business as usual.
Protasiewicz says his one-man company makes $750,000 in revenue in an average year. But he pays hundreds of thousands of dollars for supplies, materials and liability and workers' compensation insurance, leaving $75,000 in profits.
Top Notch Builders hasn't lost money yet in the current slump. Protasiewicz isn't taking chances, though, with four sons living at home or attending college.
He's focusing now on the home-improvement market, where business might be better than home building. Even during recessions, some people spend money on new decks, kitchen and bathroom work and other small projects.
"The bills are getting paid and we aren't going broke," he says. "But yeah, when the economy gets tight, you get nervous. Hopefully, the housing market will come back and people will start buying again."