A Medium to Long Term Perspective on the Job Market

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The chart below is something you need to see to have some medium to long term perspective on the economy and the job market.  It comes under the heading of something you won’t see in the mainstream media.  I have finally been doing this long enough to know that people don’t always like it when I present something that’s troubling and I actually thought about not posting it.  But I reminded myself that my job is to give you the best information I can that will help you run your business, even if it’s not cheery, or maybe especially then since nobody else seems anxious to do it.

The purpose of posting this is to give you some perspective on the possible duration of our current economic conditions.   Remember we need something like 100,000 to 125,000 new jobs a month just to keep up with population growth.   Eventually, new jobs and new industries will be created and the country will prosper if only because of its massive natural advantages.  But financially caused recessions are historically always the worse, and the deleveraging process we are going through has to be measured in years.

 

 

How is Our Customers Buying Power? A Chart That Should Make You Think

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I stole the chart below from Clusterstock (It’s not stealing if you confess, is it?) and wanted to share it with you. Look at the unemployment rate for our prime customers; the young workers aged 16-24. It’s close to 20% as of May. Now, if you’re in skate you go younger than 16 and if you’re in apparel, you’ve got some customers over 24 but it’s still relevant information.

The good news is that you’ll notice that this group has only for one period of time had an unemployment rate of less than 10% since 1974 so the baseline employment rate you should compare this with isn’t as low, thank god, as for the other groups of workers shown.

But my reading of the chart is that, as an industry, we tend to do well when that unemployment rate in this group is falling and to do, well, not so well when it’s rising. Not much of a surprise.
 
The other thing I wonder about is the extent to which this group, in our industry at least, is supported by their parents. As usual, wealthier, professional people are been less impacted by the recession and their kids are often our customers.
 
How can you make use of this information? Maybe by watching it on the Bureau of Labor Statistics web site. I’m pretty sure that a drop in the unemployment rate for 16 to 24 year olds would be good news for us- and for the younger people who got jobs.
 
 

 

 

Jeff’s First Book Report (at least since the 10th grade)

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Somewhere in the area of 75 AD the silver content of the Roman Denarius was about 100%. It was solid silver. Somewhere before 300 AD that content had fallen to around 10% or less. The value of the currency fell and the empire’s debt rose as Rome fell apart.

I thought that was an interesting fact, so I decided to tie it in to my suggestion to you that you find and read a book that came out last year called This Time is Different; Eight Centuries of Financial Folly by Reinhart and Rogoff.

The point of the book, of course, is that it never has been different. Not in the Roman Empire and not in the global financial crisis and resulting and ongoing Great Recession of 2007. The book is full of charts and tables but I guarantee you that not a single equation will rear its ugly head. Look at it this way; the time it takes to figure out the charts is probably the same amount of time you’d take to read the page.
 
“And this has what to do with action sports exactly?” you might ask. Well, nothing. Everything. We can’t make all our business judgments based on what we read in the popular media (I’ve pretty much given up on them by the way). If you listened to them, you heard that we created 88,000 new private sector jobs last month. You didn’t hear that we need close to 125,000 just to keep up with population growth. You may get told that the unemployment rate has gone down, but not that it went down only because the Bureau of Labor Statistics doesn’t, for some reason I can’t fathom, count people who have given up looking
.
 We certainly can’t rely exclusively on the discussions we have with our peers in our somewhat incestuous industry (like any industry I guess). And you can’t, especially now, take a short term perspective.
 
From around 1980 to 2000 we had what is simply the longest and strongest period of low inflation, growth, investment returns and employment we’ve ever seen. It was great wasn’t it? And we all kind of took it for granted. The cycle started to reverse itself in 2000 when the internet market crashed. The “recovery” was driven by the Federal Reserve’s decision to flood the market with liquidity and reduce interest rates, the breaking of the perceived relationship between risk and return, and tax cuts it appears we couldn’t afford.
I honestly think we would have been better off if we’d been allowed to have a bit more of a recession in the early 2000s. Maybe we wouldn’t have to be enduring our current one.
 
Anyway, we take for granted our 20 year up cycle, but are incredulous that there might be a long down cycle. I have never figured out why that is. The good news I suppose is that we’re ten years into the down cycle, however long it’s going to last. Don’t believe me? Go look at your overall stock market returns and  the change in average wages since 2000.
 
Here’s what This Time is Different teaches us.  I’m quoting at some length, because they just say this better than I can.
 
"If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government’s policies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly."
 
"We show that in the run-up to the subprime crisis, standard indicators for the United States, such as asset price inflation, rising leverage, large sustained current account deficits and a slowing trajectory of economic growth, exhibited virtually all the signs of a country on the verge of a financial crisis- indeed, a severe one. This view of the way into a crisis is sobering; we show that the way out can be quite perilous as well. The aftermath of systemic banking crisis involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources."
 
They don’t do this with stories (though there a few good ones), nor with suppositions, nor with opinions. The analysis is based on 800 years of rigorously gathered data that goes back as far as 12th century China and medieval Europe. As they admit, it’s not perfect. But it’s as objective as they can make it.
 
You need to convince yourself, as you figure out how to position and run your business, that this time isn’t different, that’s it’s happened before, and will happen again. Human nature, as the authors point out, doesn’t change. Financially caused recessions are the worst, and they last the longest.  That’s not my opinion.  That what their data shows.  Hoping things get better won’t do. As I think a sailor once said, “Call on God, but row away from the rocks.”
 
Read the book please.

 

 

What’s Going on in Greece and Why You Might Care

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The concept of the European Community and a common currency worked okay (though with massive misallocation of capital) as long as long as there was lots of growth and lots of money and lots of subsidies for poorer countries and low interest rates. For a long time, what you could earn on a German bond wasn’t that much lower than what you could earn on a Greek bond of similar duration (as little 20 basis points- one fifth of one percent- in 2007), implying a similar risk. The idea was that they were both parts of the Community, had a common currency, and that the rich would continue to take care of the not so rich.

Then, a few weeks ago, the bond market, which tends to have a mind of its own and doesn’t much care what speeches government officials make, decided that support wasn’t going to be there and that Greece, to use the technical financial term, was going in the crapper. Rates on five year Greek bonds soared to 15%.

Normally, when a country screws up financially like Greece has, a big part of the solution is to devalue the currency. That makes exports grow as they become more competitive, imports fall as they become more expensive, and it’s cheaper to pay off debt denominated in local currency. And of course, the tourists flock to the suddenly inexpensive country (assuming the people aren’t rioting in the street over austerity measures).
 
This has been doing on ever since there’s been money. Well, maybe not the tourist part. Go read This Time is Different; Eight Centuries of Financial Folly by Reinhart and Rogoff. One of the things they note is that Greece has been in some form of default for half of the last 200 years.
 
The Greeks should just crank up the printing press and turn out a whole bunch of Drachmas. It wouldn’t be easy, but over time would work.  Oh wait- there aren’t any Drachmas any more. There’s only these Euros and Greece can’t devalue them. Well, that’s an inconvenience.
 
As Greece’s cost of financing its debt goes through the roof (even ignoring that they are going to have to issue more debt that somebody is suppose to buy- no idea who) the austerity measures will have to become even tougher. This of course slows the economy further and reduces tax collections, making the problem worse.
 
I should note the Greeks are already notorious for managing to not pay taxes. In the last year for which figures are available, there were only 6 (yes SIX) Greeks out of a population of 10 million who reported income of a million Euros or more. Damn clever those Greeks. Maybe a bit too clever.
 
So I suspect that Greece is heading for an even deeper recession (I won’t use the “D” word though that’s what I really think will happen). I won’t even be surprised to see them default on some of their debt. That may take the form of a rescheduling which stretches out the term, reduces the interest rates or some other manipulation. As far as I’m concerned, that’s as much a default as just not paying.
 
The Europeans are making a whole lot of noise about injecting liquidity and bailout packages and backup lines of credit. But at the end of the day this is not longer about liquidity. It’s about a national balance stuffed with liabilities they can’t pay. Somebody is going to take a loss. The argument is just over whom. We are, by the way, having the same argument in the United States.
   
But what the hell. Our industry doesn’t sell much to Greece and we don’t buy much from them so why should we care? In the first place, the somebody who may take the loss is all the European banks who hold most of this Greek government debt. When banks lose money, their capital declines. Banks make loans based on some multiple of their capital. If they lose money, they either have to raise more capital or cut lending. If they lose 100 Euros and are leveraged ten to one, that’s 1,000 Euros of lending they can’t do. You may have noticed that has had a bit of an impact over here.
 
In the second place, there’s the little matter of Portugal, Spain and Ireland which are in none too good a shape themselves (though nowhere near as bad as Greece). Where’s the money going to come from to bail them out and which banks hold their debt? They use the Euro as well, so devaluation isn’t an option for them either.
 
Again, if each country still had their own currency, the Greek Drachma, Irish Punt, Italian Lira, and Spanish Peseta would all be devaluing, the German Mark would be rising, and the usual adjustment mechanisms would be working. They aren’t and they can’t while the currency union exists.
 
The financial markets see this and are concerned that either the currency union comes apart (very messy in the short term, though perhaps a good results in terms of resource allocation in the longer term) or there’s a potential for default on sovereign debt. The result is a lot of pressure on the Euro.
 
I expect that Europe will have a double dip recession and won’t be surprised if the Euro goes to parity with the dollar. I’m actually putting my money where my mouth is in this case and have started the process of pulling some Euros we have back into dollars. Wish I’d started two months ago.
 
I’m hopeful it’s clear by now why you care about Greece and the mess in Europe in general. Tougher economic times there mean less consumer spending. A weaker Euro means our exports become more expensive. The good news, I suppose, is that imports from Europe become less expensive. Maybe all those snowboards being made in China will be made in Austria again.
 
Remember when the subprime crisis started? “It will be contained,” said Fed Chairman Bernanke. And in Europe they couldn’t figure out why they should possibly care about a bunch of bad residential housing loans in the US. Then Lehman Brothers blew up and we went from “It will be okay” to global economic recession in about 20 minutes. 
 
That’s how these things have always happened (go read that book I mention!). It’s okay until it isn’t and everybody gets caught by surprise. Maybe, if you think my analysis is reasonable, there are some things you should be looking at now just in case so you don’t get “caught by surprise?” 

 

 

In Case You Have Trouble Sleeping: A Report from the Bureau of Labor Statistics

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You can go here http://www.bls.gov/news.release/ecopro.nr0.htm to see the report. If it does help you sleep, it will probably give you nightmares. You can see in the first line of the report, released last Thursday, that they expect total employment "…to increase by 15.3 million, or 10.1 percent, during the 2008-18 period…"

Now, that may sound encouraging, but if you push a few calculator buttons, that’s on average about 125,000 jobs a month over ten years. Well maybe that sounds good to you too, but it sounds less good if you realize that 125,000 jobs a month is more or less what we need just to provide the jobs required by an increasing population.
You do yourself a disservice if all you do is listen to the monthly unemployment number thrown at us by the talking heads in the mass media. Earlier this month, for example, they announced that the unemployment rate had fallen from 10.2% to 10%. Obviously, lower is a good thing, but the reason it was lower was because 98,000 people who had stopped looking for work (the "discouraged" workers as they are called) were taken out of the unemployment calculation.
It’s a little more work, but I really suggest you try and get at least some of your news somewhere besides the popular press.

Here’s a Chart Worth Seeing

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After my post on SIMA’s 2008 retail study yesterday, I got curious about the percentage changes quarter over quarter it implied. The Media Highlights gave me total core sales for the year and the percentage of sales in each quarter. SIMA gave me the same information for 2006. The rest of the calculations are mine and I used them to create the table below. The numbers don’t exactly add because of rounding, but that doesn’t really matter.

 

 

 

 

 

 

 

 

Fourth quarter skate/surf core sales were 17.5% lower in 2008 than in 2006. We don’t have 2007 numbers because SIMA only does the survey every other year, but I’m guessing the 2007/2008 comparison would look worse. SIMA has now told me that this information is in their full report, but I don’t have that and I’m guessing a lot of you don’t either.

I don’t think that number will surprise anybody who’s actually running a business, and I don’t believe it’s worse than other consumer related businesses. I look forward to improvement from this point on.

 

 

A Little Random Perspective on the Financial/Market/Credit crisis

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Once upon a time, way back in 2003, an investment bank could only have leverage of up to twelve to one. In 2004, the Security and Exchange Commission gave five investment banks, and only five, the ability to leverage up to 30 or 40 times or so. Guess which five they were? I almost don’t want to bother listing them, because the list is so obvious. But for the benefit of all the readers who have just awakened from a coma they’ve been in for most of the year, they are Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs.

There’s a lesson there somewhere.

On my last posting on Zumiez, I wrote about how they had to classify their various investments under the terms of FASB 157. Basically, companies are required to “mark to market” their various securities. The problem arises when you know your securities are worth something, but you have no idea what because they aren’t trading. Should you carry them at $0.00?
Back in the early 80s, I was an international banker living in Sao Paulo, Brazil and having a hell of a good time. All the South American countries had defaulted on their debt to the American banks. It was a lot of money and if the banks had been required to “mark to market” all those loans, they would have been broke. A bank’s ability to lend depends on its capital ratios. If they have to write off all their loans, they have no capital and can’t lend. The Fed decided that would be bad so they let the banks keep those loans on their book, writing them off bit by bit as they earned profits to cover them. Eventually, they did get some payments. The loans were certainly impaired, but they weren’t worth zero.
 
This mark to market provision needs to be changed. Just because there’s not a market right this minute doesn’t mean the loans are worthless, and we shouldn’t treat them as if they are. And we can’t afford for our banks’ capital to all go away.
 
Which reminds me- as you hear this number of a bailout costing $700 billion being bandied about, remember that these loans do have some value. We’re not quite sure what the number is, but it’s not small and the net cost will eventually be a lot less than the gross number. In fact, because of all the fear out there, some killer investment opportunities in some of these securities exist and anybody who knows how to tell the good from the bad and the ugly should call me.
 
This morning I read that a local Seattle utility had only been able to refinance $28.5 out of the $30 million in debt it wanted to refinance. And it had to do it at 5.5% instead of 1.5%. The possibility that these additional costs would be passed through to utility customers if the credit markets didn’t get unstuck was mentioned, in case anybody out there thinks this might not impact them. If you’ve tried to get a credit card, mortgage, car loan or home equity line of credit lately and your credit isn’t pristine, you’ve probably already figured it out.
 
The discussion about the bailout is not about losing money. The money, however much it turns out to be, has already been lost. The discussion is about who’s going to absorb the loss. I’m afraid it will largely be you and me.
 
My reading of history is that the Great Depression happened largely because of a bubble that was left to correct itself and the paralysis that followed. Chairman Bernanke and Secretary Paulsen, no slouches when it comes to reading history themselves I’m thinking, have followed the drop in commercial paper issued, saw the sudden spike in its cost just in the last ten days, and decided this wasn’t something to fool around with. Hence, the package that’s before Congress right now. I’m hopeful it will be passed quickly and without a lot of other stuff tacked on.

 

 

Subprimes, Teen Spending and the Economy; Yup, It’s a U.S. Recession. Can’t Europe Just Ignore It?

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Daniel is my favorite economic indicator. He and his guys install wood floors. To get him to do some work at our house last summer, we had to book him two months in advance. When I called him to do another room not long ago he said, “How about next Tuesday?” He told me people were becoming more cautious and pulling back on projects.

With the Daniel Indicator in the caution zone, I decided it was time to look at the rationale for and impact of a U. S. recession for a second time in my writing career. The first time was, I think, in 2001 in the midst of the Great Skateboard Boom. Shops I talked with about any softening of their sales pretty much laughed uncontrollably after they realized I was serious. The recession was short and shallow and the only damage done in our industry was to my reputation for asking retailers such stupid questions.

I’m going to try again. Let’s look at some current U. S. economic indicators with particular attention to the subprime mess and its worldwide ramifications. Then I’ll review the latest stock market results for the publically traded big retailers as well as the companies that are specifically in our industry and see what the stock market thinks is going on.
     
Housing and the U. S. Economy
Consumer spending represents 70% of U. S. gross domestic product. Keep that in your mind while we talk about the subprime situation.
 
I need to describe in a few hundred words something people are writing books about. Since a picture is worth a thousand words, check out the chart below.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Source: “The Mortgage Pig in the Python” by John Mauldin. August 3rd, 2007. You can see the article at John’s http://www.2000wave.com/article.asp?id=mwo080307.   I recommend signing up for John’s newsletter.
 
What this says is that without people taking lots of money out of their rapidly appreciating homes and spending it, U. S. gross domestic product growth would have been a fraction of what was reported, especially in recent years. Now, here’s another cheery table from the same source.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
This table shows the dollar amount of adjustable rate mortgages that reset, or will reset, each month in 2007 and 2008. You can see that the peak isn’t until next, well, now. These resets are partly what lead to foreclosures because people suddenly have a payment they just can’t afford to make and the expected refinancing is no longer available. The other piece of the puzzle of course is the decline in housing values. It was just announced nationally that they were down 10.7% in major U. S. cities compared to a year ago. Of course in some markets, it’s worse than that. Much worse. And it isn’t over. I’ll discuss the impact below.
 
Okay, so sitting in Europe, why the hell should you care about the U.S. housing market?
   
The house price run-up started with low interest rates and a generally strong economy. It accelerated when banks stopped being banks.  It has historically been the role of banks to evaluate credit, make loans based on that credit, and then get paid back. Then they learned how to “securitize” loans. They bundles them all together, got one of the rating agencies to rate them AAA, and sold them to all kinds of investors who relied on that AAA rating. Suddenly, they’re earning their money from making the loans and servicing them- not from collecting them. They don’t care about the credit risk. Neither do the loan brokers or the appraisers or the escrow companies. Neither do the investors who are buying the bundled loans, because the rating agency says they are AAA. And through some financial magic, you can package some AAA rated loans with a bunch that aren’t AAA rated and still end up with an AAA rating on the whole security. Go figure that out.
 
Lots of money available, lots of fees to be earned, no worries about credit and everybody wants to get on the house buying band wagon. So they did. And, as you’ve read, many of the loans that financed this spree, especially in the last couple of years, were interest only, or nothing down, or no income verification, or/and adjustable rate. No worries about those low teaser rates on the adjustable loans though. When it’s time for the rate to adjust upwards, you’ll be able to refinance because of all the easy money and the fact that your house will be worth even more.   
Opps. Didn’t quite work out that way. Foreclosures have doubled since the 3rd quarter of 2006. The National Association of Consumer Advocates reports that four million subprime borrowers will see their monthly mortgage payments increase by an average of 40% in the next eighteen months.  House prices have fallen a little or a lot depending on where you live, lending standards have tightened as a result of loses on subprimes, and refinancing your mortgage has gotten more difficult, assuming you can even do it. If you put no money down and your house is worth less than at the time you purchased it, what’s the motivation for the bank to refinance the house since they know they won’t be able to sell the loan? You probably aren’t surprised to learn that the market for bundled loans, even ones that the raters say are AAA (whatever that means now) isn’t what it was some months ago.
 
As you know, this isn’t just impacting the subprime market in the U.S., but credit markets worldwide. And that means you. There’s no lack of liquidity- central banks all over the world have pushed cash into the system. There is a lack of confidence. Even perfectly good corporate debt has taken a hit. Between the various forms of these bundled securities and the derivatives associated with them, there’s real confusion about how big the risk is and who is holding it. How do you decide how much a security is worth if it’s not trading? The cash is there, but it’s not flowing. Banks that are caught in this have to raise capital and tighten lending standards. That’s as true for Union Bank of Switzerland as it is for Bear Stearns (May it rest in pieces). Basically, securitization let the U. S. subprime problems evolve into a global credit crunch.
 
Let’s say you were a hedge fund. You have $100 million in capital. The banks (in the good old days) would lend you $2 billion on that, leveraging you twenty to one. And they’ll lend it at, say, 5%. You turn around and lend it for, say, 6%. On the difference between the 5% cost of funds and the 6% earnings of the assets, you’re earning $20 million a year. You have a $100 million in capital, so you’re earning 20% a year on that. And hey, those securities are all rated AAA, so what can go wrong? Life is good.
 
But suddenly there’s a glitch in the system. The value of those securities you have falls one percent. You’re leveraged twenty to one, so you lose 20%, of your capital, or $20 million. As some panic and a little paralysis sets in, you’re easily and suddenly down 5% (Since these AAA securities are no longer trading, it’s actually kind of hard to know how much you’re down) and all your capital is gone. You get the margin call from hell. You can’t meet it, so the bank steps in and tries to sell the underlying securities. But there’s no market for them. The hedge fund is out of business and the bank is facing serious loses. Cue the lawyers.
 
You’ve seen some write downs of these securities and you’re going to see more.   But so what? All we want to do is sell a few decks, some pairs of shoes, and various jackets, t-shirts and beanies. Should we be worried that the consumer spending is going to slow is our little part of the world?
 
Stock Market Wisdom
 The University of Michigan Consumer Sentiment Survey in the U. S. fell to 70.5 in March, down from 80 in October. That’s the lowest reading in 16 years. The survey also reported that inflation expectations rose sharply, but I don’t suppose that’s a surprise to anybody who buys food and gas.
 
Meanwhile, consumer spending is falling, and the people who watch the stock market seems to think that decline is for real. The S&P 500 retail index (symbol $RLX) is down 25.6% during the nine months ended 31 March. The stocks of Dillards, J.C. Penney, Nordstrom, Kohls, Sears and Macy’s (large US mainstream retailers focused mostly on apparel) are each down between 22% and 48% over the same period. The average decline was 37.7%
 
But we can argue, and I think accurately, that those retailers don’t necessarily represent our market. Let’s look at some US publically traded companies that do. In alphabetical order, let’s see what’s happened to the stocks of American Eagle, Dick’s Sporting Goods, Ho t Topic, Pacific Sunwear, Quiksilver, Urban Outfitters, Volcom and Zumiez over the same period.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The average decline here is 33.1%. That’s not much better than the average of 37.7% for the general retailers. If you eliminate Urban Outfitter’s positive result, we’re actually worse with a decline of 44.2%.
 
Some months ago, when I did this exercise over a six month horizon, it looked like Wall Street expected the action sports market to hold up better than the general retail industry. It’s always been an article of faith in the industry that we would. Now, it’s not so clear.
       
It’s A Small World After All
When I spoke to U.S. retailers months ago, they were cautious, but hoping they didn’t need to be cautious. During trade show, I found this caution had become greater.   Before, they hoped to avoid a recession. Now, they hope it’s not too bad a recession.
That we’re going to have, or maybe are having, some slowing in consumer spending seems obvious to me. Especially since the morning paper announced that Starbucks saw a 1% falloff in store traffic last summer. We in Seattle take stuff like that seriously and that seems as good as the Daniel indicator I started this column off with and that we’re somehow protected because we sell fun.
How vulnerable is our industry? The evidence says we can expect some impact- more than it looked like a few months ago. First, we hoped the problems would be limited to the U.S. housing market. Then, to the U.S. economy in general. Then we hoped that the rest of the world would make up for U.S. economic weakness. But unfortunately it looks like the process of deleveraging the world (which is a good and necessary thing in the long run) is a worldwide phenomenon.
 
If you run your business carefully, and you have a strong balance sheet, you’re going to find yourself with opportunities while others struggle. Recession or not, people want to have fun.

 

 

How to Survive a Downturn And Take Advantage of the Opportunity It Represents

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In previous articles, going back to when skating was growing like the proverbial weed, I’ve talked about issues related to a downturn. Things like expense control, if you should sell your business, characteristics of a maturing market, cash flow management, the impact of a recession, and the potential impact of foreign competition. Given the continuing, current conditions in the skateboarding industry, it’s kind of time, and probably well past time, to bring it all together.

 
This isn’t necessarily a completely cheery subject-companies do go out of business in downturns- and I’ve learned over the years that the practice of shooting the messenger is alive and well. Still, I know from my consulting practice that denial and perseverance in a period of change is what gets good companies in trouble in the first place. Getting them to recognize that continuing to do what they’ve always done successfully when the business climate changes is more of a risk than doing new and apparently risky things is hard.
 
This is important, so I guess I can deal with a little hate email.
 
The Good News
 
Let’s recognize that downturns are opportunities for companies with sound competitive market positions and strong balance sheets. As weaker competitors go into crisis mode and spend all their time managing cash, cutting back on commitments, not delivering well and scurrying around looking for money, solid player can, and will, and do, move in.
 
That’s not to suggest that the soft market isn’t impacting even solid brands. But at the least they can continue their ad campaigns, deliver product when promised, pay their team on time and service customers better than their weak competitors. If others can’t, that puts you ahead of the game even in a soft market.
 
Now consider taking the next step. If you have confidence in your market position and branding, this might be the time- when your weaker competitors can’t respond effectively- to take that next step. Come out with that new product. Introduce new POPs. Go aggressively after those retailers who’ve been carrying other brands instead of yours.
 
Established skate retailers have for sure taken a sales hit- especially in hard goods. But some established stores have watched competing newcomer retailers disappear, and they’ve found some better deals available from brands.
 
Do I know that from careful market research and talking to dozens of retailer? Nah. I’ve talked to a few, and what I’ve heard has been pretty consistent. But this is what happens in every industry after a big growth spurt. As the industry matures, margins decline (temporarily or permanently), retailers have more power, consumers get smarter (so marketing may not work as well), product differentiation gets harder to come by, overcapacity can be a problem, competition shifts to a greater emphasis on cost and service, and international competition increases.
 
Aside from that, nothing changes.
 
These structural changes are different from industry to industry, but they are always present. Think of how each can be applied to skateboarding and I think you’ll see my point.
 
Retailers, even if they are skate focused, are usually not just skate retailers. They also sell surf, snow, bike and/or others in some combination. Surf, of course, is hot right now and taking up some of the slack of a soft skate market for retailers.
 
The decline in skate hard goods sales isn’t as traumatic for retailers as it would be if those were high gross margin items. Obviously, any sale with any positive margin contributes to overhead. But if you could pick where sales were going to suffer, you’d pick the lower margin items. In skate, that’s typically hard goods. Besides being diversified across sports, retailers have the added advantage of selling shoes and clothing to people who don’t participate in the sport but still needs soft goods.
 
Bad News
 
Companies are almost organic is their single-minded focus on survival. Even when any objective analysis of risk versus potential return suggests they should go quietly away, they don’t. Well, people who are pessimists don’t start businesses or rise to lead them so maybe that’s inevitable.
 
If you’ve got a few spare minutes, go to the Harvard Business Review web site (www.hbr.com) and buy a copy of an article in the July 2003 issue called “Delusions of Success; How Optimism Undermines Executives’ Decisions.” What the authors say is that “In planning major initiatives, executives routinely exaggerate the benefits and discount the costs, setting themselves up for failure.” That consistent with what I’ve seen in my practice.
 
During the kind of fast growth and seemingly endless product demand that skateboarding recently experienced, managers could do no wrong. The truth is that growth and cash flow cover up a weak balance sheet and lack of a sustainable competitive advantage admirably. When the cash flow and fast growth goes away, so does the illusion that everything is working fine.
 
I can’t think of a single company owner who, recognizing that the ride was over said, “Say that was fun. Let’s pick up our chips and get the hell out of Dodge.”
 
They believe that what they were doing before can still work, so they try harder. But more of the same is rarely the answer. Some succeed. But many, and perhaps most, just prolong their agony. In the process, and this is why it’s bad news, the market actions they take hurt other companies better positioned to succeed. They discount product. They extend terms. They sell into discount channels. They don’t pay suppliers. They flood the market with product that devalues all brands’ products. In their attempt to return to the glory days they take action which encourage the industry structural changes I allude to above that make their survival unlikely. The HBR article referenced above specifically mentions competitors’ response as one of the things executive tend to underestimate the impact of.
 
What’s a “Downturn?”
 
The implication of “downturn” is that there will be an “upturn.” Fair enough. I guess there will be. Soon would be good. But lurking in that thought process is the suggestion (or the hope) that the upturn will take us back to skateboarding growth rates of a year and a half ago. I don’t expect that to happen, though I would be thrilled to be wrong.    .
 
I don’t expect it to happen because of the structural changes in the industry I refer to above. They don’t have to be permanent- but they often are. What is going to change about skateboarding that’s going to take us back to the days when it was a small, underground, sport? Is there some technology out there that won’t just make skateboarding easier or better, but will fundamentally change it? It has to be something like what the invention of the microprocessor did for the computer.
 
If you are concerned that we aren’t going back to the “good old days” then your job isn’t to survive the downturn, but to succeed in the new skateboard business environment. What does that mean?
 
I guess it depends what you think the skateboard business environment is and is going to be. There’s no reason to believe I can see the future any better than you can, but if you feel that a return to fast industry growth is unlikely, even when the economy improves, then you might consider the following in creating a viable business model.
 
Control your expenses better. Duh. As far as I can tell, most skate industry brands and, to a lesser extent retailers, are already doing a pretty good job at it.
 
Understand clearly and specifically why your customers are buying your product. Adjust your spending to conform to that understanding. For example, if price should turn out to be critical, maybe you should look hard at your marketing budget since you might end up with a better bottom line by reducing some of those expenses and cutting price a bit more.
 
Or maybe it’s your team, and you should be promoting the hell out of them and raising prices. But when you do that, of course, you’re making a decision to limit yourself to that segment of the market that’s highly team influenced. How big is that market?
 
Build a financial model that tells you what volume you need at what gross profit to succeed. No denial and perseverance please. Look at it hard and without the rose colored glasses. When you project growth, have really good reasons for expecting it. May I suggest again the Harvard Business Review article mentioned above?
 
Look for brand extensions that won’t damage the quality of your brand. In this business, that brand is all you’ve got.
 
Retailers, don’t stop taking chances on carrying some new product. But at the end of the day if it doesn’t check and it doesn’t have a good margin be ruthless in your pruning. And make sure you have the systems to give you the information. Skate retailers no longer have the ability to screw up their buying and survive.
 
Consider the possibility that you may need more volume, as a retailer or a brand, to succeed. With a lot of product, hard and soft goods, that’s all high quality and pretty much all the same, and smarter consumers who are no longer quite as likely to be swayed by marketing, you may not have a choice.
 
This new skate industry structure may be temporary- or not- and it may suck. But if you manage your business starting right now for the new conditions, you can succeed and even prosper. Get to it. Your job isn’t to wait out a downturn but to succeed in it.

 

 

Stuck In A Rut; Another Recession Article

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Look, I’m sorry about this. I’d really rather write about upbeat, happy stuff. It’s not my fault we’re in a recession, or are going to be in one, or whatever. I’m not making up these lousy economic statistics we’re seeing, you now. I don’t just sit here and pull them out of my ass, damn it. Sure, sure, everybody just goes, “Why should we read this crap when he’s never got anything good to say!?” and then I’ll probably be out of an assignment. Vuckovich will throw me out on the street, my wife will leave me when we can’t pay the mortgage, but what the hell, she’ll probably get the house anyway, the dog will piss on my leg and all because of a couple of lousy quarters of negative economic growth. I mean, so what, it’s just that Hey!! Leave me alone. Give me that back. Yeah, same to you……

Editors Note: The Editors of TransWorld Skateboarding wish to apologize for Mr. Harbaugh’s egregious behavior. He’s been restrained, and locked in a small room with case of beer. He should be himself presently.
 
Though it won’t be official until another quarter of negative economic growth is announced, it is generally conceded that we are in a recession. We would have had one even without the events of September 11th, though it seems likely that either the depth or the duration, or both, will be longer as a result of those events.
 
The genesis of this recession, in my judgment, is in the decade of growth and prosperity we have experienced since the 1990-01 economic downturn and a financial markets decline (driven largely by the bursting of the technology bubble) that is unprecedented since the Depression.
 
The 1990-91 recession lasted eight months. It was relatively short at least partly because while the United States experienced economic weakness, other parts of the world economy were stronger. In 2001, Japan is entering its fourth recession in a decade and the major countries in Europe are weak as well. It was during the 1973-75 recession that the world last experienced such a confluence of negative economic forces. That recession lasted sixteen months. Its proximate cause was the oil crisis. No similar crisis is imminent at this time.
 
Questions
 
If you’re running a business in skateboarding, you have the following issues to consider:
 
1)            Will favorable demographics and industry momentum shelter skateboarding from a general economic downturn?
2)            If there is an impact, will it be different for hard goods than for soft goods?
3)            How will brands and retailers be affected differently?
4)            Are there any opportunities here and how can you take advantage of them?
 
Below, each of these questions is considered in turn. Neither I nor anybody else “knows” the answer to any of them. Your goal is simply to consider the issues as they may impact your business and draw your own conclusions. The only way you can be “wrong” is to not consider the issues.
 
Demographics and Momentum
 
My sense is that we can make short work of this one. Not only is the primary demographic for skateboarding growing, but it’s extending itself, as both younger and older participants take up skateboarding. That the sport has gone mainstream, or legit, or whatever adjective you want to use is undeniable. That doesn’t make the industry immune to recessionary pressures, but maybe it means that the impact is in a lower growth rate, instead of a decline.
 
Hard goods Versus Soft goods
 
If you want to skateboard, you got to have a skateboard. There’s just no way around it. On the other hand, you probably don’t need another pair of skate shoes in your closet. The old pair will last another month anyway, and if you don’t have the latest style of pants, you’ll get by. Or at least your parents think you can get by. But it’s tough to ollie off a board with a paper-thin tip.
 
In the economy in general, most public companies that sell casual clothing to our demographic have warned that they may not make their projected numbers in at least the fourth quarter. Granted, skateboarding is just a small part of that much broader market. Still, everything I’ve read, and everything I learned at ASR in September, tells me that soft goods sales are going to be down in at least the near future. I don’t expect skateboarding to completely avoid that trend.
 
It’s interesting how the worm has turned. The hard goods companies use to complain about the injustice of it all. Through their teams and promotional campaigns, they created and maintained the vibe which propelled the market. But it was the apparel and shoe companies, based on their size and growth rates that benefited the most from the activities of the hard goods companies. Everybody needed shoes and clothes. Not everybody needed a skateboard.
 
Now it seems like the soft goods companies are most likely to be hurt by recession. Hard goods companies, with their solid market niches, may look on any slowdown in growth as their first opportunity in a while to take care of some neglected pieces of their business. That’s how Paul Schmidt, at PS Stix, sees it.
 
“I’m only running five 24 hour days a week now,’ he says. “We’re finally able to reorganize our production line and install some new equipment that will make us more efficient.”
 
With confidence that their higher levels of production are here to stay, it’s likely that other hard goods brands will also be willing to invest in upgrading their production facilities.
 
Then there are skate shoes. It seems like we’ve had about seventy brands of shoes for a couple of years. Every six months, at ASR, ten of them have gone away, and there are ten new ones. I suspect there will be fewer brands by the end of this recession. It’s already pretty typical to go into one of the mall “skate” shops and see a pile of skate shoes on sale. The piles I’ve seen are typically so big that they have to sit near the front door, a barrier to the customer getting to the full price merchandise.
 
I’ve never understood the financial model of the newer skate shoe brands. They have to spend a passel of marketing dollars just to have a hope of making a dent. But their lower volumes means that they aren’t typically getting pricing, terms, or attention from the factory that’s as attractive as what the larger, established brands get. Look for the total number of independent skate shoe brands to decline consistent with a recession-impacted fall off in soft goods sales.
 
Retailers and Suppliers
 
The first thing we have to recognize, especially with retailers, is that there are damn few pure skate retailers. There are lots of retailers who sell skateboard products and lots of retailers who are primarily skateboarding oriented. But for the most part, they also sell surf, or snow, or BMX, or rock climbing, or roller blading or some or all of those. So things can be great in skate, but if they are off thirty percent in the spring because of a decline in surf apparel sales, they could have a problem.
 
Retail sales increased at an average annual rate of 6.55% from 1994 through 2000. Now they’re not. The whole United States, in general, is over retailed. Though demographics may to some extent shelter action sports retailers from a general decline in retail sales, it won’t protect them completely.
 
It’s also generally acknowledged that retailers earn most of their money from apparels, shoes, and accessories. Skate hard goods are simply not high margin products. A decline in soft good sales will have a disproportional impact on gross margin dollars earned at retail and on the bottom line.
 
Suppliers, as we’ve already indicated, are likely to do fine if they are hard goods companies, and see some declines if they sell soft goods or shoes. For both retailers and suppliers, the ones with the established competitive positions and strong balance sheets will come through this in the best condition.
 
Suppliers should be paying more attention to how and to whom they extend credit. Retailers, on the other hand, can expect suppliers to encourage them to buy from them and to cut some other supplier’s order, if any cutting is being done. This may translate into opportunities for some better prices and terms for retailers.
 
Opportunities
 
I can put this real succinctly. In hard times, the strongest competitors, with the best balance sheets tend to gain share and grow stronger. It’s not that they aren’t impacted by hard times, but they have the financial ability and customer loyalty to not only get through them, but to take advantage of them. 
 
They can afford to offer better terms and prices if necessary. They don’t have to cut their advertising and promotional expenditures as much and when they do cut, it doesn’t hurt their recognition with their customers as much as it hurts a less established business.
 
A little decline in volume doesn’t put them below breakeven. They have enough leverage to be able to get their factories to share the pain. Customers are more likely to cut purchases of marginal brands. They have the financial ability to buy some of their competitors when they get into trouble.
 
If you’re not a leader in your market as either a retailer or a brand, you’d better gird up your loins. Take steps to strengthen your balance sheet by cutting expenses where possible. Do it now, not later because expense reductions are cumulative over time. Dump that old inventory and stop kidding yourself about how much it’s really worth. Be cautious in extending credit and ruthless in collecting from those who owe you.
 
Take a hard look at your advertising and promotion commitments. Don’t fall into the old action sport trap of spending marketing money because you have to build your brand’s recognition no matter what. I can pretty much guarantee that your expensively bought market position won’t be worth squat if you can’t make payroll and pay your suppliers. 
 
By the time of the 1990-91 recession, skateboarding was well into a period of decline. Largely, people say, because the demographic trends of that time had run their course; not so much because there was a recession. But out of those hard times came new brands and companies that are among the leaders in skateboarding today. Those weren’t easy times. Some companies made it and some didn’t. But looking back ten years it’s pretty clear they created some opportunities by breaking down some barriers.
 
Get out your sledgehammer, but try not to hit yourself.