2017 market factors that could disrupt your business plans — Part 1: The economy

In this post, part of a three-part series, we set out to provide a comprehensive review of  current economic trends affecting your business. (Read Part II & Part III in this series)

At my strategy practice here at Optimize Inc., there’s a seasoned entrepreneur who often says, “A growing company is a thriving company.” Indeed, a company that doesn’t grow doesn’t survive. Growth is never easy, but leaders who are cognizant of external forces, such as those caused by the economy, are often better positioned to manage the challenge.

This article, the first in a three-part series, intends to unpack some of these external forces. Part I will focus on economic forces; Part II will focus on technology forces; and Part III will focus on social forces. Let’s begin by looking at the economic forecast, an analysis of key economic issues and a guide to preparing for the year ahead.

ECONOMIC FORECAST

Here’s what you can expect in 2017 and beyond, according to the experts.

A stable economy. According to Kiplinger, a publisher of business forecasts, the economy will remain stable and mostly unchanged in the year ahead. It projects that, in 2017, GDP growth will increase by 2 percent; inflation will increase 2.4 percent; and housing will increase by 6 percent.

An active M&A market. A flat economy has forced many companies to look at buy-and-build strategies in order to increase their value. Multiples for mid-market companies skyrocketed last year (up to 9.7x EBITDA) and the trend is expected to continue.

Slow GNP growth. Gross national product (GNP) is expected to grow only 2 percent in 2016 and another 2 percent in 2017. However, GNP isn’t necessarily a good tool for measuring the growth prospects for most businesses. Instead, it reflects the state of the broader economy by combining four indicators: personal consumption, private domestic investment, net exports and government consumption. Indeed, GNP growth was up 2.9 percent in Q3, but that figure was inflated by exports of commodities such as soybeans. Similarly, private domestic investment was up 3.1 percent in Q3, while personal consumption softened to 2.1 percent.

Variance in sector performance. As we saw in 2016, sector performance doesn’t always synchronize with the economy. Consider the performance discrepancies between these sectors in Q3: Winners included motor vehicles (+16 percent), recreational vehicles (+12.6 percent), housing and utilities (+11.9 percent) and healthcare (+11.3 percent). Losers included transportation equipment (-11.6 percent), residential (-9.4 percent) and equipment (-7.2 percent).

Remember that your business reflects several converging cycles, including the economic cycle, monetary cycle, industry cycle and company lifecycle. Geography also plays a role; just think of how the housing markets in Nevada and Arizona haven’t recovered in the same way that the California market has.

Short-lived wage increases. The hot labor market and minimum wage increases are giving a boost to wages, but wage rates will eventually normalize. It may be an inconvenient truth, but U.S. wage rates (especially in manufacturing) are depressed as a result of global competition and robotics. On average, it costs roughly the equivalent of $3 per man-hour to operate a robot, and new automation technologies will only improve their applicability and performance.

A recession. A recent survey by the Wall Street Journal found that economists believe there’s a 60 percent chance of a recession in the next four years. The Fed’s reluctance to raise rates demonstrates their concern that they could spark one. Any number of flashpoints — from South America’s political unrest to terrorist attacks to deflation to currency fluctuations — could be the final straw that pushes our economy into decline. China’s real estate bubble may be the most signficant of global economic threats.

ISSUES TO CONSIDER

Here’s my analysis of key economic issues, many of which have potential to impact the growth of your business.

Globalization has hit a wall. Foreign direct investment is down 40 percent from before the liquidity crisis. The notion of “protectionism” is gaining momentum around the world, as evidenced by Brexit and messages communicated by one of our U.S. presidential candidates. The Euro itself may not be sustainable. U.S. relations are strained with large trading partners like Russia and China. China, facing a severe economic slowdown, has de-escalated initiatives designed to promote trade. China’s inconsistent enforcement of its stated currency polices is deepening distrust from other governments. The Trans-Pacific Partnership appeared to be dead on arrival.

The energy sector is ready for change. On Sept. 28, the Organization of the Petroleum Exporting Countries (OPEC) announced that they were tightening oil production. The depressed U.S. energy sector is in desperate need of a resurgence. Prices are normalizing in the $50 range and many of the forecasts expect crude oil to stabilize.

The banks haven’t learned from their mistakes. The Fed’s infamous dot-plot graph was supposed to predict future interest rate action. However, recent announcements from the Fed have not aligned with their own predictions. As Michael Lewis suggested in a Harvard Business Review article earlier this year, the Fed and other central banks have not changed their behavior since the liquidity crisis, and banks are still motivated by perverse incentives that could spark another monetary crisis. According to Lewis, banks still have an incentive to take risks (e.g., by making bad loans) but don’t suffer consequences if the outcome is negative (i.e., because they’re too big to fail). This is a house of cards that will eventually result in higher borrowing costs.

Zero-interest rates are a short-term fix. Many banks in Europe are offering negative interest rates on loans. While this may seem like it’s beneficial to consumers, it will drain pension and retirement plans over the long term and lead to dire economic consequences. Central bankers know this and are chomping at the bit to raise rates before deflation sets in further.

The strong dollar may reverse course. The dollar is higher due to prospects of increased interest rates that have not materialized. This strains U.S. exports, causes downward pressure on commodity processes, and puts the brakes on growth in emerging markets such as Brazil, Russia and China.

Health care is in chaos. In Q3, health care costs (as measured in GNP) grew 11 percent — further evidence that the Affordable Care Act has created a cost structure that is anything but affordable. With major insurers leaving exchanges, cost pressure will continue to escalate in the short term. Markets in chaos always present the greatest opportunity.

Brexit is so three months ago. Fears that the British economy would implode have not materialized. The pound has lost 11 percent of its value against the dollar, which is impacting British spending power. But most economists view the devaluation as a shock absorber that has driven employment and exports.

PREPARING FOR 2017

Here’s how to get your company ready for the future, no matter what the economy may hold.

Rethink your global strategy. Businesses have come to realize that free trade will not be free. Worldwide distribution remains difficult to execute, with varying systems, regulations, economic partners and transportation costs. The key to global expansion is having relationships on the ground in the form of distributors, brokers, direct salespeople or alliance partners. For example, one of our clients who opened fast food facilities in China found it much cheaper to offer a regional franchise to a Chinese national who could mitigate local politics.

Become a buyer. If you are in the market for heavy equipment, this is a great time to buy it at a lower cost.

Be wary of placing all your bets on acquisitions. Danger, Will Robinson, danger. There are many businesses starving for growth that have decided to pursue “an acquisition strategy,” which is code for “we don’t know how to grow organically.” This is a trap that you should avoid at all costs. If a company cannot articulate a value proposition that resonates in the marketplace, bolt-on acquisitions (in a similar business) will only exacerbate the problem.

Consider vertical integration as a growth strategy. Many management teams spend most of their time thinking about how to grow horizontally (across their existing markets), and spend virtually no time thinking about how they can expand their position in the value chain. To change that, download our Value Chain Analysis tool.

Brace for impact. To prepare for the next downturn, ensure that your company has the following:
• A clear strategic plan with three-year and one-year objectives, which is updated quarterly to adapt to changing market conditions
• An operational plan that cascades goals and clarifies short-term objectives
• A budget process driven by the management team (not just finance and accounting)
• A forecasting system (such as a 9+3) that allows you to constantly reevaluate your financial condition
• Low fixed cost and the ability to pivot quickly to reduce direct costs
• A performance management system and feedback loop that engages employees (They are far more likely to be retained if you are transparent, even when the company is not performing.)

These basic tools will keep your team on plan and help you adapt to whatever changes the economy has in store. The key is not to view the economy through an emotional lens. The difference in GNP growth in an upturn and downturn is roughly 2 percent. So plan, be prepared and take a long-range view of how your company can grow and deliver value.

Read Part II & Part III in this series

Related reading: Post-presidential election survey: Economic analysis for CEOs and business owners

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