Downturn In Fast Forward

Business is making instant cuts. Will that help or hurt?

When its personal-computer sales headed south three years ago, Gateway Computer was bushwhacked. The San Diego company scrambled to cut production, but still ended up with bulging inventories. They took months to work off and left a big blot on Gateway's bottom line. Seared by the experience, the company invested heavily in a monitoring system that allows it to track sales at its Web site and 785 stores with only a two-hour delay.

So at the start of last year's holiday season, when business suddenly slumped again, Gateway quickly got in touch with its 275 worldwide suppliers and shut off their spigots. The result: a modest increase in inventories that has taken weeks, not months, to bring back in line.

Welcome to the just-in-time downturn. Armed with the latest in information technology--and unrelenting pressure from Wall Street to keep profits up--many of Corporate America's manufacturers are reacting with lightning speed to the sudden slowdown in sales over the last few months. But up-to-the-minute inventory control is only part of the story. Ford,, Gillette, and a multitude of others have been just as fast to make sizable workforce cutbacks. Indeed, throughout the economy, companies are using the near-instantaneous availability of information about incoming orders to rapidly trim jobs, close excess plant capacity, and cut spending on computers and other equipment. Never before have companies been so able--or so willing--to respond this quickly to a slowdown.

And that hair-trigger response is changing the very nature of the downturn under way in the U.S. As the economy has downshifted from 5.2% growth in the first half of last year to a virtual standstill in the current quarter, production cuts, layoffs, and capital-spending reductions that used to be spread over months are occurring in weeks, intensifying the slowdown

All of which may be a mixed blessing. Clearly, such rapid response time has let companies get their costs under control much faster than in previous downturns. Collectively, though, the quick cutbacks have helped turn the expected soft landing into a sudden, sickening plummet to near-zero growth. That drop-off, in turn, puts added stress on managers as they struggle with deteriorating business conditions and attempt to gauge future demand.

Now the question is whether the speed with which the brakes have been applied to output and spending will ultimately help or hurt the recovery. The good news: The rapid-fire production and payroll cuts should bring inventories more quickly into line. That could make for a speedy turnaround once excess goods get sold off. Some are still optimistic. "I wouldn't get nervous until you start to see unemployment go up," says Sun Microsystems Inc.'s CEO Scott G. McNealy. The bad news: All the corporate bloodletting could lead to more cutbacks, as the timely response to business conditions sends the already stalled economy into a complete seizure.

If the steady flow of corporate-layoff announcements and bad economic news drowns consumer confidence, the economy could be in for rougher times. Consumers may well curb spending even more, triggering another round of corporate cutbacks, and pummeling retailers. "The technology is there [for managing production], but you still have human emotions," says Daniel R. Dimicco, CEO of Nucor Corp., the country's largest steelmaker. "You still have people, and people can panic and make bad decisions."

The classic downturn based on overproduction and a build-up in inventory is "V"-shaped. In response, companies trim output to bring inventories in line, then ramp up later as demand starts to pick up. So far, there's no reason to think that inventories will behave any differently this time, albeit more rapidly.

What's not clear, though, is how the new just-in-time management of payrolls and capital spending will affect the shape of the upturn in the overall economy. When demand perks up, will companies be as quick to pad payrolls and increase capital spending as they have been to cut them back? That depends in part on how clear the signals of a turn are. The uncertainty has top execs at Ford poring over everything from daily sales numbers to real-time feedback from Internet chat rooms. "When you have this month-to-month volatility, it creates a certain level of anxiety. You've got to really pay attention," explains George Pipas, director of sales analysis at Ford.

Pessimists argue that productivity-driven companies will be slow to rehire workers because doing so would eat into their bottom line. They also contend that companies have invested so much money in plants and equipment over the past five years that they won't turn the tap back on quickly. If they are right, then the economy could be in for an extended period of little or no growth.

Optimists, including Federal Reserve Chairman Alan Greenspan, believe the economy will avoid the worst and recover in the second half of the year. The Fed chief has been encouraged by signs that consumer confidence may be stabilizing after its steep slide in December. But he realizes that confidence needs further nurturing.

THE FED'S MEDICINE. Greenspan & Co. are betting that the strengths of the New Economy's production will win out. Not only will companies rebuild inventories once demand stabilizes, they will also increase spending on computers and other efficiency-enhancing equipment so as to boost productivity and profits. And they'll take on more workers, in part by utilizing the temporary help agencies and other contract companies that have become a hallmark of the New Economy. The process will be helped, of course, by the Fed's own brand of just-in-time monetary management--rapid and repeated interest-rate cuts--and the new Administration's tax package. "The U.S. economy will be back to rather robust growth in the second half," Federal Reserve Bank of New York President William J. McDonough told reporters on Feb. 5.

Perhaps. But for now, much of the news belies predictions of a rapid recovery. In an announcement that stunned investors, Cisco Systems, the bellwether maker of network systems for the Web, said on Feb. 6 its inventory ballooned 29% in the second quarter, to $2.53 billion, after a massive 59% increase in the first. Worse, Cisco CEO John T. Chambers said the company's troubles won't be over until, at the earliest, the third quarter. "I believe we are in at least a six-month slowdown," he told analysts on the earnings call.

That's ominous news for both the tech industry and the economy as a whole. Cisco's hypergrowth management style undoubtedly played a role in its difficulties as it continued to buy parts and add workers well after its inventories began to build. But with a client base that spans both the Old and New Economies, its stumble hints at a broader slowdown.

Just as critical are the acute inventory problems plaguing the auto industry. To bring stocks of unsold cars in line in the first quarter, General Motors is slashing output by 21%, Ford by 15%, and DaimlerChrysler by almost 27%. But experts say more trimming is needed. "We think there will still have to be cuts [in production] in the second quarter," says Scott Sprinzen, head of the automotive ratings team at Standard & Poor's.

Meanwhile companies are also reducing payrolls. The Commerce Dept. said on Feb. 7 that productivity grew by a surprisingly robust 2.4% in the fourth quarter. A key reason: Hours worked dropped 1.1%, as companies apparently cut back sharply on the use of contract workers and freelancers. And now, with the economy continuing to slide, layoffs are up sharply as managements hack away at permanent payrolls, too.

DOWNWARD SPIRAL. Capital spending will be even more crucial. Everywhere, long-term spending plans are also coming under the ax. Corporate outlays on equipment and software fell at an annual rate of nearly 5% in the fourth quarter and look likely to drop even more in the current quarter. Indeed, Cisco's Chambers says he's been told by some of the company's manufacturing customers that they will spend just one-third of what they originally thought they would this year. If such spending remains flat, the economy will clearly have trouble rebounding even if inventories are brought under control.

Already, companies are managing capital budgets as aggressively as inventories. Timken Co., a maker of bearings and alloy steels based in Canton, Ohio, nominally plans to spend as much this year on capital outlays as it did last year--$160 million. Ultimately, though, it could spend less. CEO W.R. Timken Jr. says the company is laying out cash at a slower rate, waiting to see which way the economy is headed for the latter half of the year. "We are going to short the first quarter," he says. Only if he senses that the economy has turned will he accelerate the spending later in the year.

Multiply that by the thousands of CEOs who are making spending decisions, and it's easy to see how such cutbacks could lead to a vigorous downward spiral. Burlington Northern Santa Fe Corp. has also built what company officials call "flex" into its capital-spending plans. It already intends to cut spending by $100 million this year, to $1.65 billion, including operating leases. But another $100 million reduction is possible if the economy heads downward. "We've learned that when you see signs you don't like, you take actions," says Burlington Northern spokesman Richard Russack.

So where does that leave the economy? On a knife's edge. Companies and consumers are nervously wondering what comes next. While the Fed's two January rate cuts may have lifted corporate and consumer confidence, there's still a clear risk that the just-in-time machinations of the New Economy could yet lead to a just-in-time recession.

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