Industry Outlook 2001

As growth decelerates and consumers tighten their belts, competition for increasingly scarce dollars will be hotter than ever. And while the economic expansion will continue, it's looking more vulnerable

Business executives will need to fight harder for growth in 2001. During the past five years, healthy financial markets and rapid increases in technology spending have propelled the U.S. economy forward. The growth cycle has proved surprisingly sturdy, even in the face of external shocks such as the 1997 Asian financial crisis and the Russian credit-market panic of 1998. In the aftermath of both crises, output continued to expand, despite fears of a slowdown.

But going into the New Year, America's record-breaking expansion grows more vulnerable than ever. Technology demand is weakening much faster than expected, as customers cancel orders. Projections of 2001 sales and profits have been revised down at company after company, including such giants as Microsoft Corp. (MSFT) and SBC Communications Inc. (SBC) Announcements of big workforce cuts are coming more frequently--5,000 will be trimmed at Aetna Inc. and 10,000 cut in North America at General Motors Corp. (GM) And Charles Schwab Corp. (SCH) is slashing executive pay and encouraging employees to take unpaid leave. It is clear the economy will see a substantial deceleration of growth in 2001. "The slowdown is here," says David Wyss, chief economist at Standard & Poor's, a unit of BUSINESS WEEK's publisher, The McGraw-Hill Companies.

Every sector will contribute to the reduction in growth. Consumers won't increase spending at the same rate as last year. In fact, auto sales are anticipated to fall, perhaps sharply, from 2000's record level. Business purchases of new equipment will moderate: S&P's DRI forecasts investment to grow 6.9% this year, down from 14.5% in 2000. And prospects for exports will dim as the expansion slows in Europe and Asia. That doesn't necessarily mean a recession. According to DRI, inflation-adjusted gross domestic product will rise 3.1% in 2001--a rate that "would have been considered a boom year in the 1980s," Wyss adds. Still, it means growth will be less than 3.5% for the first time since 1995. "The economy's performance will feel painful because it's such a comedown from where we've been in the past five years," says Mark M. Zandi, chief economist at Inc.

What's worse, with growth slowing, there's less margin for error. A negative shock--a Middle East crisis that drives up oil prices, say, or a continuing stock market slide--could push the economy into negative territory. Interest-rate cuts by the Federal Reserve may not help soon enough, since it takes 12 to 18 months for monetary policy to swing into full effect.

BATTLE PLANS. Whether 2001 brings a slowdown or a real slump, companies are preparing to battle the situation by releasing new products and services and intensifying efforts to boost the efficiency of their operations. To counter the expected fall in auto sales, for example, carmakers are trying to lure consumers into showrooms with new models such as the sleek Ford Thunderbird. Increased efficiency will come via consolidation within industries and also by the adoption of technological and management innovations.

The spotlight in this slowdown will be trained on the same high-tech industries that led the boom. Computers and semiconductors are likely to enjoy only moderate growth of 13.9% in 2001, down from 18.2% in 2000, based on DRI forecasts. But a widespread economic slump could hold down tech growth even more. Already besieged telecoms such as AT&T (T) are coming under ever greater pressure, while companies that specialize in building Web sites and helping companies develop Internet strategy are slicing jobs left and right.

Slower growth also will be felt in traditional areas of the economy. Auto companies are struggling to cut costs in the face of weakening demand. Advertising will see its lowest growth since the mid-1990s, while financial-services companies, riding high for years, are expected to make large job cuts. In retail, the slowdown will be compounded by recent overexpansion among office-supply chains and other specialty retailers, and by a lackluster fashion season early in 2001. Retail analysts expect some specialty stores to close. And high-end retailers will be hit, "particularly those not offering anything unusual," says Wendy Liebmann, president of WSL Strategic Retail, a New York consulting firm.

Businesses that sell to families with modest incomes will also struggle, as wage growth slows and unemployment rises. Debt levels have never been higher among households with annual incomes under $50,000, and lenders will "batten down the hatches" in response to increasing delinquencies and bankruptcies, warns Zandi. Moreover, many families are already struggling with higher energy bills.

NEW STUFF. To compete for scarce dollars, companies in nearly every industry are rolling out new goods and services. Computer makers are attracting attention with new handheld units. Food producers are creating products to be eaten on the run. And drugmakers are unveiling new medicines. Eli Lilly & Co. (LLY), for instance, plans a treatment for damage caused by serious infections.

Expect new services in fields ranging from accounting to entertainment. More consulting firms will offer environmental and social audits. Media companies will promote digital television and Web-based services: "The Internet is being integrated into the thinking and strategy" of established entertainment firms, says Peter Kreisky, head of the media practice at Mercer Management Consulting Inc.

At the same time, businesses will seek to boost profits by becoming more efficient. In many industries, cost savings will come from recent mergers and acquisitions, such as Viacom Inc.'s (VIA.B) purchase of CBS Corp. (CBS) Savings are also expected from recent consolidations among railroads, drug companies, and energy companies, with more mergers expected in industries such as telecommunications and insurance. In some cases, the goal will be "to wring out costs by marrying blocs of business," says John S. Scheid, a partner in global insurance-industry services at PricewaterhouseCoopers LLP. Other companies will want an expanded base of operations to "get the most mileage out of new technologies," says Jeanne G. Terrile, director of strategic research at Merrill Lynch & Co.

Even without consolidation, managers are using information technology to revolutionize how they buy, make, and distribute what they sell. At United Technologies Corp. (UTX), for example, Kent Brittan, vice-president for supply management, needed to cut purchasing by $750 million in 2000. He beat that by $100 million--by buying materials through Internet-based auctions and by using the company's internal Web site to coordinate and track all purchases. "We're on a roll here, and we're just going to keep expanding this search for efficiencies," says Brittan. Similarly, General Mills Inc. (GIS) expects to reduce per-case shipping costs as much as 7% by pooling deliveries through its new Web-based alliance of carriers and manufacturers.

HELP FROM THE FED. While greater efficiency will help the economy grow, managers know their individual efforts may not be enough. "Whatever the government can do to stimulate the economy will make the year a little better for everybody," says Thomas G. Elliott, executive vice-president of Honda of America (HMC). And it looks like the Federal Reserve will oblige by reducing interest rates. William C. Dudley, chief U.S. economist at Goldman, Sachs & Co. (GS), expects the federal funds rate to fall from its current level of 6.5% to 5.75% by the middle of the year.

One significant danger to growth would be an unexpected surge in energy costs. Oil and gas prices are projected to fall during 2001. But a serious conflict in the Middle East could send prices sharply in the other direction, damaging the many businesses that can't raise prices to offset increasing fuel costs. Higher energy prices would also force a wider cutback in consumer spending than currently expected. Because such a hike would stoke inflation, the Fed would find it harder to keep the economy buoyant: Fed officials would fear that any interest-rate cut would only add to the inflation.

Financial markets are also vulnerable to a downward spiral of expectations. If profit news in 2001 is worse than expected, then stock prices could tumble further, the terms on business loans would tighten, and venture capital would dry up. That would bring investment and productivity gains to a halt--reversing the virtuous cycle that drove the current expansion.

An American recession would be bad news for the global economy. That's because "the U.S. economy is playing supercharged locomotive to the world," says David A. Levy, director of forecasting at the Levy Institute Forecasting Center. Since trade and international investment are so integrated, Levy argues that "the entire global economy is headed for a severe financial crisis" if the U.S. fails to grow.

Still, many economists expect growth to pick up again in the second half of 2001, especially if the Fed cuts rates early in the year. For businesses trying to cope with the slowdown, that outcome would be very good news indeed.

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE