Too Much of Everything

Overcapacity is so widespread in the U.S. that it could jeopardize a recovery

Local leaders in Austin, Tex., had high hopes for the $120 million research facility that Intel Corp. (INTC ) had begun to build in the city. They were counting on it to lure high-paying tech jobs to the city's downtown area. Now they have to go back to the drawing board. Faced with a sudden swoon in demand, Intel halted work on the project in early March. All that's left is a six-story concrete shell encircled by barbwire.

Consider it a relic of the New Economy boom. In the go-go years of the late 1990s, all things seemed possible to brash business leaders. They threw up plants, bought equipment, and staffed up in every department from sales to service as if the good times would never end. But now, of course, they have. Companies throughout the economy, in high tech and in low, are scurrying to adjust by cutting spending and laying off workers. After years of frantically investing to build up the human and physical capacity to keep up with soaring growth, the U.S. economy is struggling with overcapacity as far as the eye can see. From Intel's half-finished building in Austin, to the multitudes of identical retail stores that seem to dot every other corner, to the gaping, empty billboards that loom over New York's Times Square, every sector is struggling with the hangover caused by too many years of too much investment.

Much of the problem is centered on the core manufacturing sector. The Federal Reserve estimates that manufacturing was at 78.1% of capacity in February, the lowest level in nine years. Technology manufacturers have been particularly hard hit. As recently as last summer, semiconductor makers were running their plants at close to 100% capacity. Now they've plunged to 80%, and falling. Ditto for computer companies, whose operating rates have fallen to their lowest levels in three years. The auto industry, where factories were running at nearly 90% a year ago, is now wavering at around 70%.

RIDING THE WAVE. Those declines, however, tell only part of the story. Huge swaths of the service economy added to a different kind of excess capacity during the boom years. From New Economy rockets like the dot-coms and Net consulting firms to traditional stalwarts such as financial services or advertising, many went into overdrive to staff up and build the infrastructure needed to ride the wave of the economic boom. Now, with sizzling growth rates gone, many find they have too much capacity for sharply low demand.

Excess capacity, of course, doesn't pose a problem just for individual companies. It risks prolonging the economic downturn and blunting the Fed's interest rate cuts. That's because the current slowdown--driven by sagging investment rather than a drop in consumer spending--is much less susceptible to the quick fix of lower interest rates. Companies saddled with too much factory capacity or computer equipment are not going to go out and spend more on investment, no matter how low rates fall. In a sign of the dangers that may lie ahead, the Commerce Dept. on Mar. 27 said that capital-goods orders, a reliable proxy for future investment, fell 4% in February.

Even if the economy manages to dodge a recession, growth still will be held back by the need for Corporate America to work its way through the late- 1990s excesses of investment and hiring. Experts say it will take months, and in some cases years, to undo the damage. "It's going to be a significant retarding force on the economy for some time," says veteran Wall Street analyst Henry Kaufman.

So how much excess capacity is out in the economy right now? It's hard to measure exactly. For one thing, it depends on the level of growth expected. If top executives at a company believe that economic growth rates will quickly bounce back, they would be crazy to scale back production capacity. But executives would have to have an awfully rosy view of the future to feel comfortable with current levels. The Fed, for instance, says semiconductor makers, computer companies, and communications equipment companies boosted factory capacity by a breathtaking rate of nearly 50% last year.

No industry has slammed into a brick wall more forcefully than telecommunications. Carriers spent much of the past several years tearing up streets and laying down fiber routes as if demand knew no bounds. But now the utilization rate of that vast network is a staggeringly low 2.5%, according to Merrill Lynch & Co. telecom equipment analyst Tom Astle. The glut has triggered an all-out price war and sent shock waves through the telecom industry as carriers slash equipment spending. On Mar. 27, Nortel Networks Inc. (NT ), the big telecom equipment maker in Brampton, Ont., warned that its first-quarter loss would be much larger than expected, and said it was stepping up its planned job cutbacks to 15,000 from 10,000 because of rapidly deteriorating business conditions.

NO QUICK FIX. Nor is there any easy or quick relief in sight. Fiber-optic companies are in the midst of a "dead zone" that will last until 2002, says Astle. Worse, there are now about 1,300 local carriers and about 14 long-distance players in the U.S. Susan Kalla, an analyst at BlueStone Capital Securities, reckons the economy can support only about 300 to 500 competitive local carriers and about five to seven long-distance companies. Adds analyst Blake Bath of Lehman Brothers: "It could take a while to work through: anywhere from one to four or five years."

Chipmakers aren't doing so well either. In two rapid-fire announcements in mid-March, Intel said it was postponing a $500 million plant expansion in Hudson, Mass., and pushing back the opening of a $2 billion chip factory in Ireland from the second half of 2002 to the third quarter of 2003. Ironically, chipmakers have found themselves saddled with overcapacity partly because they've used new technology to become hypersensitive to their customer's needs, says G. Dan Hutcheson, president of market researcher VLSI Research Inc. In the past, it took three years from the time a chip was dreamed up to the time demand for it was being satisfied. Today, that cycle time has been slashed in half.

As a result, chipmakers can ramp up new capacity to meet growing demand much faster. But the converse also holds: When demand growth stops, the semiconductor industry has lots more capacity installed. And that excess capacity sends prices reeling. The fallout is being felt worldwide. Taiwan's Big Three chipmakers, Taiwan Semiconductor Manufacturing (TSM ), United Microelectronics (UMC ), and Standard Chartered, are operating at about 70% capacity, down from 95% last year. Dataquest Gartner analyst Ben Lee believes the bottom has yet to be reached and sees the operating rate continuing to fall throughout 2001. In response, chipmakers are slashing global capital spending by 16% this year.

Computer companies also have cut back as sales of everything from PCs and servers to handhelds from Palm Inc. (PALM ) are melting fast. On Mar. 15, Compaq Computer Corp. (CPQ ) said it would lay off 5,000 employees, or 7% of its workforce, and combine its consumer and corporate PC units as it expects to miss first-quarter profit goals. That news came in the wake of big layoff announcements by Dell (DELL ), Gateway (GTW ), and Hewlett-Packard (HWP )--and few think the bloodletting is over.

That's because the tech companies' customers--both New and Old Economy--suffer from an overcapacity problem of their own. Driven by the dot-com boom and fear of Y2K computer breakdowns, corporations went on a tech spending spree in the late 1990s, snapping up computers, servers, software, and other gear. But now that buying binge is boomeranging on tech-equipment makers. Faced with sliding profits, tech customers are concentrating on getting more out of what they have. "Companies have sunk [huge amounts] into their technology infrastructure," says T.M. Ravi, chief executive of software maker Peakstone Corp. "They want to get the most out of that capacity. They're not buying more."

MOTOWN BLUES. Old Economy stalwarts like steel and auto companies are hurting as demand slackens around the globe. Having beefed up in recent years as global markets opened, the world auto industry is now selling just 74% of the 70.1 million cars it can build each year. In the U.S., the Big Three have already begun layoffs and cutting hours, but to bring capacity more in line with demand, analysts say they will need to close plants after their current labor contract with the United Auto Workers runs out in 2003. "There will be a couple of facilities at each of the Big Three that will go by the wayside," says Michael Robinet of CSM Forecasting Inc. in Northville, Mich.

But excess factories and equipment relative to current demand is only part of the problem. Many companies are also going to be forced to further trim staff. For proof, look no further than dot-com land. In California's Bay Area, 80% of the remaining dot-coms are expected to go under by year's end, according to a study by Cushman & Wakefield Inc. and Rosen Consulting Group in Berkeley, Calif. That could cost about 30,000 jobs. Sickly dot-coms have plenty of company. Convinced that the boom was here to stay, securities firms, retailers, ad agencies, and consulting firms all ramped up hiring in the late 1990s. Now they're laying off staff or cutting back on contract or other temporary workers to bring staffing more in line with reality. On Mar. 22, the Charles Schwab Corp. (SCH ) said it would eliminate up to 13% of its 25,000-strong workforce. That comes on top of cutbacks at Bear Stearns (BSC ). Having added more than 150,000 people since 1998 alone, the securities industry now boasts a record 772,200 workers. With the market's collapse, further retrenchment is likely.

Retailers too have been guilty of wildly overexpanding. Confident that the U.S. economy and consumer spending was on a roll, they've been opening store after store. In the last eight years, square footage growth among retailers has grown five times as fast as the population, says Therese Byrne, who tracks retail square footage for MAX-SI, an industry publication in New York. Now companies are being forced to cope with the overbuilding. "We were too undisciplined in the size of stores and the number of stores," says Millard S. Drexler, president and CEO of Gap Inc. (GPS ) "We are in the process of doing a very tough review of all outstanding deals." Even onetime e-tail star Inc. (AMZN ) now says it went overboard. It opened up too many warehouses in anticipation of tremendous growth that never materialized. On Jan. 30, Amazon announced it was closing one of the five snazzy new distribution centers it had recently opened. Concedes Jeffrey P. Bezos, CEO of the Seattle-based company: "We overbuilt a little."

By a little or a lot, there's no getting away from the fact that a host of companies spent too much, built too much, and hired too many people during the boom times. It was a giddy ride while it lasted. Now the economy is having to deal with the inevitable hangover. And the headaches aren't likely to subside anytime soon.

By Rich Miller in Washington, with Andrew Park in Dallas, Steve Rosenbush in New York, Peter Burrows and Cliff Edwards in Silicon Valley, Michael Arndt in Chicago, David Welch in Detroit, and bureau reports

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