Forecast 2002

What's next for small business in finance, technology, labor, the economy, and more

Shakir Khan has always faced the future head-on, methodically setting goals for himself and then meeting them. That discipline helped him build InnSecure Inc. into a $3 million company in just a year--and to start a second company, Colowatch Inc., last June with a partner. But now when Khan looks ahead to 2002, he's hard-pressed to see exactly where he will end up. It's easy to understand why. Last summer, the technology downturn forced InnSecure, a Hayward (Calif.)-based network-security company, to lay off three people. The four remaining employees were dismissed just after September 11.

Today, Khan, 39, is struggling to reverse the sagging fortunes of Colowatch, an information-technology infrastructure outfit. He had projected sales of $1.8 million in the first year, but his investors turned skittish after the terrorist attack, and he's still trying to raise the funds he needs to get there. When it comes to the future, he has more questions than answers. Will investors come through? Will he be able to bring in new business? Or will he face personal bankruptcy? "I have borrowed on my house for InnSecure and put all my savings of 15 years into Colowatch," Khan says. "It's pure blood coming out of my veins."

Get out the tourniquet. The forecast for 2002 has no recovery in sight until second quarter at the earliest, and the current climate of war and insecurity makes predictions more speculative than usual. What's certain is that it's a world of diminished expectations, as entrepreneurs downsize their growth projections and their budgets. In a recent PricewaterhouseCoopers survey of fast-growth CEOs, 30% said they expected the U.S. economy would decline over the next 12 months. Before September 11, only 22% felt that way. As for revenue growth, just 11.5% expected increased sales, vs. 17.2% before the attacks. They were equally gloomy about capital spending and hiring for the coming year (table).

Indeed, nothing about the 2002 economy is going to be easy. Tightening credit will make it harder to finance business expansion or bolster your cash flow, and it's a safe bet investors will continue to shy away from anything that's remotely risky. Worse, health-insurance costs will rise dramatically next year, forcing you to make some tough decisions about your workforce and benefits.

But that doesn't mean you should wait passively for an upturn. To the contrary, you'll need to be proactive, continuing to invest in marketing, for example, even as your cash flow tightens and profits sag. And for some entrepreneurs, adversity can create opportunities. This might be the time to grab market share from weaker or disappearing competitors. Rising unemployment means looser labor markets and the chance to hire some highly skilled workers at saner wages. And if you're on the prowl for an acquisition, it's a buyers' market. To help you clear up the uncertainties ahead, we've set out the management challenges you'll face in the coming months and what you can do about them.

LABOR & BENEFITS. Unemployment will climb in the first quarter of 2002 as corporate layoffs continue. Sadly, that's good news if you want to hire the skilled employees you couldn't get during the boom years. Salaries will be slowing too, with increases for small businesses averaging about 4% in 2002, compared with annual hikes of 7% over the past few years, says Daniel Moynihan, principal of Compensation Resources Inc., a compensation consulting firm in Upper Saddle River, N.J.

But don't get too smug. Even as salary costs moderate, you'll face huge jumps in your health-insurance premiums. Brace yourself for increases next year ranging from 20% to 50%. For some small companies, hikes will be steeper still. Robert Klein, who owns a seven-person labor law practice in Highland Park, Ill., faces a 60% hike for 2002. That's on top of 25% to 35% average annual increases over the past five years. "It's our single largest cost component after salaries," he says. Reluctant to cut benefits, Klein is shopping around for alternatives such as a Medical Savings Account in which employers contribute a fixed amount to employees' accounts. If employees don't spend the money on medical needs, they can pocket the cash. But if costs continue to rise at this pace, he says he'll have to cut staff.

To save on health-care costs, Larry Levitt, vice-president at the Henry J. Kaiser Family Foundation, recommends that small companies form purchasing pools (such as PacAdvantage in California) to increase bargaining power. Or consider using an online broker like ehealthinsurance.com or Quotesmith.com to scout out discounts and get a wider array of choices.

BUSINESS INSURANCE. In a riskier world, expect your insurance bill to rise. You'll see premium increases of 15% to 25% next year on most business insurance. That may lead you to consider dropping coverage for 2002, especially if you suffered losses on September 11 and had trouble collecting on your policy. But think twice about going unprotected. "It's always been important," says Bill Wilson, director of the Independent Insurance Agents of America's online research and education center. "Now it's critical."

So what are the essentials? Don't go without liability coverage, property insurance, workers compensation, and business interruption insurance, advises Pat Moore, principal of Antalek & Moore Inc., an insurance agency in Beacon, N.Y. "You'll be cutting into the meat if you do," he says. Watch out for terrorism exclusions. They're expected to surface next year in many policies, especially business interruption and property insurance.

MARKETING. It's tempting during a recession to slash your marketing budget to the bone. Don't give in. This is precisely when you need to woo new customers and strengthen your relationship with existing ones. You could even pick up clients from competitors who aren't being as aggressive. "The best time to advertise and market is during the worst of times," says Joe Vitale, a marketing consultant in Austin, Tex., who has worked with small companies over the last two decades. Vitale says companies that persist with marketing in bleak times tend to have stronger sales coming out of a recession.

Susan Berkley, CEO of The Great Voice Company, a recording studio in Englewood, N.J., has been holding her own so far. She says her five-person business will have $750,000 in revenues this year, up 15% from 2000. But she knows her gains could be easily erased in 2002 if she doesn't keep plugging away to bring in new business and increase revenues from existing clients. That's why Berkley is boosting her 2002 marketing budget by 15%."Cutting my marketing budget now would be like writing my own death warrant," she says. She plans to attend more trade shows and produce an e-mail newsletter about voice training to establish her expertise. She's even launching a new voice and presentations skills training program to increase her value to clients.

But if you must cut your marketing, don't cut your own throat. Focus on keeping your existing customers happy, says Al DiGuido, CEO of Bigfoot Interactive, a New York Internet marketing consultancy. Send thank-you notes or gifts to stay top-of-mind when they resume spending, suggests Vitale. Or, as many small companies are doing these days, partner with competitors that serve the same clients to share customer lists and costs. Anthrax fears aside, you might want to lessen your dependence on direct mail. E-mail marketing is much cheaper. Put your catalog online or try an e-mail newsletter to a carefully targeted list.

CREDIT MARKETS. Can there really be a credit squeeze after 10 rate reductions by the Fed this year? So it seems. In early 2002, small companies may well have a hard time borrowing. Already, 42% of lenders say the September 11 attacks make them less likely to lend to small companies, says a survey conducted in October by Phoenix Management Services in Philadelphia. And 54% are tightening loan terms, such as collateral requirements and guarantees, on loans of $1 million to $5 million, up from 41% in the second quarter. The news from the Federal Reserve is no better: Its quarterly survey released in November found 40% of lenders are tightening credit on small-business loans, up from 32% in August. The irony: Rates have plunged to 8.2%, says the National Federation of Independent Business, down from 10.5% just 12 months ago. "Credit is tighter than at any time in the last 25 years," says Mike Gibbons, partner at Brown, Gibbons & Lang, an investment banking firm in Cleveland devoted to small and midsize companies. "Interest rates may be coming down, but banks are aggressively ridding themselves of questionable credits and imposing significant restrictions on their customers."

Want to extend your existing line of credit? That will be tough, too. Jerry Valetta, national sales manager for business financial services at Merrill Lynch, says you'll boost your chances if you improve your financial record-keeping and alert your banker to any declines before sending out your financials.

On the plus side, interest rates on credit cards have also come down--and many small-business cards offer rich rewards. Try tapping into your network of suppliers, who may take a stake in your business to keep you as a customer, suggests Edward Cox, partner at New York law practice Patterson, Belknap Webb & Tyler. Or you can resort to factoring. Although you'll pay 15% to 22% by financing your receivables, vs. 5% to 8% on a bank loan, says Richard Drath, a CPA in Fort Lauderdale, Fla., it's worth exploring if you lack the cash flow to qualify for a bank loan.

TECHNOLOGY. Small business next year will shell out just $50.6 billion on technology, up only 1.9% from this year, says International Data Corp., of Framingham, Mass. That will prompt PC makers to deepen the cuts made this fall on the price of higher-end systems. Because low-end PCs are already priced below $500, don't expect any reductions there. However, PC makers and retailers are likely to add software and accessories to sweeten deals. Better still, generous financing terms from IBM Corp., Dell Computer Corp., and other PC makers will make buying new computers even more enticing.

That makes a recession a fine time to buy technology--but only if you truly can't do without it. Try focusing on purchases that improve your business' day-to-day efficiency or cut costs (table). Otherwise, try to squeak by with your present equipment. Prices will continue to fall, and those financing deals will still be in place for months to come.

The same cautious approach goes for software purchases. Some upgrades--for example, Symantec Corp.'s pcAnywhere Version 10.5, just hitting store shelves now--make good sense. With it, you can improve Internet security for remote workers. Other upgrades--most notably Microsoft Corp.'s Windows XP--offer benefits that are concrete and commendable, but probably not compelling enough to make you spend precious cash.

If not a new server or software, what should you buy? Consider new high-speed wireless local area networks that increase current data-transfer rates nearly fivefold, to 54 megabits per second. They include Intel Corp.'s new Pro/Wireless 5000 LAN Starter Kit. While slightly more expensive than older 11 megabits-per-second wireless LANs ($750, vs. $600 for a comparable network), your boost in productivity may make up for the extra cost.

Second, consider buying technology that allows you to route long-distance calls over the Internet. The audio quality of the technology, known as Voice over Internet Protocol, or VoIP, still leaves much to be desired. But Internet phone calls are fine for sending faxes, and some of your less important long-distance phone calls. An added bonus: You won't pay federal taxes or phone company surcharges. "I don't know that I'll use it if I'm closing the biggest deal of the year," says Rick Waters, CEO of 25-person Web site design firm Webcast 1, of Boca Raton, Fla. "But if I'm just maintaining the account, then I would." Using technology from Net2Phone Inc., Webcast 1 has reduced its monthly long-distance bill by $400.

Up-front costs are modest: about $1,800 for the hardware device, known as a VoIP gateway, needed to handle up to eight phones; and about $200 to install each device. Of course, if you want to ensure audio quality, you had best maintain at least one long-distance service contract from a federally regulated telephone company. If you make lots of long-distance calls--say, over $1,000, your phone company may offer you a discount.

MERGERS & ACQUISITIONS. Valuations on businesses have already fallen 20% from a year ago and should remain flat for the first quarter of 2002, says Rich Jackim, CEO of Chapman Associates, an M&A specialist in Schaumburg, Ill. Distress sales are likely to increase over the next six months, too, says John Mack, CEO of USBX Advisory Services in Santa Monica, Calif. That means plenty of buying opportunities.

One such opportunist is Ed Rankin, CEO of People Solutions Inc., a 30-person human resources outsourcing and consulting firm in Dallas. In June, he bought a small technology company that had its own human resources outsourcing software. The deal has boosted his revenues by 25%. And Rankin is currently closing two others, both acquisitions of smaller competitors. In 2002, he says he'll go shopping for at least two more companies. "Organic growth is good, but it can be accelerated through acquisitions, Rankin says. "Right now, there are some wonderful bargains out there." Of course, that depends which side of the deal this sagging economy has put you on.

By Naween A. Mangi

With Kevin Ferguson in Boston

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