Volume 4, No. 1
March 2008


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Ann Arbor Area BUSINESS MONTHLY magazine brings the reader the latest business news and information important to the businesspeople in Washtenaw County. Each month articles cover real estate, legal, Internet, employee concerns and the climate of business in the greater Ann Arbor area. There is news about company employees and feature articles on local businesses. We cover business news from Ann Arbor, Chelsea, Dexter, Manchester, Milan, Saline, Whitmore Lake, and Ypsilanti.

When The Going Gets Tough,
It's Time to Get Going

By John Agno

John Agno As you know, 'good times' don't last forever . . . yet, people want to believe they do. Like the turkey, which believes good times are commonplace until the third week of November, most people expect the good times to roll on. And so, they only see what they are looking for. Even your stockbroker won't tell you that "when in doubt, get out."

Yet, if you understand that there business cycles, you look for the unexpected and, thus, see the unexpected when it surfaces . . . long before others do. Here in Ann Arbor in 1974, when it was difficult to get gasoline, the RV and Boating industries experienced tough time. Since those two industries represented the only markets for locally based Thetford Corporation, it was sink or swim time for that company.

Because of short supplies of raw material to manufacture the company's plastic recreational toilets, throughout 1973 management decided to build inventory to insure there would be no shortage of product for their customers (RV and Boat manufacturers and Aftermarket Distributors). So, when the 1974 gasoline distribution crisis happened, the company was stuck with a huge inventory of product but few sales. If the banks knew how to sell toilets, Thetford would have been flushed down the drain.

As Thetford's General Sales Manager in 1973-74, I discovered that though times are a very good time to build your market share-because your prospects are more receptive to switching suppliers and suppliers are motivated to maintain or increase sales volume. In 1973-74, Thetford had less than 50% market share of the RV industry with larger and better financed companies (Monogram Industries and Mansfield Sanitary) holding over 50% market share.

By 1975-76, Thetford had increased its market share to over 90% and profitability soared. Thetford management was energized and focused because the alternative was unacceptable. Becoming #1 in the #2 business, recreationally speaking, was a case of turning lemons into lemonade.

In Tough Times, What Risks Should We Avoid and Which Should We Snap Up?

Probably no one in American business has answered that question better than Sam Zell who amassed millions by looking at the same data everyone else has, and seeing what others don't. He has invested in everything from radio stations to sports franchises to newspapers to cruise ships. His practice of bypassing the blue chips for undervalued opportunities-often times businesses on their backs, even in bankruptcy-explains why he is known as the "grave dancer."

Zell co-founded, with Bob Lurie, Equity Group Investments ion 1968. Now, the Chicago-based firm controls a multi-billion dollar mix of private, public, domestic, and foreign businesses. They made their names by viewing risk differently than their competition did. Contrary to their public image, they were not riverboat gamblers throwing their money around with reckless abandon. Rather, they invested in companies and industries that merely seemed excessively risky because other simply didn't recognize the underlying situation.

"One thing I know for sure: The assessment of opportunity is an art. There have been many examples in my career where the information was available to everybody. But why was I able to see that opportunity-and the rest of the world didn't-I don't know. And, by the way, the rest of the world didn't see it until long after we were up and running.

Example: Barges

In 1979, the federal government passed an investment tax relief to encourage the construction of barges with a 25-year lifespan. "Well, as you might expect," Zell explains, "this resulted in too many 25-year barges being built, glutting the market. So, for the next 25 years, the business was just horrible. But we figured that 1979 plus 25 was 2004, when that huge glut of barges was going to be taken out of commission. So, if you could get control of that industry before the original supply finally shrank, you'd do pretty well. So, we got into the business when everyone else was getting out, and when 2004 came around, we were looking pretty good."

Source: LSAmagazine, University of Michigan, Fall 2007

Expect the Unexpected

Unexpected events-surprises, whether good or bad-can make or break your business

Your ability to recognize and react to these events is key to both your growth-and your survival. As an entrepreneur, you must have enough knowledge to plan and anticipate, yet enough street savvy to know when things are going unusually right or unusually wrong. We're talking here about really big surprises-like discovering that one of your products is selling much better than expected-and you don't know why. . or . . . discovering that you are selling to the wrong customers . . . or . . . that your product or service needs to be revamped from top to bottom . . . or . . . even discovering you are in the wrong business.

For example, you may have started your company to be in the software product business, but month after month your computer consulting service revenue far outpaces your software sales. This is a clue that you should begin to rethink your business strategy. You may not need to switch businesses but, clearly, you should change your resource allocation and operations management in recognition that the company is now consulting services driven. With this altered strategy, your software development efforts might better be redirected toward providing a stronger competitive edge for securing and maintaining your consulting service customers.

The Chinese work for crisis is "wei ji". When written, the calligraphic representation is the combination of two works: "peril" and "opportunity." Management of the unexpected is to understand the perils of the current situation while, at the same time, having the vision to seize the opportunities presented. Your acceptance that your marketplace is in constant flux is key to your understanding that the marketplace will unexpectedly push you to rethink your business strategy-hopefully, before your competition rethinks their strategy.

Source: John Agno, The Entrepreneur Network, www.tenonline.org

Prepared for the Unexpected?

We have a natural tendency to look for instances that confirm our story and our vision of the world-these instances are always easy to find. You take past instances that corroborate your theories and you treat them as evidence.

Those who believe in the unconditional benefits of past experience should consider this pearl of wisdom allegedly voiced by a famous ship's captain:

"But in my experience, I have never been in any accident . . . of any sort worth speaking about. I have seen but one vessel in distress in all my years at sea. I never saw a wreck and never have been wrecked nor was I ever in any predicament that threatened to end in disaster of any sort." E.J. Smith, 1907, Captain, RMS Titanic Captain Smith's ship sank in 1912 in what became the most talked about shipwreck in history.

How can we logically go from specific instances to reach general conclusions?

Bertrand Russell's "Problem of Inductive Knowledge" (i.e., what we have observed from given objects and events) reminds us there are traps built into any kind of knowledge gained from observation.

Consider the turkey that is fed every day. Every single feeding will firm up the bird's belief that it is the general rule of life to be fed every day by friendly members of the human race "looking out for its best interests," as a politician would say. On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of an assumption or belief.

What can a turkey learn about what is in store for it tomorrow from the events of yesterday? A lot, perhaps, but certainly a little less that it thinks, and it is just that "little less" that may make all the difference. Consider that the feeling of safety reached its maximum when the risk was at the highest. Something has worked in the past, until-well, it unexpectedly no longer does, and what we have learned from the past turns out to be at best irrelevant or false, at worst viciously misleading.

You may be a turkey when:

Source: "The Black Swan" by Nassim Nicholas Taleb (Random House)

Nassim Nicholas Taleb: The Black Swan: the Impact of the Highly Improbable

Recessionary Storm Clouds

In the past 25 years, Americans have kept shopping through good times and bad. In every quarter, except one since 1981, consumer spending rose over the previous year, adjusted for inflation. The main fuel for the spending was easy access to credit. Banks and other financial institutions were willing to lend households ever-increasing amounts of money. Loans to consumers were viewed as low-risk and profitable.

Economists have been complaining about excessive borrowing and spending since the early 1980s. But no matter how many times economists predicted the demise of the consumer, the spending continued. The latest data from the Bureau of Economic Analysis show that the personals savings rate-the share of income left after consumption-fell from 12% in 1981 to just over zero today. And debt service, which is the share of income going to principal and interest on debt, kept rising.

The sub prime crisis marks the beginning of the end for the long consumer borrow-and-buy boom. Standards for real estate lending have been raised. Credit cards are still widely available, but it is only a matter of time before issuers get tough. Research by economist Carroll suggests that every $1 decline in house prices lops off about $.09 of spending. That accords well with calculations by BEA economists. They figure that households took out $340 billion in cash from mortgage and home-equity financing in 2006. That source of funding could largely disappear over the next couple of years.

What comes next could be scary. Reduced access to credit will combine with falling real estate values to hit poor and rich alike. "We're in unchartered territory," says David Rosenberg, chief North American economist at Merrill Lynch, who's forecasting a mild drop in consumer spending in the first half of 2008. "It's pretty rare we go through such a pronounced tightening in credit standards."

Source: BusinessWeek, November 26, 2007

An Unfortunate Truth

As Americans cut back on imported LCD TVs and Starbucks coffee, the U.S. consumer slowdown will undermine the world economy.

This consumer slump in the U.S. will affect business investments overseas, including factories that are springing up in China and elsewhere to feed American demand. The rule for a prudent individual is simple: Don't spend more than you make. For a long time, the U.S. economy obeyed that rule. As far back as the1960s, personal spending, adjusted for inflation, has basically tracked the overall growth of the economy, as measured by gross domestic product (GNP).

That pattern changed in the 1990s. As of the third quarter of 2007, the 10-year-growth rate for consumption was 3.6%, vs. GNP for the same period of 2.9%. This difference represents an enormous gap. If consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001. The question now is how much of that extra $3 trillion we will have to give back.

Non-self-liquidating credit is a loan that is not tied to production and tends to stay in the system. When financial institutions lend for consumer purchases such as expensive cars, boats, or homes, or for speculations such as the purchase of stock certificates, no production effort is tied to the loan. Interest payments on such loans stress some other source of income. Such lending is almost always counter-productive; it adds costs to the economy, not value.

The result is the subtle deterioration in the quality of spending choices due to the shift of buying power from people who have demonstrated a superior ability to invest or product (creditors) to those who have demonstrated primarily as superior ability to consume (debtors). Near the end of a major expansion, few creditors expect default, which is shy they lend freely to weak borrowers. Deflation involves a substantial amount of involuntary debt liquidation because almost no one expects deflation before it starts.

When the social mood trend changes from optimism to pessimism, debtors, producers and consumers change their primary orientation from expansion to conservation. As debtors and potential debtors become more conservative, they borrow less or not at all. As producers become more conservative, they reduce expansion plans. As consumers become more conservative, they save more and spend less. A downward "spiral" begins, feeding on pessimism just as the previous boom fed on optimism.

The resulting cascade of debt liquidation is a deflationary crash. A deflationary crash is characterized in part by a persistent, sustained, deep, general decline in people's desire and ability to lend and borrow. A depression is characterized in part by a persistent, sustained, deep, general decline in production. Since a decline in production reduced debtors' means to repay and service debt, a depression supports deflation.

As asset prices fall, people lose wealth, which reduces their ability to offer credit, service debt and support production. For prices of assets to fall, it takes only one seller and one buyer who agree that the former value of an asset was too high. If no other bids are competing with that buyer's, then the value of the asset falls, and it falls for everyone who owns it.

The past 10 years will go down as one of the greatest consumer-lending sprees ever. Adjusted for inflation, consumer debt-including mortgages, rose an average 7.5% per year since 1997, far faster than the 4.2% rate of the previous 10 years. If Americans had kept borrowing at their pre-1997 pace, they would have had about $3 trillion less in debt. "Going forward, we're not going to see this credit-driven growth," says Alistair Milne, a professor and banking expert at City University in London. "Banks are saying, 'we have to be more careful here.'"

Sources: BusinessWeek, February 4, 2008 and Conquer the Crash by Robert R. Prechter Jr.