Businesses Tightening Their Belts
Cost-Cutting Could Slow Economy More

By Neil Irwin and Zachary A. Goldfarb
Washington Post Staff Writers
Sunday, March 2, 2008

U.S. businesses are holding off on hiring, delaying new investments and trimming expenses, creating a new threat to the nation's economy.

Corporate America is reacting to a pullback by consumers and the crisis in the financial system. Businesses are acting defensively, seeking to avoid the massive layoffs and dramatic falloff in profits like those in 2001, when they were in less sound financial shape.

Innovative Business Interiors, a Silver Spring furniture company, for example, is putting off replacing a nine-year-old sport-utility vehicle. A Floral Affair, a Woodbridge florist and wedding planner, has cut back its inventory of flowers. And SLM Holdings, a Long Island, N.Y., firm that sells software to financial advisers, has turned its salespeople and other staff into independent contractors who work remotely -- and can be easily dismissed if business turns down.

The cutbacks are large and small, but it is the cumulative effect that has economists worried. Business belt-tightening is likely to create an additional drag on the economy, contributing to the period of slow growth that economists almost uniformly expect and to the recession that some fear.

"For the last few years, the emphasis has been on looking for ways to grow," said Mark Toon, chief executive of EquaTerra, a Texas-based consulting firm that advises large companies. "Since August, companies have been looking for ways to reduce costs."

An index of optimism among small business owners fell in January to its lowest point since 1991, according to the National Federation of Independent Businesses. Several surveys of chief executives report confidence in the future at multi-year lows. And purchasing managers at non-manufacturing firms expect a sharp contraction in business activity, according to a January survey by the Institute for Supply Management.

"We're being very conservative in our expenditures," said Diane Sheldon, vice president of ExecuSuites I-270, a Rockville firm that provides conference space and other services to businesses. The firm has postponed replacing older computers and buying new furniture and has instituted a hiring freeze.

So far, this is a more gradual, tentative pullback than the corporate sector experienced in the 2001 recession. Then, businesses had overexpanded -- which was the major cause of the slump -- and consumers and firms in the financial sector were the collateral damage. This time, consumers and the financial sector are cutting back, and businesses are the collateral damage.

Consumers, with their houses less valuable and their ability to borrow money constrained, are spending less, sending ripples through a variety of businesses.

"The corporate sector is not what brought you to the edge, but it could push you over," said Joel Naroff, an economist who has advised businesses for decades.

The crisis in many credit markets has made it more costly -- and sometimes impossible -- for companies to raise money for future investment. At one point last year risky companies could borrow money through the bond market at an interest rate just 2.4 percentage points more than that paid by the U.S. government. Now, the premium is 7.4 percentage points, according to a Lehman Brothers junk bond index.

Businesses entered this period of distress in far better shape than in the last downturn. In the third quarter, just before the economy started its slide, nonfinancial businesses had liabilities that were 3.5 percent higher than their financial assets, according to data from the Federal Reserve. In the comparable period of the last downturn, the fourth quarter of 2000, their liabilities exceeded assets by 24 percent.

That improved financial situation could explain why, so far at least, the corporate sector is merely holding back on investments and spending, not engaging in the kind of wrenching pullbacks of 2001 and 2002.

"As a whole, the nonfinancial business sector remains in good financial condition, with strong profits, liquid balance sheets and corporate leverage near historical lows," Federal Reserve Chairman Ben S. Bernanke told Congress last week. He also said, though, that lower demand and tighter credit conditions "suggest that investment in equipment and software will be subdued during the first half of 2008."

There have been fewer layoffs in this downturn. An average of 360,500 people have filed new claims for unemployment benefits in the past four weeks, the highest since Hurricane Katrina -- but below such claims in the last recession, when that number frequently exceeded 450,000.

While not slashing jobs in epic numbers, employers are making fewer new hires. Employers made 6.5 percent fewer new hires in December than a year earlier, according to Labor Department data.

"I know we're in for a ride," said Jason Bishara, chairman of SLM Holdings, the software company. "I need a flexible business," he said, which is why he is adding only independent contractors, not permanent staffers, to his team of 25 people, most of whom work remotely.

Companies are reducing inventories to save money. In the National Federation of Independent Businesses survey, 21 percent of companies said they reduced inventories while 11 percent increased them.

"I'm very careful now," said Carol Kalbfleisch, owner of A Floral Affair, a wedding planner and large florist that has been reducing its staff and supply of merchandise.

Fewer businesses are looking to make investments in the future, delaying capital expenditures. Twenty-nine percent of senior bank loan officers surveyed by the Federal Reserve saw lower demand for commercial and industrial loans in the fourth quarter, compared with 13 percent who experienced stronger demand.

"What you have to do is be prepared to live through the bottom of a cycle and come out on the other side," said Leslie Goldberg, chief executive of Bowl America, an Alexandria company that owns 19 bowling centers. The firm has paid off mortgages on most of its properties and built up its cash.

"If you live on the edge, you're going to get wiped out," Goldberg said.

Many business people describe an atmosphere of caution.

"I've got larger customers who both because of the stock market and their perception of the economy put some significant projects on hold with us that we had forecasted would come in the first quarter," said Charles Atwell, owner of Innovative Business Interiors.

The company has declined to renew its membership in a couple of business organizations to save cash and is more discriminating in its philanthropy.

"We're probably reviewing those kinds of things more closely and watching our budget and expenditures more closely," Atwell said.

As companies pull back, the effects ripple through the economy. Rebecca Barnes, co-owner of Bargain Boxes Moving and Storage in Manassas, routinely replaces her truck fleet. This year, "I'm not even considering it," she said.

And she knows that others suffer as a result.

"If I'm not buying a new truck every two years, then Cowles Parkway Ford is not getting my sale on a regular basis," Barnes said. "Everything has an effect on everything else."

Researcher Richard Drezen contributed to this report.

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