BWSmallBiz -- Strategies February 20, 2008, 3:00PM EST

Don't Let the Downturn Get You Down

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You need to establish credibility with your banks and anybody else who is extending you credit," says Robert Friedbauer, a Teaneck (N.J.)-based CPA. Keep in mind that commercial bank loans often come with covenants, or requirements that you meet certain financial benchmarks—a ceiling on the ratio of debt to equity, say. If you run into trouble during a downturn and trip a covenant, you may have to repay the entire loan. Before that happens, talk to your banker about striking more lenient terms. "With your bank, there should never be a surprise," says Hauck.

NARROWER VISION

If you're an entrepreneur, you are what you make. A downturn is a perfect time to take a close look at your products to see which are worth keeping and which you ought to sacrifice. Give a quick hook to money-losers, of course. But even some profitable products might not bring in enough to justify the effort of making and selling them. Elaine Romanelli, an associate professor of strategy and entrepreneurship at Georgetown University's McDonough School of Business, says small companies with a tight focus may thrive during economic downturns. Often it is better to give a narrow group of customers something you know they want or need than to pursue a wider group you don't really understand. "The more specialized firm will retain customers and target them fairly efficiently during tough times," says Romanelli. Specialization has another benefit: Your business will likely spend less on product development.

One way to assess the value of your product line is through a technocratic-sounding procedure called an activity-based cost analysis, which tallies everything you spend to make each of your products and to serve each set of customers. Oracle (ORCL) and sas both sell cost analysis software. A standardized industry checklist can help, too. In the end, you'll know the fixed and variable costs associated with everything your company does. You'll also see how those costs compare with the associated profit margins. You will know, for example, if your fixed costs are rising for a particular client, customer group, or product line, helping you decide which product lines to eliminate and which customers you'd be better off not serving.

After performing a cost analysis, Bill Cox decided to wean Cox Manufacturing from the auto industry. "Even though it's an incredibly high volume of business, the margins are squeezed down so much it's no longer a good choice for us," he says. "We always choose to focus where the sunshine is." Similarly, after office remodeling contracts began to dry up last spring, interior designer Bray decided to focus more attention on his furniture procurement operation, which distributes about 200 lines of office furniture. Procurement provides about 40% of Bray's revenues, but because the business has no storage costs, its share of profits is significantly higher.

As important as the numbers are, use common sense as well. In 2001, Greco saw the unit selling business forms, which had a margin of 7%, was bringing down profits, and he thought about killing it. A closer look revealed that the problem was the high cost of warehousing the forms. Greco cut the square footage allotted to storage, and the unit's margins jumped to 23%. Today the line contributes $1.2 million to revenues.

You may also want to diversify customers to hedge your bets. In 1982 an oil company that accounted for 50% of Cox Manufacturing's sales went under. "It was one phone call that nearly put us out of business," says Cox. "We had to stop production and lay off a shift of workers." The company now won't give more than 20% of its business to a single customer.

A period of slack revenues should get you thinking about adding to your product line, too. Small business owners "could look into half-step diversifications," says Eric Siegel, a lecturer in management at the University of Pennsylvania's Wharton School. Consider products that are closely related to what you do best and that get you into slightly different markets. This past October, Polla Tray launched a new facial scrub, and she is looking to add a line of sunscreens. Although she'll be taking on big competitors and will have to spend $50,000 to develop the line, she believes that expansion is far less risky than sitting back and hoping to hang onto what she's got. "We have to keep it new and interesting for clients," she says.

To look at the world a little ruthlessly, the good news about bad times is that some of your rivals will fold, giving you a chance to scoop up their customers, enter a new niche, or simply find some bargains. When business cooled after the September 11 terror attacks, Cox bought three used Swiss precision cutting machines from a competitor for $70,000 apiece, $30,000 less than the typical sticker price for a used machine and about half the price of a new machine.

During bad patches in his industry, Steven Boal gobbles up staff. Coupons Inc. grew more slowly through the tech boom than many of its Silicon Valley peers, but the leisurely pace worked in its favor when the bubble burst. "A lot of companies had overinvested early to generate immediate profits and didn't have the resources to withstand the bust," says Boal. "We were able to pick up a lot of talent, and it was a great time to show our perseverance to potential clients who might have experimented with some of our competitors." In tough times, an eye for a good bet can separate the entrepreneurs who make it from the ones who fail.

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