What exactly should you do when hard economic times cause your enterprise to suddenly operate in the red? Commonly you'll have three choices:
In addition, the owners of a minority of troubled small businesses that have obvious long-term value may have a fourth choice, to sell.
Let's look at all four options.
When times are good, it's easy to expand too fast or be too casual about controlling costs. Like a victorious army that advances so quickly it outraces its own supply lines, a rapidly growing business can easily become a victim of its own euphoria, snatching defeat from the jaws of victory. It can become financially, personally, and logistically overextended if, for example, owners open a second café, hire more production workers, or ambitiously expand a website. And when this occurs, you become highly vulnerable to any significant drop-off in business.
Even if a business hasn't been on a growth binge, a long period of financial success often leads owners to tolerate inefficient and sometimes even downright sloppy business practices. For example, the head of a solidly profitable time-share management company in a booming resort area might pay himself and key employees generous salaries and lavish perks, while still expecting to take off Fridays to play golf. He'll quickly be in trouble when the real estate boom goes bust.
As you might expect, both in war and business, the best antidote for advancing too fast or managing too loosely is to pull back quickly and consolidate your initial success. Executing a strategic retreat can work particularly well when your expansion hasn't locked in high capital costs. But if your car dealership, furniture store, or financial management company has maxed out its credit and increased its expenses to move to a fancy new sales complex, simply cutting the number of employees and other expenses won't solve your problem. You'll either have to figure out a way to keep sales growing, sell to someone who can, or find a way to shed your newly acquired overhead costs.
Likewise, opening a second or third location or otherwise substantially expanding just before an economic downturn hits almost always leads to serious economic troubles. If your new location, new product line, or expanded operation isn't quickly profitable, your survival usually depends on shutting it down. If you don't, you are at high risk of transferring precious time and energy from the successful part of your business to the new piece that is sucking your cash while killing your profits, almost always a terrible strategy.
EXAMPLE: Just before the recession hit, Alexia, the owner of Patina, an upscale hair salon that earned good profits for over a decade, decided to open a branch on the other side of town. Facing several entrenched competitors at the new location, Alexia lost money from day one, something that suddenly threatened Patina's survival when business at her original shop dropped 25%. Alexia wanted to close her new shop, but had agreed to a pricey two-year lease and bought a shop full of expensive equipment.
With the help of her lawyer, Alexia convinced the landlord that Patina faced bankruptcy if the lease couldn't be terminated—with the result that, in exchange for a payment equal to four months' rent, he canceled the remainder of the lease. Then Alexia moved the fancy new work stations to her old shop, selling the older equipment to a low-rent shop in the next county. Helped by a short-term loan from her mother, Alexia had just enough money left to hang onto her still-profitable core business.
Assuming for now that your business's situation is still sufficiently sound that a cutback plan can work, you'll want to focus energy and resources on your profitable core competencies while shucking off other money- and energy-draining activities. To develop your back-to-basics business plan, start by looking at the profit margins of each key area of your little empire. You'll probably find that the areas that made you successful in the first place are still your cash cows. For example, a coffee shop that added dinner to its traditional breakfast and lunch business just a few months before the local economy turned sour might find that most of its profits are still made before 2:30 p.m. and that the new dinner business, no matter how excellent its long-term prospects, is causing unsustainable losses. Fine—cut dinner, take a hard look at lunch, and reemphasize coffee and breakfast. When the operation is profitable again, and sunnier economic times return, take another look at expanding into pork chops and pasta.
Although there is no one-plan-fits-all business formula to cutting costs in bad times, most businesses should cut expenses by at least as much as lost income. For example, if sales drop 30%, you'll want to quickly cut costs by that many dollars. In a very small business, this will almost always mean cutting your own pay as well as trying to minimize every possible expense. At the same time, you'll want to work hard to increase sales.
Cut first, market second. Don't forget that when you cut spending, you save 100 cents of every dollar. Marketing can bring in profitable new sales, especially for low overhead service businesses, but you never get to keep 100 cents of every dollar.
In some situations, cutting expenses will simply forestall failure, not prevent it. Pivoting your business so you can face the recessionary era is essential, especially where it's obvious that failure is inevitable if you stick to your old business model. Innovating in tough times is hard to do, especially when your company is already under financial pressure, but your chances of success will improve if you are moving with, not against, the spirit of the times.
For example, a lawyer might shift from advising business startups to helping entrepreneurs with the legal problems that frequently accompany downsizing. Or the owners of a rural bed and breakfast with a substantial mortgage, who are hit by too much local competition and an area-wide economic downturn, could combine expense cutbacks with a new recession-sensitive marketing strategy, such as using the Internet and other outreach efforts to market to urban families looking for an affordable place to hold family reunions, weddings, or retirement events.
If your business is in danger of failing despite expense cutbacks, we suggest a two-step approach to analyze whether a major change of direction may save you. First, inventory and list your enterprise's core skills and competencies. Second, assess whether or not you can market them in new and affordable ways. For instance, if Wang Flooring spots a potentially lucrative opportunity to sell a suddenly popular new type of kitchen flooring to existing customers, or an existing commercial floor product to new home-remodeling customers, exploring whether either will work quickly and on the cheap is probably its best survival strategy.
EXAMPLE 1: Sandrine, Mavis, and Paul formed SMP & Associates to design websites for e-commerce companies. For two years, business was so good SMP's headcount ballooned to 30, and it was about to sign a lease for office space in a pricey area. Then the credit meltdown scared potential customers, who axed new projects, and new business dried up. Still, for months, the partners believed they could survive until business picked up by completing SMP's many existing contracts. But when two of their best remaining customers suddenly declared bankruptcy and a third simply closed without paying its bills, SMP's owners concluded that SMP was no longer viable.
That's when Mavis mentioned that River People, a nonprofit environmental group whose board she chaired, needed help with its website. With nothing else on the horizon, SMP made River People a quick proposal and landed a fair-sized job, albeit at an hourly rate far lower than they were used to charging profit-making enterprises. Based on this success and a few days of calling other area nonprofits, the partners decided that redeploying their skills to design state-of-the-art websites for nonprofits was their best strategy to stay in business, at least until higher-margin commercial business again became available.
To get started, they made a list of the 20 largest health, environmental, and education groups in the area. Next, they studied each organization's website, easily spotting a number that badly needed improvement. Then they pitched SMP's design services, taking the time to do quick redesign specs for the largest nonprofits. Although many of these potential customers claimed to have absolutely no funds to improve their sites, a half dozen changed their minds when Mavis explained how River People had quickly raised the needed money through a focused membership appeal.
Over the next six months, SMP continued to work with a number of nonprofits, still intending to eventually return to the profitable world of e-commerce. But then, at an owners' meeting one fine spring day, a funny thing happened. In the middle of outlining his planned proposal to a potential client in the children's health field, Paul announced that he was having so much fun working for people who really stood for something that he didn't want to do anything else. When Mavis and Sandrine agreed, the owners realized that they hadn't just temporarily adjusted their business plan in reaction to a financial emergency, they had fundamentally changed it.
EXAMPLE 2: Jorge and Guillermo thought they would be tremendously successful when they opened Los Padres Grill, a midpriced Mexican restaurant across from a university's large complex of married-student housing. With the exception of a McDonald's, there was no real competition nearby. Initially quite successful, the grill's monthly numbers began to display red ink when the recession hit and anxious families cut their eating-out budgets. After four bad months, each one worse than the last, Jorge and Guillermo realized they had to either quit or try a different approach.
With the help of a small loan from their uncle, they converted their sit-down restaurant to a takeout place with just a few tables. Because customers now lined up at a counter to order food, there was no need to provide table service. Prices could be reduced, which somewhat improved their student business.
But still, because only the dinner business was marginally profitable, it was obvious Los Padres Grill needed to quickly develop additional markets or close down. Jorge and Guillermo decided their best bet was to increase sales to people who worked in the light industrial area just north of the campus. Taking a few days to talk to workers at an auto body shop, metal fabricating company, wholesale plumbing supply outfit, and similar businesses, the partners learned that few workers patronized Los Padres at lunch primarily because they were too busy to take a formal lunch hour. Instead, they grabbed a sandwich off a roving lunch truck or brought food from home. To improve access to their food, Jorge and Guillermo converted Guillermo's truck into "the Los Padres Taco Wagon" complete with warming ovens, coolers, and food display units.
Now able to take its food to customers, Los Padres' business immediately improved, something that encouraged Jorge and Guillermo to further diversify into catering. Reasoning that even in tough times virtually all small businesses sometimes order food for meetings and celebrations, and financially challenged students occasionally have parties, the partners created a menu of reasonably priced catered meals. When flyers were distributed at all businesses on the Taco Wagon's route and throughout the student housing complex, orders quickly began to come in.
Very few owners of economically troubled small businesses have the opportunity to sell their business as a whole. But if your company has a valuable asset, such as real estate, intellectual property, a respected brand, or valuable equipment free of debt, you may be able to sell it. You'll be able to pay off your debts and, if you are truly fortunate, end up with a few dollars in your pocket.
While you explore whether it's possible to profitably sell your business or its assets, you will almost always need to also cut expenses quickly. That's because finding a buyer and completing a sale will almost always take time, something you don't have if losses are mounting. There's not much point in selling your business or its valuable property only to have all of the proceeds go to pay your creditors.
Learn more about selling a business.
For a variety of reasons, including new competition, a changing marketplace, or most frightening, a recession-driven loss of customers and pricing power, many small businesses won't survive. Sadly, when an economic tsunami hits and customers stop spending, many small businesses fail despite the fact that their owners work hard and do lots of things right. In these circumstances, even formerly highly successful businesses can sail into weather too heavy to survive. In short, if you are the owner of a terminal business, your best course of action is to repeat "I am not my business, and my business is not me," as you close the doors for the last time.
Perhaps it will help you maintain your perspective if you think about the many New York City tourist-based businesses that failed after 9/11. Suddenly, with no out-of-towners to ride their excursion buses, sign up for their theater tours, or buy their souvenirs, many either qualified for government assistance or closed down. Only you can decide whether your business occupies a niche that can outlast a severe downturn, but especially if business has dropped by 40% or more, chances are the decision has been made for you. For example, if a recession decimates your sales of luxury watches, there may be little you can do to survive—unless you come up with a successful new marketing campaign, perhaps one that focuses on value, practicality, and durability and that can convince wealthy penny-pinchers that it still makes sense to purchase a fine watch.
Learn more about closing down your business in Nolo's section Going Out of Business.