Rationalizing The Doldrums
The explanations for the early 21st-century business funk vary greatly, from the terrorist attacks of September 11 to corporate malfeasance at the likes of Enron, Tyco, and World-Com. Most economists, however, rationalize the sluggish economy as cyclical in nature, and therefore a temporary setback.
The resulting fear, however, has dampened consumer confidence in the equity markets. Coupled with an extraordinarily cautious venture capital community, the lowest levels of merger and acquisition activity since the mid-1990s, and reduced research and development budgets at major public corporations, there is little evidence to suggest that there is any new revenue growth driver on the near-term horizon.
Through it all, though, cheerleaders for an up, up, and away economy abound. Optimism is certainly a good thing, especially in difficult times. However, narrowing rates of growth in all industries raise new questions about new economic fundamentals that could be more permanent in nature. The lingering inelasticity in demand that we are witnessing today suggests the possibility that we are approaching real saturation levels in some sectors. Normally, demand inelasticity is a temporary condition, ordinarily fixed by downward price adjustments. However, saturation could change that and create a more permanent condition of "maintenance sales" that provides no growth.
Meanwhile, back in the day-to-day corporate world, senior managers must deal with the realities of slower revenue growth with age-old marketing tactics that are designed to stimulate demand. We have already pushed the limits of expansion, both domestically and internationally. We have already created a seemingly endless number of line extensions that more often result in the cannibalization of our own sales. More often line extensions slice the pie into many more and smaller pieces and add unnecessary costs to an equation that rarely brings us new revenue. How many variations of salad dressing do we need, and does it really help the corporation grow?
Discounting has become commonplace as we adjust the manufacturer's suggested retail price, trading profit for volume. In the process, we have conditioned consumers to always expect a discount, and more often adjust their buying patterns to times of the year that they know will be more advantageous to them.
In many ways, we already have a built-in stimulus package in the form of consumer credit card debt. Each year Americans buy more and more on credit and pay less and less of the outstanding balance. According to The Nilson Report (nilson-report.com), consumer credit card spending nearly tripled from $466 billion in 1990 to $1.3 trillion in 1999. Outstanding balances on that spending have historically hovered around 50 percent, or $243 billion and $614 billion for 1990 and 1999, respectively. To put that into perspective, the outstanding debt of $614 billion in 1999 would have translated into nearly $2,500 for every man, woman, and child in the United States. Is it really possible to stimulate the U.S. economy any more?
When All Else Fails, Cheat
Cooking the corporate books is another symptom of our inability to generate new revenue growth. Although many point to greed as the reason many corporate executives cheat, greed has been part of the human condition since Adam and Eve. We now know, in fact, that some corporations cheat. We even know how they cheat. But we really haven't fully answered the question of why they have to cheat. The question, then, really should be this: What has changed over the last 25 years to force some corporations to cheat in order to deliver expected earnings growth?
As a corporation runs the natural course of maximizing both revenue strategies (domestic and international distribution, and merger and acquisition activity) and cost-cutting strategies (downsizing, consolidation, and productivity efforts), it ultimately reaches an ethical fork in the road, forcing a choice between delivering reduced earnings or simply faking the numbers. Obviously, some have opted for the latter. Although the Enron, Tyco, and WorldCom debacles represent extreme cases of revenue and expense manipulation, these cases demonstrate what can happen when revenue slows or is greatly reduced.
Pushing the boundaries of Generally Accepted Accounting Practices (GAAP) to paint a rosier financial picture than actually exists has been raised to an art form in recent years. Such practices have largely been the result of corporate revenue reservoirs drying up, and include such common practices as the inflation of revenues through bogus inter-company billings, inventory stuffing, or simply an overstatement of sales.
Xerox's stock price suffered greatly in the wake of an SEC investigation that focused on the firm's alleged artificial inflation of lease revenues. The original intention of such practices can often backfire, depressing revenue, earnings, and ultimately the stock price. Although the matter is now considered settled, Xerox's stock price has taken a beating since the investigation began in June 2000, dropping by nearly 75 percent over a two-year period.
Drug manufacturer Bristol-Myers created a serious problem for itself when pipeline inventories expanded in the fourth quarter of 2001. The inflation of wholesale inventories created a short-term sales windfall of 10 percent in Q4 2001 when wholesalers aggressively stocked up. As a result, this helped cause a sales shortfall for Q1 2002, and the company was forced to restate sales and earnings estimates both for the quarter as well as for the full year 2002. Bristol-Myers' stock price also suffered, losing nearly 60 percent of its value in less than a year.
These cases represent some of the more public examples of alleged numbers manipulation. It would be nearly impossible to identify and penalize every public corporation that has strayed from strict adherence to accounting standards in the name of self-interest over the last decade. Although tougher laws and heightened accountability on the part of senior executives for their numbers are important and necessary steps, it doesn't solve the fundamental underlying problem: the lack of revenue growth.