Doing Business in a Volatile World
Graziadio School faculty reflect on ways in which business perspectives have changed since September 11.
Insights on professional recovery and revitalization.
On September 11, 2001, the World Trade Center in New York imploded after being struck by two hijacked planes, while in Washington a third plane demolished part of the Pentagon. In the fourth plane crash of that day, the Graziadio School lost one if its own. We now know a struggle took place on Flight 93 when a group of passengers determined to overpower the hijackers and prevent their plane from becoming yet another weapon of mass destruction. Although saddened, we are also proud that one of those who was actively involved in that heroic effort was a part of our graduate family. Thomas Burnett was a 1992 graduate of the Graziadio School’s executive education program.
Inspired by these and other sacrifices, we must as a nation move toward recovery in emotional intellectual, professional, and spiritual terms. Part of recovery is to take a personal inventory of how we might have grown or changed, to question our assumptions, reflect on our values, and reaffirm our responsibilities as business leaders. The following roundtable discussion is a first step in this direction.
Importantly, despite the layoffs, the exorbitant costs, and the uncertainties, Americans have courageously moved forward together. Business has continued, but not business as usual. To help put some of this in perspective, faculty members from the Graziadio School have engaged in a virtual roundtable to discuss how business practice has been affected and what this means for the decisions of business leaders and managers. These comments range from particular points about certain industries to more philosophical thoughts. Some are abstract, others more concrete. But it is our hope that the reader will find useful information to help in decision-making and to stimulate some thinking about what decisions are the most important to consider.
We also welcome your insight and invite you to join this important discussion. A response link is included at the end of the discussion.
William Larson, Interim Dean
The George L. Graziadio School of Business and Management
Applied Behavioral Science
GBR: To begin this discussion, would you please look ahead from the perspective of your discipline at how you think the events of September 11 will impact business.
Darrol Stanley: From the perspective of finance and the stock market, there are some obvious impacts. When the market re-opened following the attack, it was seriously altered but functioning in the face of massive selling. The initial responses were anticipated: airline and insurance stocks were down while oil and defense stocks rose. Not so obvious were the many fundamental changes that will follow.
One key result should be the long-term reduction in the growth rate of the American economy. Most financial analysts believe that this will be a modest decline. However, overall intrinsic corporate valuations are such that, given this economic scenario, the stock market should produce lower returns in the future than in the recent past. We have enjoyed a long-term growth rate in the stock market near the 11 to 12% range whereas normal long-term growth rates should be, in my opinion, in the 8 to 9% range. A reversion to that mean was already in the making before September 11th. What happened only gave added significance to this reality correction.
For the investor, low intermediate-term stock market growth means there is a need to focus on individual company valuations and prospects instead of taking the easy way by indexing the S&P 500. An individual investor should also save 1 to 2% more to compensate for this lower growth rate in the stock market. Real estate selectively purchased becomes likewise more attractive than stocks, even when purchased on solid fundamentals.
John Paglia: Evaluating individual companies may be more difficult in the near term than it has traditionally been though. The events of September 11 have severely impaired the parameters by which companies are valued. One of these parameters – earnings – has been declining steadily over the past few quarters. Analysts, who have been waiting to see evidence of a bottom, now find it incredibly difficult to separate the financial performance due to normal business operations in a weak economy from the economic fallout resulting from the terrorist attack.
This problem is further exacerbated by the Financial Accounting Standards Board (FASB) Emerging Issues Task Force’s (EITF) ruling on October 1 that disallows the use of an extraordinary item treatment for losses incurred in connection with the recent terrorist attacks. Therefore, on the financial statements, expenses from normal business operations will not be differentiated from expenses associated with the events of September 11. This ruling allows companies to hide economic weakness and its associated events – such as layoffs, soft sales, and poor earnings – behind the cloak of the September 11 fallout. Since analysts will need to separate these effects, albeit subjectively, to compute intrinsic values, company valuations are likely to be widely varied over the next few months.
David Smith: Going forward, I think the likelihood of a recession has to be accepted. There is just not going to be enough force to prop up GDP after the events of September 11. As John notes, company earnings have been falling for months, and the economies of Europe and Asia are too weak to help fill in the gap. Moving beyond our domestic situation, evidence suggests we are all likely to sink together in a global, synchronized recession, the first since 1973. Thus, companies whose sales have a strong correlation with income and economic growth need to plan ahead to deal with slowing and declining sales. The good news is that aggressive fiscal action and monetary initiatives are likely to keep the recession short and, hopefully, shallow.
GBR: The Fed has already cut the interest rate several times this year, and the general expectation prior to September 11 seemed to be that those rate cuts, plus the tax rebate, should begin to have some effect shortly. How will the government fiscal stimulus package intersect with all of these trends and events? Are we looking at the possibility of inflation returning at some point?
David Smith: Increased government spending, along with the tax rebate, will help prop up GDP in response to the expected decline in consumer spending. Unless there is a significant oil crisis that results in the near term, I wouldn’t expect inflation to become a problem, at least in the short-run. If anything, prices are likely to fall in response to reduced consumer demand. However, in the long-run, given the lag that characterizes both monetary and fiscal policy, we are likely to see a moderate increase in inflation. Right now, though, I think we are willing to accept a bit more inflation for increased GDP.
Terri Egan: From a different perspective, one of the immediate impacts likely will be the degree to which individuals and organizations are willing to use travel – both international and domestic – as a means of conducting business. Even before September 11, articles in the business press were highlighting the increasing prevalence of employees as “hyper-travelers” in multi-national organizations. These employees travel hundreds of days a year in order to meet face to face with customers, suppliers and associates across the U.S. and the world. Faced with increased federal and industry-related restrictions, reduced flights, and fearful employees it is likely that organizations will begin to question the usefulness of “hyper-travel” and seek alternatives grounded in the application of sophisticated technology. An unintended consequence may be a reduction in the economic, physical, and emotional costs associated with “hyper-travel.”
Darrol Stanley: There is likely to be a substantial slowing of the trend toward globalization of business. The risk-reward tradeoff was insufficient these past ten years for most emerging market investments. The demanded rate of the return to compensate for this now substantially increased risk will make many global investments unacceptable. Smart money will see this altered tradeoff early; money will not return to emerging markets in serious amounts the rest of this decade. The exception to this will be those countries that integrate into NAFTA or the EU. I would see Greater Mexico becoming a far better investment opportunity in the future than any other emerging market for an American. Along with reduced investment in most emerging markets, there will be a refocus on internal expansion within a greater defined NAFTA and a greater defined EU.
David Smith: To pick up on Terri’s point about travel, it is interesting to note that on the day the stock market reopened, stocks of firms developing video and internet conferencing technologies, moved upward. To respond to Darrol’s point, a move away from globalization, if it occurs, could have a significant negative impact on the long-term prospects for the world economy. Expanding markets have led to much of our economic growth over the last 20 years. You can be sure this issue is on Alan Greenspan’s “Top 5 Worries” list right now.
Scott Sherman: The idea that companies promoting physical travel (airlines, hotels, etc.) will suffer and those providing alternatives (video conferencing) will prosper in a post-September 11 economy is almost self-evident. The potentially interesting question is “What other companies will be able to prosper in a post-September 11 economy?” An example may be that the automotive tire industry may prosper as a result of an increase in automobile travel. Or, regional transportation alternatives (i.e., passenger trains, shuttle services) may do better than they have been. Firestone-Bridgestone may be able to turn its fortunes around if the American people transfer their wanderlust from air to automotive travel. Gasoline refiners-distributors may or may not see an upward bump because of the switch-off between the loss of jet fuel sales and international travelers to the U.S. Other potential winners may be television broadcast and cable providers, if Americans stay home more.
The attack on September 11 represents a punctuation of the prior equilibrium mechanisms of the market, i.e. the creation of a new system of equilibrium dynamics. The airline industry may not be as clear a “loser” in the post-September 11 economy as many have predicted though. True, the economics of the airline industry have been changed forever. However, the attack of September 11 may allow airlines the opening to change factors that should have been changed anyway. It will create more pressure for true economic change in the industry. One research institute predicted the industry would post FY2001 losses in excess of $2 billion before September 11 occurred. More secure cockpit doors, sky marshals on board, and additional checked baggage will increase the non-revenue producing weight of every passenger airliner and the short-term loss. Several airlines will enter bankruptcy in the next year, even with the federal bailout. Several others will be forced into major restructuring. The post-September 11 restructuring may allow a culling of the airline herd.
David Smith: One unclear issue is the future direction of prices for airline travel. Airlines will face higher costs as they tighten security, although the Federal government may subsidize some of these costs. Everything else held constant, that would generally lead to higher prices for the flying public. However, everything else is not being held constant, as demand is falling at the same time costs are rising. If the impact of falling demand is relatively greater than increased costs, prices could fall. That said, assuming the anxiety regarding flying will eventually subside, the impact of falling demand is likely to be short-term while cost increases are likely to be permanent. So, while in the short-run prices may hold steady, or even fall, in the long-run prices are likely to increase.
Scott Sherman: Prices may be forced down in the short-term, but only the more munificent airlines would be able to support such a price cut (i.e., Delta, American, United, and Southwest). Several other airlines had less than 30 days cash, and some had less than 15 days cash on hand, before the federal bailout. The federal bailout could be used to finance such sales. However, the burn rate on that cash will be extremely fast, and price increases will follow shortly after at least two of the second tier carriers have left the stage. The loss of weak performers is good for the overall efficiency of the market, but it may be bad in the short-term for those seeking cheap air fares. The bottom 20% of fares will disappear in the next 90 days. Airlines were already pricing seats below cost. Air travel will be more expensive (20-30%) after the herd is cut, but a better fit with the existing air control/air safety system will be possible.
GBR: Are there other effects that need to be noted?
David Smith: Another question to ponder is, “What impact will the events of September 11 have on labor markets?” Some impacts are clear, such as increase in demand, and wages, for security personnel. Another important factor to consider, particularly over the long-run, is what might happen to specific labor markets if, as is likely, immigration standards are tightened. Despite some of the rhetoric we hear in our day-to-day discourse, there is broad consensus among economists that immigration increases US output and productivity. In other words, immigration is good for the economy. In labor markets, these positive impacts are particularly felt at the “extremes:” high-skilled and low-skilled labor markets. So, the hospitality industry (e.g., hotels, restaurants, theme parks) which hire a lot of low-skilled labor, may suffer a double-whammy as a result of the events of September 11: decreased demand for their product, and higher labor costs.
GBR: Moving from general analysis to a more prescriptive tone, what do you think alert business practitioners should be doing in this environment? What questions should they be asking?
Scott Sherman: For one thing, the practitioner should be asking what structural elements of the market have changed and how does that affects his or her business. For example, does it make a difference in my business if high-rise office space loses market appeal and low-rise space becomes more popular? This could create a significant shift in the real estate and building products industries as firms shift to larger lots, fewer elevators, and more lateral hallways. The successful practitioner will play out these changes three or four steps ahead, and be ready with an opportunity when the market has moved through the necessary steps to reach that third or fourth move.
Darrol Stanley: Companies (as well as individuals) should basically adhere to their already- written business plans. If they do not have written business plans (or an individual financial plan), September 11 called attention to that failure. A company needs to have a firm grounding in the direction it is going and not change course in the short term unless there is a strategic change to the business model, such as the change that may occur in the airline industry. Businesses should then review, on a timely but not panicked basis, their short term, intermediate term, and long term business plans.
There are four key questions that must be addressed for each time frame. The first is the impact of declining or stagnant sales on their EBIT (earnings before interest and taxes). Does the Cost-Volume-Profit relationship need to be changed? The second is a review of the impact of any change in the cost of capital to the firm. The third is a review of the impact of any changes in the risk-adjusted IRRs (internal rate of return) of proposed new projects. One should review all cost and benefits coming from these proposed projects in light of the many new uncertainties. Are all costs fully noted? Are benefits realistic under the new emerging reality? The fourth is the percentage of vendor supplies coming from vulnerable parts of the world. A definite concern would be at a 20% or greater level. Any company that has an emerging market exposure of this magnitude must have a solid contingency plan.
Terri Egan: As the events of September 11 so harshly demonstrated, the US is inextricably linked to, and part of, a set of political, economic, social, and spiritual forces that extend beyond its national borders. Isolationism and extreme forms of nationalism at best offer the illusion of control, and at worst inspire a form of ignorance that can have devastating consequences. The complexity and chaos of our environment requires a systems thinking approach be developed and valued at all levels of the organization.
Scott Sherman: I agree that the attack of September 11 represents a sharp call for a larger-scale, more systems-related approach. One of the outcomes of such an approach should be an understanding that profits, at least quarterly profits, are not the principle outcome of business. They are a momentary gauge of the inflow-outflow exchange within the organization and between the organization and the market. A systems approach will illuminate that the sustainability of the organization – economically and in more human terms – is based on the firm as an organic, synergistic entity that envisions its life cycle in terms of decades, not quarters.
Strategy is defined as the search for above-average returns. The nature of those returns is not necessarily defined in solely financial returns. The continuing economic success of firms such as Johnson & Johnson suggests that a longer-term view of the marketplace may be more economically sound, and the market may now be ready to look past “what have you done for me lately” and focus on “what will you be doing for me 10 years from now.” The real goal may become to appreciate the flow of returns over time rather than the volume at any given point.
GBR: These last two responses in particular move us toward a question of values. In light of what has happened, what fundamental values do you see being emphasized – or do you think should be emphasized?
Terri Egan: Several of my students and clients have questioned the relevance of their work in the context of recent events. For some, this questioning has led to the consideration of a change in career path, or a re-balancing of work and family obligations. In light of an increasing number of layoffs and economic uncertainty, employees may also question the short-term and long-term intentions of their organization. After decades in which the loyalty and commitment of both the organization and its employees have become increasingly questionable, we find ourselves at a crossroad.
Chris Argyris once asserted that life inside of most contemporary organizations is fundamentally incongruent with the growth needs of healthy adults. Leaders who seize this opportunity, and dare to examine the alignment between the vision and values of the organization and the vision and values of its employees, can create an environment that inspires respect, commitment and excellence. Leaders who retreat into a reactive mode, risk losing employees that seek meaning and honor in their professional life.
Michael Magasin: Our values are so ingrained in our thought processes that the average person takes very little time to ask, “What does it mean to be an American?” The people who planned and attacked the United States on September 11 – and earlier, our embassies in Africa, the USS Cole and other locations – think that they understand what Americans are, but they really do not. Regrettably, while so many Americans are buying flags to show their support, they have very little awareness of the great values it represents as well. We need to educate ourselves, including those who hate us, about those values and the opportunity they provide not, only for us, but for all of humanity.
I have addressed this issue with my students, “What does it mean to be an American?” The responses have been interesting. Students who were born in the United States or who have lived here for a long time, have no difficulty identifying the first word of concepts such as “African-American,” “Irish-American,” “Italian-American,” etc. But they have considerable difficulty articulating what the second word, “American,” means. The students and others who have recently arrived in this country have no problem expressing what it means. Without exception, they say “opportunity for the individual”. The fundamental values associated with “opportunity for the individual” include freedoms such as religion, speech, association and due process. If you do not have such freedoms, the individual who practices a particular religion or expresses a new but unpopular idea would not be able to succeed in this country.
We respect the individual and desire that he or she realize his or her full potential. Respect for merit as a basis for success as opposed to privilege is another key part of that. We cheer for the person who accomplishes something by individual effort. Associated with “opportunity” are other values that require respect for the efforts of other individuals to succeed. “Doing your own thing,” was historically never meant to be at the expense of the community. This is important.
Recently, I was listening to an elder Afghan representative of his community speaking about equality. He stated that it is not God’s will that people be equal. We, on the other hand, believe in equality in many forms: equal opportunity for all, equality before the law; the equal value of each vote. This concept is fundamental to who we are and the way we do business. Assuming this man was expressing the views of his community, our two communities have diametrically-opposed views on a very vital issue.
Terri Egan: On September 11, I was teaching a class in Northern California. After my initial reaction, I struggled with the tension between my desire to continue the morning’s work, facilitating a personal development lab with a small group of our executive students, and a visceral yearning to immediately return several hundred miles home to the perceived “safety” of my family. Author and philosopher Peter Koestenbaum proposes that the fundamental price of accepting freedom, be it personal, organizational, or social – is to live in a state of anxiety. Freedom and free will require a degree of moral courage that some may find untenable – that is, the courage to understand and accept the consequences (intended and unintended) of one’s own choices. This extends beyond the individual, and applies to any organized institution operating in a democracy. This position does not mean that we abandon our efforts to address national and personal security concerns, but it does change the nature of the debate. One answer to increased calls for safety is the willingness to accept a certain level of anxiety and to act in ways that promote taking responsibility, including fostering debate and dialogue about unpopular issues.
David Smith: It’s a difficult balance. I would offer that we are just going to have to accept the tradeoff between security and freedom. It’s going to take some time to figure out what amount of freedom the populace is willing to give up for increased security. Although concern over safety is likely to lessen with time, I expect things will never “go back to normal.” What’s “normal” has now changed.
About the Author(s)
Graziadio Business Review, is an online journal that delivers relevant business information and analysis for business, government, and non-profit managers. From accounting and finance to ethics and work/life balance, the Graziadio Business Review extends current business debates in new directions that you can use to advance your business and professional career.