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Are You on a Treadmill or are You Running the Race?

Last week&

By Dr. Joe Webb
Published: November 12, 2009

Last week's unemployment report was creepy enough, moving to 10.2%, and 17.5% once discouraged and underemployed workers are included. I discussed this in Monday's column, but did not directly address the employment data for our industry. This is where we now stand.

Employment October is now moving at a greater rate on a year-over-year basis. Since October 2008, industry employment is down -13.2%, even though industry volume for the past 12 months is down about 9% (we don't have October shipments data yet).

The industry is shedding workers at a faster rate than it is declining in revenue. That happens when the industry is posting persistent bottom-line losses. Companies are trying to catch up with demand levels so that they can survive. The reason that the number of employees is contracting faster than revenues is that companies are moving backwards on the economies of scale curve.

Economies of scale describes why after fixed costs are covered by increasing production rates, each additional unit produced has a greater per unit profit (or marginal profit, as the economists call it). When production declines, the opposite occurs, each unit lost means that every unit remaining bears a greater portion of fixed costs. When fixed costs are not covered, the firm loses money.

Where do the fixed costs come from? Fixed costs are the cumulative purchases in production capabilities, plant and equipment, that a company makes over time. When the assumptions and the expectations of the current and future marketplace are different than the actual marketplace there are two outcomes. If the market is better, the company may not have enough capabilities to meet demand. It is very profitable, but it is not as profitable as it could have been.

If the market is worse, then the company experiences losses because its fixed costs, the plant and equipment that it bought for what turned out to be wrong reasons, become a dead weight on its performance.

This is the primary reason why the number of employees is decreasing faster than shipments are. Companies are trying to catch up to have their costs match demand. Unfortunately, the real way to catch up is to change the fixed costs.

If a shop owner persists in the belief that demand will sometime return to the levels that were used to justify their investment, they will not change their fixed costs.

This is, unfortunately, the plight of print businesses who keep believing that once the economy revives, everything will return to the way it was. The marketplace is not like a riverbed that stays basically the same no matter the water level.

This is the choice that print businesses are facing. Keep shedding employees, or change the fixed costs. It's easier to let employees go, once the emotional aspect is set aside. Unneeded equipment has to find a buyer. Real estate needs to be sold. These take time, and market conditions may not yield acceptable prices for their divestment. I believe that this is the exact situation of many printers.

There are other printers, however, who have made cautious choices about their plant and equipment, have managed debt carefully, and carefully protect a core of employees. While it is difficult for them, these shops will see the real benefit, not of an economic turnaround, but the closure of weak competitors.

Even though industry shipments may be declining, that does not mean that individual companies cannot succeed. They generally do so by aggregating the work that would have gone to weak and closed competitors. The brutality of the process may be difficult to accept, but this is exactly what anyone who long-complained about the industry having too much capacity, or the industry needing to consolidate, should have foreseen.

One cannot emphasize enough that this process needs to be accompanied by a renewal of the capital base of the surviving companies. Based on what I discussed above, new equipment, purchased with the right motives, and a clear view of the marketplace, is essential. The market for print next year will be quite different than it was this year. The market for the year after will be different as well. Building flexibility into the fixed cost decisions requires a great deal of wisdom, but that is what is required.

Finally, it is essential to be careful in mergers, acquisitions, and what are commonly called “roll-ups” where books of business are purchased from an existing company without purchasing their equipment. The use of print media is very dynamic right now. Corporate austerity will persist, even through the beginning of a recovery, and the media selection process will be changing. Because many print businesses will have free time on their presses, now is a good time to start building alliances to access those capabilities rather than the risk of a bad equipment investment.

Yes, there are still CEOs of printers and suppliers who persist that all they need is an economic upturn to right their ships. They have their companies on treadmills and have forgotten about running the media race.

Dr. Joe Webb is one of the graphic arts industry's best-known consultants, forecasters, and commentators. He is the director of WhatTheyThink.com's Economics and Research Center.

What do you think? Please send feedback to Dr. Joe by emailing him at drjoe@whattheythink.com.

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