Firms like DELL will continue to thrive...
Cash, Efficiency Are Top Tools When The Enemy Is Deflation
By Donna Howell
Investor's Business Daily
Tuesday October 22, 10:59 am ET
It used to be that deflation wasn't talked about at all. Now it's another worry on Wall Street, a potential recession gremlin.
The deflation meme in the air carries aloft some questions for American business. In a scenario where inflation drops below zero to become deflation, falling prices spell the bane of sustainable commerce. What would companies do to survive? Who could, as buying slows and the real cost of debt rises?
Some early lessons in surviving deflation can be gleaned from firms that already deal with it daily. Not those headquartered overseas, caught in Japan's deflation spiral, but American companies fighting the lowball-pricing battle largely on home soil.
Firms such as fare discounter Southwest Airlines Co. and online computer seller Dell Computer Corp. have learned a thing or two from working in sectors subject to price deflation.
These firms can watch the prices of their goods fall and manage to thrive better than their peers.
How? They stay lean, and at least relatively clean of debt.
"We're fortunate in that we're a 31-year-old company and have always operated under the premise that we need to be able to weather bad times," said Gary Kelly, Southwest's chief financial officer.
Cash Is King
The first deflation survival lesson that hardy firms teach is financial caution. In deflationary times, money in the bank is a good thing.
It's a maxim borrowed from the macroeconomic schoolroom. During inflation, people still buy goods. But in deflation they slow spending, as prices will be lower tomorrow. For companies, and thus their workers, the potential to earn drops. Existing debt becomes costlier. Dollars become dear.
"The way to get rich in deflation is to keep your money in your pocket," explained David Blitzer, chief investment strategist at Standard & Poor's.
Southwest and Dell both do. Dell, of Round Rock, Texas, ended its fiscal 2002 with $8.3 billion in cash and investments. The company's total debt is less than 4% of assets.
"When you're profitable every single quarter, it's pretty easy to keep generating returns," said Lehman Bros. analyst Daniel Niles. "Money's not an issue for these guys. It's a competitive advantage."
The same is true for Southwest. "Right now we've got about $2 billion in the bank," said Kelly. The Dallas-based airline also has about $600 million in unused credit, just in case. "That is a very good war chest in case things really got bad," Kelly said. Southwest keeps a debt level near 15% of assets.
"They have more of an ability to win in the price game because they have so little debt compared to their peers," said Jason Trennert, senior managing director at International Strategy & Investment Group Inc., in New York.
The second deflation survival lesson that both Southwest and Dell teach is efficiency, coupled with frugality.
"Southwest as an operating discipline has kept its operations extremely simple and has kept its cost structure far below that of its major airline competitors," said Lehman Bros. analyst Garrett Chase.
Southwest is the only major carrier to stay profitable since the Sept. 11 attack. The rest suffered losses totaling billions, as costs such as insurance rose while business travel demand flagged.
Air fares in September rose 0.5% year over year after months of decline, but remained 18% below September 2000 levels. As a low-fare airline, Southwest has to keep its seats cheap.
"This is not an environment where you can raise prices," said Kelly. "The way that we manage our profitability is to keep our costs low."
About a third of costs go for salaries and benefits, and another 15% for jet fuel. Southwest manages its risk in both areas.
Workers have a profit stake in the company, which helps motivate them. Southwest hedges risk its in fuel markets with derivatives that cap costs. In all, Kelly says, the airline's cost per seat-mile has fallen since the fourth quarter of 2001.
Low Inventories
Frugality is a mantra at Dell, too. Its just-in-time manufacturing style curbs costs and helps cope with the downward pricing trends that pervade its industry.
"In Q2 we were managing about four days of inventory, which is a company record," said Dell spokesman Venancio Figueroa. "We're able to pay the most up-to-date pricing on components, so if those prices are going to be decreasing we're truly able to pass those on to customers."
The prices of some components are dropping half a percent a week, Figueroa says.
Dell also keeps costs down by doing its own assembly in six locations around the world. "What we want to do with manufacturing is to be in close proximity to customers," said Figueroa. "We're saving inbound and outbound logistics costs - the time to reach the customer is collapsed."
One more tactic both Dell and Southwest use is direct communication with customers.
Southwest was the first major carrier to put up a Web site. That now accounts for nearly half of the airline's ticket sales.
"Southwest.com is the cheapest way for us to sell a seat," said Kelly. "The customer's doing the work."
Dell likes the direct route, too. It builds computers to order for customers, rather than sell through traditional channels.
By running lean and clean, Dell and Southwest have added to market share at a time when their industries are suffering overall. So one could say optimism is the third deflation survival lesson they teach.
Trennert calls Southwest, Dell and discounter Wal-Mart Stores the best at coping with price pressures and thus likely to be sturdy in deflationary times. "The whole idea is these companies won't necessarily be home runs, but will outperform their peers," he said. |
