February, 2008

Fruits of Thought

Prelude To A Recovery

If we are currently in a recession or are about to enter one, we can count ourselves blessed to be in the produce industry. For the industry as a whole, the effects of a recession may be surprisingly small.

Unlike the dot-coms or subprime mortgage industry, where massive inflows of capital set the stage for a massive collapse when the bubble burst, this industry supplies food to 300 million-plus Americans, as well as others around the world. It will continue to do that through all but the most extreme business-cycle swings.

One doesn’t enjoy benefiting from the distress of others but, ironically, the first pangs of a mild recession are generally positive for the produce industry. If there is economic uncertainty, people hesitate to make big ticket purchases. They don’t buy new homes or vacation homes; they may postpone buying cars or going on major vacations.

The practical effect is simple: Initially the vast majority of those who have jobs or live on fixed incomes actually increase their disposable income since they aren’t buying homes or cars or taking elaborate vacations. Combine higher disposable income with a mild sense of deprivation and you have a recipe for small indulgences. They may go out to eat a bit more or splurge on some higher priced produce items.

As a recession deepens, one can expect reallocations of where food is eaten. Businesses cut back on expense-account dining, so white tablecloth restaurants start to suffer. Business and vacation travel gets depressed, so restaurants in hotels and vacation destinations start feeling softening demand.

Although this hits these businesses, and those who supply them, hard, it has little effect on total demand for food or fresh produce. The people still eat, just at home rather than out of town. In fact, restaurants in areas that traditionally empty during the summer or on holidays, as the local population heads to the mountains or shores, often experience a boost as the population stays put.

At some point in the process, fast-food chains start to suffer from a one-two-three combination punch: First the inner-city clientele, who consider a night out at KFC as a sign of affluence and prestige, lose their jobs and pull back. Second, the important teenage market, fueled by after-school jobs and generous allowances, find that both get cut. Third, the convenience crowd picking up a salad before or during work often decides to brown-bag it.

It is impossible to know precisely how deep a recession may get. Still, it seems likely that the kind of changes described on this page, which basically represent a rejuggling of where consumption takes place, will be the main effect of any likely recession. Of course, theoretically, if things get very bad, more people may plant gardens, buy less expensive canned or frozen produce, or buy more inexpensive starches, including potatoes, to stretch their meals.

The biggest wild card is probably fresh-cut. We have never had a major recession since the blooming of the modern fresh-cut industry. If unemployment rises, people will have time on their hands; will they chop their own lettuce? It is possible, but it would have to get pretty bad before we had a massive move in that direction.

Long before that happens, you will see a squeeze at retail, as consumers react to tough times by scouting for deals. High/low operators may be cherry-picked, and deep discounters such as Aldi and Sav-a-Lot may find business brisk. Coupon clipping will rise and consumers will not accept many price increases.

People may pool together to buy large quantities at warehouse clubs and divide them up at home. Restaurants will offer deals to attract consumers. Yet brand loyalty can actually increase as consumers become risk-averse and avoid trying things they may not like.

Although the overall industry is likely to sell as much or more produce each year, recession or not, the effect on individual businesses can be vast. Those in particular sectors, say purveying to white tablecloth restaurants, need to both watch the credit and look for other outlets. Geographically limited businesses are more vulnerable than those with a national and international account base. If demand for some items get depressed, that can create export opportunities.

The biggest change for industry executives, though, may be in dealing with banks and other lenders and equity investors. Banks that are looking to charge more and reduce their loans outstanding will hesitate to sign waivers of loan conditions. Valuations can easily shrink. An investor may point to the stock market and show that he can buy a listed company for much less than he could have a year ago, so the effect is to depress the value of all companies.

Yet, the truth is that there are never more opportunities to make money than in a recession. Why? If you expand through acquisition, you are typically buying companies at lower valuations. As long as they are good operations that will make it through to the next upturn, you will do well.

Recessions are also a fantastic opportunity to build a brand. As some pull back and weak players are lost, the amount of marketing noise is reduced, so marketing messages will have stronger impact in a reduced playing field. Study after study shows that those who market themselves most aggressively during downturns are the ones positioned to pick up business in the next upturn.

Perhaps that is the key lesson: We are very lucky in that in the depths of a recession lie the seeds of the next upturn. And in this industry, of all industries, we know the value of seeds growing where no one can see.  pb