Making the best of a slowdown

Michael Alan Hamlin

Posted on September 12, 2008

Opportunities are there for well-managed firms

Signs are that the U.S. recession is being felt in traditional sectors of the Philippine economy, which are highly dependent on consumer buying fueled by overseas remittances. Although remittances from overseas foreign workers (OFW) reached their highest peak since 1989 in June at $1.5 billion, that is because there are more Filipinos overseas, not because they are individually sending more money home. Year-on-year, remittances are up 17.2% to $8.2 billion, according to the Central Bank.

OFW remittances have been a major driver of the residential real estate industry over the past five years. These remittances and investment in commercial office space by business process outsourcing (BPO) investors have accounted for a sustained real estate boom. The BPO industry has expanded 50% annually according to the Business Processing Association of the Philippines (BPA/P), from US$1.47 billion in 2004 to $7 billion in 2007.

The industry will continue to drive investment in commercial real estate. According to CB Richard Ellis vice chairman Joey Radovan, almost 750,000 square meters of BPO space is under construction and expected to be completed this year, increasing BPO-dedicated space 70% from last year’s 1,080,000 square meters. BPA/P CEO Oscar Sañez and other industry experts say that the U.S. recession is increasing pressure on U.S. businesses of all sizes to outsource non-core business processes to lower costs. The recession is actually helping fuel growth in Philippines BPO and commercial real estate. (Disclosure: CBRE and BPA/P are clients of my firm.)

Residential real estate is another matter. Although remittances could reach record levels this year based on results for the first six months, developers are quietly conceding that sales of condominiums and starter homes have slowed. The combined effects of the U.S. recession, its global impact, and the stronger peso are moving a new home out of reach for many OFWs, at least for now.

The residential real estate sector is just one sector feeling the pinch. Manufacturers have been struggling for many years as low-cost production centers spring up elsewhere in Asia, Eastern Europe, and South America. With the cost of fuel and food increasing rapidly – inflation is up to 12.5% – the relatives of OFWs are using more of the funds remitted for basic needs. That means less is being spent on non-essentials, such as electrical appliances, fashionable clothing, eating out, and automobiles (Manufacturers are still forecasting an eight percent increase in sales for the year, but with an increasing number of commuters leaving their cars home and taking public transport, I just don’t see that happening.).

So it’s not surprising that retailers look glum. In fact, recent McKinsey & Company research shows that virtually all retailers get hit hard in recessions. Worse, when the economy does begin to turn around, the retail sector is one of the slowest to benefit. U.S. retailers grew just 0.3 percent in the first year of recovery following the last two recessions.

Although the Philippine economy continues to grow, the examples above show that there are both winners and losers here as a result of the U.S. slowdown. It’s an odd position to be in, where growth overall is at least somewhat robust due to economic pressure in the U.S., and growth is slowing or negative in traditional sectors because OFWs can’t afford to buy as many goodies for their relatives here.

A McKinsey study also shows that companies react to the downturn in different ways. In the retail industry, companies that were weak before growth slowed but demonstrate good prospects for future growth tend to focus on improving processes, reducing direct costs (i.e., outsource), and renegotiating with suppliers. Mature retailers with limited upside try to increase financial flexibility by cleaning up their balance sheets and improving return on investments.

Healthy but mature companies look for new ways to drive short-term growth, including better communicating value, shifting promotions to traffic-generating channels such as the Internet and television, cross-selling on the Internet, and improving market intelligence and stocking processes. Indeed, Cherokee Chamorro, Philippine country manager for JDA Software, tells me that his clients are coming to him for better forecasting and supply chain management tools. (Disclosure: JDA Software is a client of my firm.)

Finally, companies that are healthy and have a strong upside invest when times are tough, according to the McKinsey study. Investments are targeted at selectively remodeling stores in key markets, acquiring promising upstarts, recruiting talent from struggling players and laying off poor performers, and focusing other resources on key markets.

In challenging times, the study shows that how well we’ve managed in good times determines the alternatives available to us in tough times. For companies that have done well in good times, the opportunities are abundant, and rich.

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