December 11, 2007

Business Cycles

Prior to the arrival of the internet, there was a semi-predictable cycle of business performance, one that occurred every two to four years.

It went something like this:

Year 1 = Poor Profit. In planning for next year, inventories were significantly reduced, while circulation/prospecting were reduced as well. In some cases, the leadership team was overhauled.

Year 2 = Flat Sales, Better Profit. With lower inventory levels and reduced circulation, the fundamentals of the business were managed better, improving profitability. With sales flat or improved, and profit improved, business leaders put their foot on the gas. Circulation increased, prospecting increased, but inventories were still managed reasonably well, given the sour memories of the prior year.

Year 3 = Good Sales, Good Profit. At times, there wasn't enough inventory to fill demand. With a good year in the books, business leaders became aggressive. Investment and inventory increased, especially inventory, because fulfillment levels were so poor in year three, and sales were forecast to grow fast in year four.

Year 4 = Poor Profit. Inventory levels were bloated, and the investment didn't convert to profit at rates anticipated by leadership. This completed the business cycle. The direct-to-consumer business "started over" at "year one", if you will.

Some of the best business years I've been part of followed this cycle. 1993 was a great year at Lands' End, followed by a sluggish 1994, and a terrible 1995.

I went to Eddie Bauer, which had a great 1996, a sluggish 1997, an awful 1998, a great 1999, then a sluggish 2000.

The internet seemed to change this dynamic. With phone/mail sales decreasing and online sales going sky-high, it became more important to focus on managing inventory by channel, managing investment by channel. With each channel having a common (but opposite) trajectory, maybe it was easier to manage the growth and profitability of a direct-to-consumer business.

Next year, as online sales volumes flatten out, we may see the return of the business cycle.

This will be very interesting to monitor. As you know, the online channel has disadvantages, when compared to the catalog/phone/mail channel. In catalog, when an item is sold out, you get to keep recording "demand" via the telephone. As customers continue to call for sold-out items, you record what the customer "wanted". This allows the cataloger to better forecast demand for the item next year.

Online, items are "pulled" from the website when not available. This is considered a "best practice", or "great customer service". Maybe it fits the latter category.

Of course, the online inventory manager is placed at a significant disadvantage. She doesn't have knowledge of how much she could have sold. So she's likely to underbuy the following year, limiting the growth of the online channel.

Maybe this style of inventory management will dampen the impact of the business cycle. Maybe this prevents the inventory manager from over-buying in the online channel, limiting the risk of having too much inventory, a fatal condition for direct-to-consumer businesses.

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