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Some economists have jokingly defined a recession like this: If your neighbor gets laid off, it's a

recession. If you get laid off, it's a depression. Economists officially define a recession as two consecutive
quarters of negative growth in gross domestic product (GDP). The National Bureau of Economic
Research cites "a significant decline in economic activity spread across the economy, lasting more than a
few months" as the hallmark of a recession.

Both definitions are accurate because they indicate the same economic results: a loss of jobs, a decline
in real income, a slowdown in industrial production and manufacturing and a slump in consumer
spending - spending that drives more than two-thirds of the U.S. economy.

In the article we'll explain how the impact of these broad-spectrum slowdowns on both large and small
businesses can be very damaging, and in some instances, catastrophic. Some businesses may be
affected only moderately, or not at all, if the recession is mild and brief. If the recession lingers and the
downturn is widespread, all big businesses - firms publicly traded on major stock exchanges - may
ultimately be hurt. (Read about classic examples of economic downturn in Stagflation, 1970s Style and
What Caused The Great Depression?)

How a Recession Impacts Large Businesses

Let's take an unnamed Fortune 1000 manufacturer as a typical big business suffering the effects of a
recession. What happens to this firm will likely happen to other big businesses as the recession runs its
course.

As sales revenues and profits decline, the manufacturer will cut back on hiring new employees, or freeze
hiring entirely. In an effort to cut costs and improve the bottom line, the manufacturer may stop buying
new equipment, curtail research and development and stop new product rollouts (a factor in the growth
of revenue and market share). Expenditures for marketing and advertising may also be reduced. These
cost-cutting efforts will impact other businesses, both big and small, which provide the goods and
services used by the big manufacturer.

Falling Stocks and Slumping Dividends

As declining revenues show up on its quarterly earnings report, the manufacturer's stock price may
decline. Dividends may also slump, or disappear entirely. Shareholders may become upset. They and the
board of directors (B of D) may call for a new CEO and/or an entirely new senior management team. The
manufacturer's advertising agency may be dumped and a new agency hired. The internal advertising and
marketing departments may also face a personnel shakeup.

When the manufacturer's stock falls and the dividends decline or stop, institutional investors who hold
that stock may sell and reinvest the proceeds into better-performing stocks. This will further depress the
company's stock price. (Learn how understanding the business cycle and your own investment style can
help you cope with an economic decline in Recession: What Does It Mean To Investors? and Recession-
Proof Your Portfolio.)

The sell-off and business decline will also impact employer contributions to profit-sharing plans or
401(k) plans if the company has such programs in place.

Credit Impairment and Bankruptcy

Also impacted by the recession is the accounts receivable (AR). The customers of the company that owe
it money may pay slowly, late, partially or not at all. Then, with reduced revenues, the affected company
will pay its own bills more slowly, late, or in smaller increments than the original credit agreement
required. Late or delinquent payments will reduce the valuation of the corporation's debt, bonds and
ability to obtain financing. The company's ability to service its debt (pay interest on the money it has
borrowed) may also be impaired, eventuating in defaults on bonds and other debt, further damaging
the firm's credit rating and preventing further borrowing. (Debt Reckoning can teach you how a
company's debt is an indicator of financial health.)

Debt will have to be restructured and/or refinanced, meaning new terms will have to be agreed upon by
creditors. If the company's debts cannot be serviced and cannot be repaid as agreed upon in the lending
contract, then bankruptcy may ensue. The company will then be protected from its creditors as it
undergoes reorganization, or it may go out of business completely. (For related reading, see An
Overview Of Corporate Bankruptcy, Profit From Corporate Bankruptcy Proceedings and Taking
Advantage Of Corporate Decline.)

Employee Lay-offs and Benefit Reductions

The business may cut employees, and more work will have to be done by fewer people. Productivity per
employee may increase, but morale may suffer as hours become longer, work becomes harder, wage
increases are stopped and fear of further layoffs persists. (Read about how employment statistics
influence corporate confidence in Surveying The Employment Report.)
As the recession increases in severity and length, management and labor may meet and agree to mutual
concessions, both to save the company and to save jobs. The concessions may include wage reductions
and reduced benefits. If the company is a manufacturer, it may be forced to close plants and discontinue
poorly performing brands. Automobile manufacturers, for example, have done this in previous
recessions.

Cuts to Quality of Goods and Services

Secondary aspects of the goods and services produced by the recession-impacted manufacturer may
also suffer. In an attempt to further cut costs to improve its bottom line, the company may compromise
the quality, and thus the desirability, of its products. This may manifest itself in a variety of ways and is a
common reaction of many big businesses in a steep recession. (Learn about the importance of
production levels in Understanding Supply-Side Economics.)

Airlines, for example, may lower maintenance standards. They may install more seats per plane, further
cramping the already squeezed-in passenger. Routes to marginally profitable or money-losing
destinations may be cut, inconveniencing customers and damaging the economies of the cancelled
destinations.

Giant food purveyors may offer less product, for the same price, in the same size package in which the
larger amount was previously sold. Quality may also be reduced. Coffee, for example, may be cut with
lesser-quality beans, compromising flavor and driving away cost-conscious consumers with little brand
loyalty who have noticed the change. (Read about the importance of standing out from the competition
in Competitive Advantage Counts.)

Reduced Consumer Access

As firms impacted by the recession spend less money on advertising and marketing, big advertising
agencies which bill millions of dollars per year will feel the squeeze. In turn, the decline in advertising
expenditures will whittle away at the bottom lines of giant media companies in every division, be it
print, broadcast or online. (Read about successful marketing strategies in Advertising, Crocodiles And
Moats.)
As the effects of a recession ripple through the economy, consumer confidence declines, perpetuating
the recession as consumer spending drops. (To learn more, read Economic Indicators: Consumer
Confidence Index (CCI).)

A Recession's Impact on Small Businesses

The impact of a recession on small businesses that have annual sales substantially less than the Fortune
1000 and that are not public companies is similar to large businesses. Without major cash reserves and
large capital assets as collateral, however, and with more difficulty securing additional financing in trying
economic times, smaller businesses may have a harder time surviving a recession. Bankruptcies among
smaller businesses may therefore occur at a higher rate than among larger firms.

The bankruptcy or dissolution of a small business that serves a community - a franchised convenience
store, for example - can create hardships not only for the small business owners, but for residents of the
neighborhood. (Learn how businesses can safeguard their assets in Asset Protection For The Business
Owner.)

In the wake of such bankruptcies or dissolutions, the entrepreneurial spirit which inspired someone to
go into such a business may take a hit, discouraging, at least for a while, any risky business ventures. Too
many bankruptcies may also discourage banks, venture capitalists and other lenders from making loans
for startups until the economy turns around. (Read Six Steps To A Better Business Budget to learn about
an easy but essential process that helps owners keep their small businesses afloat.)

Recessions Don't Last Forever

Recessions come and go and some are more severe and last longer than others. But history shows that
recessions invariably end, and when they do, an economic recovery follows.

For related reading, see The Federal Reserve's Fight Against Recession.

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Since the economic downturn began in 2007 and into 2010, the world is experiencing a credit crisis.
Declining values in real estate, record high foreclosure rates and default rates on loans are responsible
for the credit crisis, which is making it harder for businesses to obtain the loans and credit to grow and
expand. The global credit crunch has caused business owners and managers to make management
decisions that cut costs but maintain operational productivity.

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Lack of Cash Flow

Most businesses are experiencing a lack of cash flow from business operations, which comes down to
two primary reasons. First, customers of the business are cutting spending in light of the recession,
causing the cash flow coming into the business to slow down. Because of this lack of cash flow, many
businesses turn to lenders to obtain small business loans or lines of credit. Since lenders have
implemented stricter guidelines, it is more difficult for businesses to obtain the loans businesses need to
get through slow cash flow times.

Layoffs and Unemployment

Some businesses had to cut back on their employees because of budget cuts, so one of the major
fallouts from the credit crisis is employee layoffs. The volume of layoffs at one time has caused some of
the highest unemployment rates the world has seen since the United States went through the
recessionary period during the 1980s.

Flexibility
In general, the credit crisis has caused businesses to have to operate in a realm they have not had to
operate in before. The direct effect is that businesses have become more flexible in order to keep
business operations afloat until the crisis ends. Flexible measures include closing one or two additional
days per week and working out payment arrangements with customers.

Business Property Defaults

Many businesses that own the properties where they operate had adjustable rate mortgages that
adjusted up during the credit crisis. Unfortunately, the stricter lending guidelines prohibited many of
these businesses from refinancing, mortgage payments rose to an unaffordable level and many
commercial property owners went into default on their mortgages. Even some businesses leasing
commercial property found themselves without a place to function when landlords defaulted on the
mortgages and banks foreclosed on the properties—forcing the leasing businesses out.

Increased Creativity

Operating a business in an economic crisis has forced entrepreneurs, business owners and managers to
come up with creative ways to keep their doors open. Some have renegotiated buying terms with
suppliers, while others have switched full-time employees to a part-time status to keep them employed
and reduce costs.

Research by Marc Cowling and colleagues examines what happens to smaller businesses in a time of
economic crisis. They find that recessions do take their toll on the smaller business sector, but these
effects appear relatively short lived in general and affect specific types of small businesses and
entrepreneurs more than others.

The global financial crisis that unfolded in 2008, and the economic recession it subsequently caused, led
to a huge increase in UK unemployment and a large contraction in the general level of demand for
goods and services. Our news was dominated by large numbers of lay-offs and job losses in monolithic
firms that are household names to us. Against this backdrop, senior UK government ministers
increasingly began to see the small business sector as a fundamental part of the solution to the
country’s economic problems.
This assumption has some credibility as the evidence does suggest that smaller businesses tend to be
more flexible, responsive and resilient than their larger, more bureaucratic counterparts due to the
concentrated nature of decision-making in smaller entrepreneurial firms, closely-held ownership, and
the lack of hierarchy. Resilience, despite a relative lack of resources, relates to entrepreneurial
characteristics such as the desire for independence, to be in control of ones’ own destiny, but also to the
closer inter-personal relationships between the entrepreneur and the workforce.

In short, it is harder, psychologically rather than legally, to get rid of a personal friend or family member
than a faceless employee amongst thousands. Equally, small firm workers are more closely tied to the
firm and are often willing to work with the entrepreneur to overcome problems when they arise. On a
more tangible level, smaller businesses, for a variety of reasons, not least capital constraints, tend to
adopt a more labour intensive mode of production thus any increase in demand for their output is often
met with an increase in demand for new people rather than buying a new machine.

The ‘special person’ view of entrepreneurs, one which is favoured by the media for obvious reasons, but
has its roots in Schumpeterian theory dating back to 1942, allows for periods of economic and social
upheaval to create new opportunities for entrepreneurial action. Yet even if we generally believe that
the small business sector is more dynamic and opportunistic than the large firm sector, they are
certainly not immune to large contractions in the general demand for goods and services.

But within the small business sector there is evidence that periods of disequilibrium and economic
instability are precisely the times when the best entrepreneurs are able to take advantage of new
opportunities as large firms and the public sector withdraw from markets as was the case in the UK and
worldwide. This is an entrepreneurial quality effect. This occurs as in periods of economic growth more
people become willing to pursue an entrepreneurial career path, but the marginal quality of the last
entrepreneur declines. In recessions, low quality, marginal, entrepreneurs exit the market. In short only
the fittest survive.

Our research

Against this backdrop we wanted to examine the data and find out what really happens to smaller
businesses in a time of economic crisis. We focused on 4 key questions:

How many smaller businesses still managed to grow in the recession?


Was the small business sector able to maintain its employment levels during the recession?

What types of entrepreneurs and smaller businesses had the capability to grow and create jobs during
the recession (is there an entrepreneurial human capital (EHC) effect)?

Can smaller businesses provide the future growth that will create new employment opportunities as the
economy emerges from recession?

Our broad purpose was to add to the general understanding of what really happens to the small
business sector during a severe economic downturn. This will enable us to speculate about the potential
contribution of the small business sector to future economic growth. This is of great importance given
the political onus placed on the small business sector to provide new jobs and economic prosperity in
the future.

So what did we find? In terms of the question as to how many smaller firms were still capable of
achieving growth during the recession, we found that between 20% and 30% of firms grew their sales –
much less than the 50% that grew in more favourable economic conditions. On jobs, between 15% and
20% of firms grew their employment during the recession, but again this is lower than in the pre-
recession period when 30% grew their employment. This suggests that the recession had a very strong
adverse effect, at least in the first six months, on the ability of firms to grow.

Figure 1: Proportion of business with increased sales and employment before and during the recession

Cowling fig 1

*Base: All SME employers (weighted data); unweighted N = 2,396 (pre-recession N = 2,138).

During the recession, it is the access to financial resources rather than the more subjective measures of
human capital that are more important determinants of recessionary growth, especially sales. This
suggests that in more stable economic environments many more firms are able to take advantage of
general growth in demand without having to compete vigorously with other firms and entrepreneurs.
Nevertheless, during a recession when the whole small business sector is further constrained by limited
resource, only the entrepreneurs that have access to essential financial resources can manage to
achieve growth.
Further, we also identified a positive synergy between sales and employment growth. This positive
relationship is only slightly diminished in terms of its effect size during recessions. What this does
suggest is that any policy levers that stimulate either job growth or sales growth will be more likely to
create a positive economic multiplier.

In relation to our fourth, and final, question relating to future growth orientations, we have several
important insights. Firstly, general growth orientations do decline during a recession, with 10% fewer
firms reporting these intentions, but this depressing effect begins to recover within six months of the
onset of the recession.

Figure 2: Proportion of business with a growth orientation before and during the recession

Cowling fig 2

*Base: All SME employers (weighted data); unweighted N = 2,396 (pre-recession N = 2,138).

Conclusions and Implications

Recessions do take their toll on the smaller business sector, but these effects appear relatively short
lived in general and affect specific types of small businesses and entrepreneurs more than others. But
perhaps our most significant finding is that in a stable and growing macroeconomic environment,
growth in more randomly spread across all types of firms and entrepreneurs. This is not true in periods
of economic downturns when only the best entrepreneurs, in terms of larger size and better access to
finance, are able to grow their businesses.

For policymakers our results suggest that helping firms’ access finance may create a positive growth
multiplier, and many countries have adopted this policy position. But more importantly, any policy
levers that stimulate jobs or general spending in the economy will help create a positive jobs-growth
multiplier as they tend to operate in parallel in smaller firms.
As to the general capability of the small business sector to grow and help drag depressed economies
forward, our findings do offer some support for the contention that smaller businesses are more
resilient and flexible enough to cope with the disequilibrium caused by economic recessions.

About the Author

Marc Cowling is Professor in Entrepreneurship at the University of Brighton. He was previously Professor
and Head of the Department of Management Studies at Exeter Business School.