Bankruptcy seems to be the theme for today, and it’s worth noting that the rate of business bankruptcies and other business failures doesn’t seem to be following the arc of the business cycle in the classic sense. You expect the depths of a recession to cause the most troubled businesses to fail, and it did six and seven years ago, but only in a relatively muted way. Some of the businesses that looked like they were done for in 2007 have managed to limp along to the present, never quite getting back on their feet and still looking to have a high risk of failure within three years. When you look at it a certain way, there is something to be said for letting a business fail at this point in the cycle, after seven years of historically strong employment growth, particularly if you are a creditor. In a recession creditors tend to give a struggling business a chance to show it can do better when economic conditions improve. That logic no longer applies. If a consumer goods retailer like Sports Authority cannot justify its existence now, with national employment numbers at an all-time high and consumer confidence reasonably strong, then it never will.
When you read some of these bankruptcy stories, you can’t help but imagine that some of the executives in charge are not listening to what their accountants are telling them about the costs the company will face if an initiative fails. Sports Authority was planning large-scale store expansions right up until December and the Christmas shopping season that fell slightly short of expectations. In the span of that month, the retail chain went from aggressive expansion to the first stages of winding down. It was a similar story years ago when Broders failed. The book chain had already put its sign on the front of what it hoped would be its new stores, and found out in the middle of its expansion plans that not only did it not have the money to expand, but it could not even keep operating.
One problem may be that executives are writing bankruptcies as alternative scenarios in their expansion plans. I’m afraid many executives have come to see bankruptcy as a survivable event and are actually charting their course through a bankruptcy two or three years out as they draft their strategic plans. To be sure, there are many stories of businesses emerging from bankruptcy, but it is not something to plan on, in either a legal or a practical sense. Both Borders and Sports Authority originally filed for reorganization in bankruptcy only to find, a few weeks in, that there was no financial path forward.
Part of the difficulty businesses face is the assumption, taught in management schools, that tough economic times are a good time for a business to gain market share. This is true in the sense that the cost of adding to market share may be lower during a recession, when certain prices are lower than usual. However, as we have seen, the risks of expanding in the early years after a recession are considerably higher. Businesses that expanded aggressively in 2009 were bankrupt in 2013; those that thought they were being more cautious by waiting until 2010 and 2011 are the ones filing for bankruptcy now. Many of the recently failed businesses are in business segments that in retrospect were obviously shrinking and are closer to being in balance after one of the major players is taken out. That explains how a business that thinks it has friends can discover, after entering bankruptcy, that the world of business is not such a friendly place.
