Remedies For An Economic Hangover The slowdown is giving corporate America a headache. These four companies are getting relief by turning to management basics.
By Julie Creswell; Nelson D. Schwartz; Brian O'Keefe; Suzanne Koudsi

(FORTUNE Magazine) – If you've been to a Starbucks lately (and 15 million of you went last week), you may be surprised that just two short years ago Chairman Howard Schultz declared that the coffee merchant was going to be an Internet powerhouse. He vowed to "convert physical store traffic onto the Web" and perhaps start selling All-Clad pots and pans online. Everything short of delivering an icy cold Frappuccino would be done via cyberspace. But here we are in 2001, and you're still bringing your physical self to the local Starbucks, aren't you?

That's because Schultz sobered up. It's as if he woke up one morning, rubbed his eyes, sipped a strong Sumatran brew, and said to himself, "Wait a minute! I sell coffee!"

What actually happened is that Schultz steered Starbucks back to business basics. The first step to doing that is asking: What are we good at? What is our company's core? Sure, those questions should always be in the forefront, but during a downturn, when companies can't afford expensive side trips, they are especially important. Answers can be difficult to come by--Is Starbucks best at selling a brand? Is it best at running a fast-food establishment?--and following through can be even harder. But that's the key to success in tough times. "You've got to understand with great clarity what you can do better than any other company in the world," says Jim Collins, author of Built to Last and the upcoming Good to Great. "Few companies have the discipline to do that."

Maintaining discipline in a downturn takes special strength. When money tightens, the reflex is to stop spending. As the earnings per share of the S&P 500 declined 31% in the first quarter of 2001, managers everywhere were exhorted to cut costs, pull back on projects, reduce head count. It makes sense to trim costs, but the smart way saves money without slicing into the heart of a business. Companies that slash budgets or staff by 20% across the board could be making a big mistake. "The first thing you do in a recession is figure out what you want to be when you come out," says Bob Atkins of Mercer Management Consulting. "If you don't know that and you're making big cuts, it's like putting on a blindfold and taking out a buzz saw." Ouch.

A smart company might also, paradoxically, want to spend money now. That's what Best Buy did when it bought Musicland just as the downturn hit. "If you have the resources," says Atkins, "this is the time to buy companies, to buy factories, and to spend money on advertising."

So how do real companies get back to basics? To explore that question, we turn to four businesses--Starbucks, Best Buy, Emerson Electric, and IBM--that have held up well so far. They aren't immune to economic forces; they have felt shocks and are cutting back. But they aren't just throwing ballast from the boat willy-nilly. They are getting smarter about spending. They are sticking to a plan. And they are thinking hard about where they want to be when things start to look up. --Julie Creswell

STARBUCKS The Basics: Focus on your strengths--and get the details right.

--If consumers cut back on anything during a downturn, you'd think it would be those high-priced coffee concoctions that made Starbucks an earnings machine in the late 1990s. After all, the dot-com wunderkinder who tanked up on $4 venti cappuccinos to stoke all-nighters are now unemployed, and the rest of us aren't feeling quite as indulgent as we used to.

But despite the economic slowdown, Starbucks has been steaming ahead with new locations, new products, and strong earnings. Analysts expect a 31% jump this year, and earnings rose 37.6% in the first quarter of 2001. Indeed, Starbucks shares have nearly doubled since their low two years ago, and the company is now opening roughly three stores a day.

While it was Chairman Schultz's "We Be Internet" proclamation that drew headlines in 1999 (we'll get back to that), the most important decision the company made then was to crank out more Starbucks shops. According to CEO Orin Smith, managers realized they had underestimated how many new coffee shops the market would bear. At the time, Starbucks had roughly 2,100 stores. It now operates 3,500 stores in North America, with 800 more overseas, mostly in East Asia and Britain. The goal is 10,000 stores worldwide by the end of 2005. Critics have warned for years that Starbucks is close to saturating its core domestic market. But the truth is, same-store sales keep rising.

Of course, steering a massive expansion is tougher when you're confronting a deep downturn. As early as last fall, Smith noticed a slight slowdown in traffic. "There hasn't been a great impact, but there are fewer people shopping on the street and in malls," Smith says. Rather than pull back from the expansion strategy, Smith and Schultz have launched a series of small adjustments. They imposed a hiring freeze on noncritical employees at headquarters about three months ago. And while the stores have continued to hire, automated espresso machines have been introduced in hundreds of busy shops, so baristas can move customers through in less time.

These kinds of small changes can make all the difference in a slowing economy. Even before the downturn, Starbucks was focused on improving efficiency and bolstering its gross profit margins, which now run at a caffeinated 57%. Milk, for example, is the second most expensive product after coffee beans, says Ted Garcia, the company's executive vice president for supply-chain management and coffee operations. Two years ago Starbucks had 65 different milk suppliers in the U.S. Now it has fewer than 25, an efficiency gain that has saved a lot of money. Garcia has smoothed out coffee-bean purchasing too. His team now negotiates long-term contracts with some growers, thereby preventing unexpected price hikes.

And all those new stores? Starbucks takes great care to pick the right location. Lehman Bros. analyst Mitchell Speiser says that while chains like McDonald's and Wendy's routinely shutter 50 to 100 restaurants a year, Starbucks has closed only a small number of outlets in its 30-year history. One secret: In car-centric cities, Starbucks almost always locates its shops where traffic flows downtown in the morning so commuters can pick up a cup without having to do a U-turn.

And what about the Internet? Well, Starbucks is currently in the process of wiring its stores for high-speed wireless Internet access so customers can surf the Net on their laptop or Palm. About 500 U.S. stores should be Internet-ready by mid-summer. But that's reinforcing a core strategy, not dabbling in Net mania, says Speiser: "They're providing a service to their customers, not putting money into Internet startups." The payoff is simple: The longer people linger in online chat groups, the more likely they are to order another latte.

Even better, Starbucks isn't paying for its Web strategy. Compaq and Microsoft are supplying the equipment and labor to get coffee shops online and they receive product exposure in exchange. Hence another basic lesson: Let the other guys foot the bill. --Nelson D. Schwartz

BEST BUY The Basics: Don't abandon important long-term goals.

--The timing couldn't have been worse. Last October, while Best Buy was cruising toward its fourth consecutive year of record profits, the consumer electronics giant felt the slowdown kick in. As revenues dipped, CEO and founder Richard Schulze realized that he would have to report some grim quarterly numbers to Wall Street. Even worse, the shortfall seemed to threaten an expansion strategy Schulze had spent more than a year crafting. Confident in both the rightness of the plan and the soundness of his company, Schulze decided to press ahead.

It was a test of his persuasive talents. On Nov. 9 the company announced that third-quarter earnings would fall far short of analysts' estimates. The stock price plunged, and tensions mounted inside Best Buy's suburban Minneapolis headquarters. The company had planned to use stock to buy Musicland, another Minnesota-based retailer; now several execs pushed to delay or abandon the deal. "It was one of the mostly deeply felt and contentious debates we've ever had here," says COO Brad Anderson.

Schulze, the feisty 60-year-old founder, eventually prevailed. He reminded his executives and the board of the essential soundness of the acquisition. Best Buy, with a network of more than 400 big-box stores, was beginning to run out of good locations for new outlets. Musicland would add 1,300 stores to the company (including more than 600 Sam Goody outlets). Musicland's smaller stores, located mostly in malls and small towns, gave the company a way to reach new types of customers and gain further leverage with suppliers. "Some of the leadership lamented the fact that it would have felt a lot better if [Best Buy's] stock price was at $80," says Schulze. "I said, 'Yeah, sure it would. But it doesn't change why we think this is a good deal.' We were likely to have this adjustment period in the economy anyway, and once it was over we would be well positioned."

It helped Schulze that during recent years Best Buy had built up a war chest of $1 billion. That gave him the flexibility to scrap the stock deal and announce that Best Buy would acquire Musicland with $425 million in cash plus the assumption of $260 million in debt. (It also paid $87 million in cash for Magnolia Hi-Fi in Seattle.)

Having invested in Best Buy's future, Schulze turned to address some very real problems in the present. Starting last November, the retailer squeezed more productivity out of its work force by scheduling fewer employees to work during off-peak hours. And it tightened up its already impressive supply chain. "They have some of the best inventory managers in the business," says Thomas Weisel analyst Sara D'Eathe. The line managers' efforts paid off: In April the company announced fourth-quarter earnings that beat expectations, with a 20% increase in gross margin on a record $15.3 billion in sales for the year--quite a comeback. Best Buy is on track to make its consensus earnings numbers in the most recent quarter. Although those earnings are expected to be lower than a year ago, eager investors have pushed up the stock from its 52-week low of $22 to $61; analysts expect the company to romp through the second half of the year.

Schulze and Anderson are not out of the woods yet. The stock is still well off its $86 high, and they know that integrating the Musicland stores won't be easy. But Schulze is confident he made the right decision about Best Buy's future. "Acquisitions and new strategies need to be developed even when the economy is a little soft," says Schulze. "You have to keep investing in yourself, and that's what we're doing." --Brian O'Keefe

EMERSON ELECTRIC The Basics: Be disciplined.

--David Farr took over as CEO of Emerson Electric in October--just as customers were starting to reduce orders or cancel them altogether. But if ever a company was built to tough it out and produce long-term consistency, it's Emerson. The St. Louis manufacturer has churned out earnings growth for 43 consecutive years--yes, that's years. Farr has been at the company for 20 of them and doesn't seem worried about spoiling the run: "We're just going back to some of the things we've learned to do whenever we've had a tough year coming at us."

One reason Emerson can grow earnings even in downdrafts is that it spreads its bets. The company makes many things for many customers, including measurement devices for heavy industry; temperature controls for heating and ventilation systems; and power tools sold at Home Depot. There's always a buffer.

When Emerson recently made some big acquisitions of companies that sell power systems to the volatile telecom sector, some analysts criticized the move as risky. Indeed, sales in that business unit are expected to be flat. But Farr, 46, defends the move as consistent with the company's goals of diversifying and finding new ways to grow. He sees the downturn as an opportunity to pick up telecom power companies on the cheap. "We are facing some difficult times in that group over the next six months, but I want us to come out of it stronger," says Farr. "If that means we should make a strategic acquisition, we'll do it." Meanwhile, other business units are picking up the slack: Sales of valves and regulators to now-booming oil and natural gas companies are up.

Diversifying--and a fetish for careful planning--has thus far spared Emerson the deep wounds inflicted on competitors. While net profits in the electrical equipment sector during the first three months of the year fell nearly 40%, Emerson's net rose 1.7%.

It takes discipline to hang on like that, and Emerson doesn't spare the rod. Each month, Farr, President Jim Berges, and CFO Walter Galvin meet with the leaders of the five business segments in "the Hole"--a small, underground conference room at the St. Louis headquarters. Farr jokes that he sometimes brings a baseball bat to those meetings, which can be tough indeed. Farr uses the sessions to drill managers about the health of their businesses. And it can get testy. "We constantly challenge management over the realism of their forecasts," says Berges.

Also discussed and revised at every management meeting is the company's five-year cost-cutting plan. The four-inch-thick binder is Emerson's playbook for hard times. So, when customer orders started to slow last fall, all Farr had to do was turn to the book. The answers were already there. --J.C.

IBM The Basics: Treat the customer right--but be sure you get the right customer.

--Sure, IBM's splashy e-business campaign is hip. But the company itself? Anything but. In the late '90s, while IT companies left and right rode the dot-com explosion, IBM chugged along at a snail's pace--growing at an average of 4% a year. But these days it's clear that IBM's prudence--once perceived as a flaw--is paying off.

While the rest of the tech sector is falling apart, IBM recorded first-quarter sales and profits of $21 billion and $1.75 billion, respectively (up 9% and 15% from last year). The company's technology-solutions business, known as Global Services, drove about 50% of IBM's total revenue growth and helped distance the company from its traditional hardware rivals, like Hewlett-Packard, Compaq, and Sun Microsystems, whose earnings and stock prices have plummeted. Critics are quick to point out that pension income and stock buybacks also bolster Big Blue's earnings per share. And its relatively slow growth makes it easier for IBM to meet profit targets. Still, says Sanford C. Bernstein's Toni Sacconaghi, "relative to other players, IBM has hit its stride."

What has IBM done differently? Lou Gerstner, IBM's McKinsey-trained CEO, wouldn't tell us himself (IBM declined to comment). However, Global Services alums and industry analysts agree that Gerstner's ability to remain hardheaded about taking on only the best customers--and then catering to those customers' needs--has made the $33 billion division a success.

Discipline and following strict procedures are at the core of IBM's strategy, and that sometimes means losing business to competitors. During the heady days of the bull market, IBM was tempted to jump into dot-com deals. Gerstner, however, stuck to the company's strict bidding process. Deals were rigorously vetted--the scope, cost, and potential profitability had to be reported and approved before any work could begin. And, unlike many new e-consultants, IBM rarely traded services for equity in the customer's company. "The thing that kept us in check is that we had to come back to headquarters and explain what the profits and losses would be," says Jim Goetz, former head of ISP services, who left IBM a year ago and is now CIO at WeServeHomes.com, a housing- services company. The bidding process, sometimes slow and cumbersome, was frustrating to some potential customers, but it saved IBM Global Services from deadbeat deals.

Gerstner also pressed consultants not to overpromise. Gordon Myers, who left his job as Global Services' head of technology and operations in April 1999, recalls one manufacturing company that wanted IBM to complete a major tech project in a very short time. Myers knew the complicated task couldn't be done so quickly, and when the company wouldn't agree to a later deadline or less customization, IBM backed away. IBM didn't get the contract, but it also didn't get the headaches of cost overruns and a frustrated customer.

Once customers do come onboard, Gerstner is maniacal about keeping them happy--and holding IBM employees accountable. He instructed senior-level employees to meet with customers on a regular basis. "He asked all the top managers in the company to send him activity reports and call reports," says Lloyd "Buzz" Waterhouse, formerly one of Gerstner's strategic advisors, "and we all got a quota of how many calls we had to make in a certain number of weeks." To further solidify customer relationships, IBM put a managing director in charge of each major account so that clients would have one high-level contact who could get any question answered. That change made a big difference to Merrill Lynch's CTO John McKinley, a longtime customer of Big Blue's, who feels liberated from the frustration of navigating the company's labyrinth on his own. "Fundamentally, they became an easier company to do business with," he says. In other words, it's the kind of company customers want to work with over the long haul--which is the best recession-proofing strategy of all. --Suzanne Koudsi

FEEDBACK: jcreswell@fortunemail.com