NFIB

Small Businesses Optimism Inching Up, But Labor Costs Squeezing Out Profits
06/21/2002

America’s gradual economic recovery continued in May as NFIB’s Small Business Optimism Index inched up a tenth of a point to 102.3. While sales prospects are getting brighter, increasing labor costs and a lack of pricing power are cutting into profits.

“Owners are very optimistic about the future – for their own sales and for the economy,” said William Dunkelberg, NFIB’s chief economist. “This bodes well for hiring, capital spending and inventory building for the balance of the year – as long as those sales materialize.”

The net percent of owners expecting the economy to be better in six months rose a point to 38 percent of all firms. Unadjusted, 44 percent expect the economy to strengthen over the next six months – down 5 points – and 6 percent expect the economy to weaken, down 1 point. This indicator continues to signal solid economic growth.

The cost and availability of insurance held on to second place in the balloting for the single most important business problem, garnering 18 percent of the votes, while taxes received 23 percent for a first place finish. The third place finish went to poor sales with 15 percent of the vote.

SALES: Sales trends deteriorated a bit in May, with more firms reporting lower sales than higher sales. The net percent of firms reporting higher sales was –6 percent, a 5-point deterioration but far better than the –19 reading in February. A substantial part of the weakness in sales continues to come from the price side.

EARNINGS: There was no evidence of improved profits in the May survey. The major problem seems to be a lack of pricing power and labor’s growing share of productivity gains. Seasonally adjusted, a net 22 percent of the owners reported raising worker compensation, but only a net 2 percent reported raising selling prices.

PRICES: The net percent of firms reporting higher average selling prices was unchanged at 2 percent of all firms. This follows readings of -4 percent, -7 percent and -5 percent, -5 percent, 1 percent and 2 percent over the preceding 6 months. This was the most prolonged period of price cutting in NFIB survey history and the net 2 percent raising prices is hardly pricing power. The frequency of planned price hikes rose 1 point to a seasonally adjusted net 19 percent of all firms, up 1 point. Overall, the inflation outlook has become more fragile in that the economy has become bifurcated, with strong upward pressures on prices in the services sector, and deflation in the goods sector.

EMPLOYMENT AND COMPENSATION: Plans to increase total employment were steady at a net 12 percent of all firms. Unadjusted, 22 percent planned to expand employment – down 2 points – and 4 percent planned work-force reductions. Twenty-two percent reported raising worker compensation over the past three months, up 1 point from April and 12 points below the record high reached in 2000.

CREDIT CONDITIONS: A net 5 percent reported harder borrowing conditions, down 1 point. Thirty-five percent reported all of their borrowing needs met – down 2 points – while 5 percent reported financing difficulties, down 2 points. The bulk of the borrowing firms had no credit market problems. The average interest rate paid on short-term loans rose 20 basis points to 7.4 percent.

INVENTORIES: Firms continued to sell off inventory, with the net percent of firms reporting inventory accumulation over the past 3 months at -8 percent, the fourteenth consecutive month in which more firms reported inventory reductions than reported gains. A net -4 percent reported inventories too low, not as good as the very rare +3 percent March reading, but historically a favorable reading. Plans to add to inventories slipped a bit, falling to a seasonally adjusted 5 percent of all firms, net of those planning reductions in stocks.

CAPITAL OUTLAYS: Capital spending plans were steady at 32 percent of all firms. In the current environment, following five years of heavy capacity expansion, firms are less than anxious to move ahead with new capital expansion. If economic growth is modest for the near future, there is more than enough excess capacity to meet demand. Reports of actual outlays in the past six months fell 2 points to 60 percent of all firms.

“The economy continues to move forward – always good news,” Dunkelberg said. But it’s not going to be a barn-burner in spite of the spirited start. Capital spending and hiring plans are moderately positive, although plans to add to inventories are very solid. This should help the GDP numbers for the second quarter.