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Posts Tagged financial

Understanding the Business Cycle

Aug 31

Posted by Tod McKenna in Decision Support

There’s been a lot of talk lately about how the US economy is crawling out of recession. You may have heard terms like “bottom” and “trough”, seen graphs of GDP growth, and read articles referencing NBER.

You may be highly skeptical and unwilling to believe that the latest recession is a thing of the past; after all, you likely know someone still looking for a job and you likely know someone else who recently lost a home. Or, you may be very optimistic, and knowing how the business cycle revolves, you are beginning to invest and think about growth. Understanding the business cycle will help you make better decisions — individually and in business.

Off the bat, I should state that economics is not an exact science (but you likely knew that already). And while there are a few axioms (supply/demand, money supply) and indicators (GDP, unemployment) that can help paint a realistic picture, most of what you see and read is based on analyst insight and experience, backed up with historical data and predictive models. There are faults all along the way. When you consider the complexity of the global economy, it should be clear that economics is more of an art than a science. The Business Cycle, though, seems to be something you can count on.

What is the Business Cycle?

Plainly put, the Business Cycle represents 4 phases of aggregate economic movement, ranging from periods of high growth to recession and back again. John Maynard Keynes (d. 1946) referred to these cycles as “waves of optimism and pessimism”, or to put it another way, waves of expansion and contraction. These phases were first written about more than 50 years ago by Arthur Burns in his book “Measuring Business Cycles”.

The four phases

  1. Peak - The highest point of economic output just before a downturn
  2. Recession - When the economy actually shrinks, or contracts
  3. Trough - The “bottom”
  4. Recovery - The economy has stopped shrinking is growing once more

Last 5 US Business Cycles

Peak YYYY-MM Recession Period Trough YYYY-MM Recovery Period
1980-01 6 1980-07 12
1981-07 16 1982-11 93
1990-07 8 1991-03 120
2001-03 8 2001-11 73
2007-12 ? ? ?

Data Source: NBER

Notice that peaks and troughs are represented by month and year, while the other two phases are measured over a number of months. You’ll also notice that recession and recovery periods can vary greatly.

Who determines when each phase begins and ends?

In the US, the task is managed by the National Bureau of Economic Research (NBER). NBER is a private, nonprofit, and nonpartisan research organization (stocked with Nobel Prize winning economists). They work on many economics projects and work closely with businesses and universities. They self-proclaim their dedication to promote “a greater understanding of how the economy works”.

For example, NBER most recently concluded that “the last [US economic] expansion ended in December 2007″. We know that after such expansion, according to the Business Cycle, will come a period of recession, followed by a bottom, leading to a new period of expansion.

Does everyone agree?

In short, nope. Milton Friedman, to name one prominent example, believed that the economy fluctuates rather than cycles. The new classical framework states that the economy is much more flexible than that which is implied by the business cycle framework.

There’s also an issue of market equilibrium. Having a somewhat predictable business cycle implies that the markets will be out of sync quite a lot — allowing some speculators and investors to take advantage of price differences at different phases of the cycle (this is called arbitrage, take a look into Rational Expectations Theory as well). Other differing methodologies include the credit/debt cycle, political cycles, and Marxian cycles.

Final thoughts

Even against dissenter argument and alternate viewpoints, the Business Cycle framework still works and is easily observable. Economists at NBER continue to assign dates to peaks and troughs. Individuals, businesses and organizations still base many of their purchasing and hiring decisions on what phase we’re currently in. This likely won’t change any time soon.

The only problem with relying on NBER is that they lag reality. For example, we have very likely reached the bottom of the current cycle and are now in a phase of recovery. NBER might make it official at some point this year, maybe next year. Investors waiting for official announcements will find that they’re missing the boat.

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Actionable Business-IT Alignment

Jun 22

Posted by Tod McKenna in Business & IT Issues

geek & pokeFor several years I’ve been following the Business-IT alignment movement. Alignment is necessary for fostering innovation and realizing greater profits as IT resources are used to their fullest to satisfy business goals and objectives.

But many organizations still struggle to make the connection.

Some suggest varying 3-, 5-, and 7-step approaches for better alignment. They typically consist of diving into new organizational structures, or implementing new frameworks and service models. Other sources say that the business is to blame, that IT is misunderstood and underutilized. While finally, some say it is a dead issue altogether.

I’m not convinced this is a dead issue, nor am I convinced that the business is to blame (especially nowadays). I’m also not convinced that 3-, 5-, and 7- step plans will magically work.

A few basic actions, initiated by IT, must happen first.

The Actions

Business has long ago recognized that better alignment with IT is essential. We can argue about how well they’ve understood IT and how it can best be utilized, but across the board, the recognition is there. IT, after many years of making the case for alignment, seems to be coming up short during this crucial period. I hope that the following actions, from an IT-perspective, can help:

  • Understand: Learn the language of the business. Plainly put, this means you need to become more financially intelligent. All businesses exist to earn a profit, and understanding how this works is the first critical step. You must understand where the estimates and assumptions are in the numbers, when you would want to depreciate or amortize, and what constitutes a capital expenditure or operating expense. Among many things, you must understand ROI, cash conversion, and how to use profitability ratios.
  • Participate: Take part in strategic and other long-term planning initiatives. IT professionals must be able to see the company’s vision and turn the vision into actionable IT initiatives. If a representative from IT is not present during steering committee and other board meetings, make this a priority. You will need to convince the business that IT is capable of playing an important role in all long-term decision making. Fortunately, businesses already realize this need, but in many cases don’t feel that IT can effectively contribute (perhaps because IT doesn’t understand the business language).
  • Contribute: Provide business with the ability to make fast and accurate decisions. This means pioneering smart business intelligence initiatives that can provide decision-makers with the tools and reports — distilled — that business can utilize. You need to prove your flexibility, agility, and ability to understand what the business really needs. Much of this is tied to understanding, and extended with participation. These initiatives also include business process improvements; tighter integration of business, meta, and master data; and managing performance.

If IT can take action, better alignment can be achieved. This isn’t to say that the business can’t do more, but before the business can make IT a full partner, understanding, participation, and contributions from IT are a must.

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