Most businesses will live through several economic cycles. Some cycles are gentle; others involve a full boom and bust in the markets a business sells into, buys from or borrows from. A builder may see a housing boom and collapse. A technology firm may see a surge of investment followed by a drought. A regional business may ride a mining boom and then watch it end.
The behaviour that feels right during a boom (expand quickly, borrow while credit is easy, hire ahead of demand, lock in long leases, buy assets before prices rise further) is often exactly the behaviour that turns a downturn into a crisis. And the caution that feels timid during a boom is often what allows a business to survive the bust, and to take advantage of it.
This article sets out a practical approach to running a business through a boom and bust: recognising where you are in the cycle, deciding what to do during the boom, preparing for the turn, managing through the downturn and positioning for recovery. It draws on GoCore’s series on bubbles, especially The anatomy of a bubble and After the peak.
Know your exposure
The first step is to understand how exposed your business is to a boom and bust. Exposure comes through several channels.
Your customers. Do they work in a booming industry? Is their spending driven by rising asset prices, such as home renovations funded by home equity? Do they depend on credit to buy from you?
Your inputs. Are your costs rising because of competition for materials, labour or premises from a booming sector?
Your funding. Is your borrowing secured against property or other assets whose prices are inflated? Are lenders offering unusually generous terms?
Your assets. Have you bought, or are you considering buying, premises, equipment or other businesses at boom prices?
Your location. Is your local economy dependent on one booming industry, such as mining, tourism or construction?
A simple exposure map, listing each channel and rating it low, medium or high, makes the risk visible. Businesses with high exposure in several channels need to be especially disciplined.
During the boom: enjoy it, but do not extrapolate it
Booms are good for business. Demand is strong, customers are optimistic, credit is easy and prices can often be raised. There is nothing wrong with benefiting. The danger lies in assuming that boom conditions are permanent.
Separate trend demand from boom demand
Some of your growth during a boom reflects lasting improvements: a better product, a stronger reputation, new customers who will stay. Some reflects the boom itself: customers who feel richer, industries that are temporarily flush, speculative demand. A useful exercise is to estimate what sales would look like in an ordinary year, and to plan fixed commitments around that figure rather than around boom-time peaks.
Prefer flexible capacity
When demand rises, there are two broad ways to meet it: add fixed capacity (permanent staff, long leases, owned equipment) or add flexible capacity (contractors, overtime, short leases, rented equipment, outsourced production). Fixed capacity is usually cheaper per unit when it is fully used. Flexible capacity is more expensive per unit but can be reduced quickly.
During a boom, leaning towards flexible capacity costs a little margin in good times and can save the business in bad times.
Be careful with boom-time prices for assets
Premises, equipment and businesses are often most expensive at the height of a boom. Paying those prices locks in a high cost base and, if the purchase is financed with debt, exposes the business to falling asset values. Leasing rather than buying, or waiting, can be the better choice. The valuation thinking in Rising prices or a bubble? applies to business assets as much as to shares.
Borrow from strength, not from availability
Lenders compete to lend during booms. Credit that is easy to obtain can be very hard to repay when conditions change. Measuring borrowing capacity in years of normal-year earnings, rather than in what lenders will offer, keeps debt manageable. GoCore’s article Debt as a warning light explains the measures.
Build reserves
The boom is when reserves can be built most easily. Setting aside a portion of above-normal profits as cash, or using them to repay debt, creates the buffer that will matter later.
Watch customer credit
Customers in booming industries can grow quickly and order heavily, often on credit. When the boom ends, they may be the first to struggle. Credit checks, sensible limits and attention to slowing payments protect the business from being left with unpaid invoices.
Price for the long term
Booms often allow businesses to raise prices, and doing so is reasonable when costs are rising or demand exceeds capacity. But prices raised far above what customers would accept in normal conditions can damage relationships when the boom ends. Customers remember being charged boom prices, and competitors will use it against you in the downturn.
A balanced approach is to keep core prices fair and consistent, and to manage peak demand through lead times, scheduling or clearly temporary surcharges. Customers who feel they were treated fairly during the boom are more likely to stay when they have more choice.
Hire for the long term too
Booms make good staff scarce and expensive. Hiring rapidly to meet peak demand can mean lowering standards, overpaying and building a team that will be hard to sustain. Hiring carefully for roles the business will need in an ordinary year, and using flexible arrangements for the peak, protects both the business and the people who join it. Staff hired in a rush and laid off in a downturn are a cost to the business and a real hardship for them.
Recognising the turn
Nobody can time the end of a boom precisely, but some signals suggest that conditions are changing:
- interest rates rising after a long period of low rates
- lenders tightening standards or repricing facilities
- customers delaying orders, asking for longer payment terms or paying more slowly
- new capacity in your industry or your customers’ industries coming on stream
- falling prices for the asset at the centre of the boom, such as property or shares
- prominent failures among overextended businesses
When several of these appear together, it is time to shift from growth mode to protection mode.
Preparing for the downturn
Preparation is most effective before the downturn arrives.
Stress-test the business. What happens if sales fall by 20%, 30% or 40%? How long can the business continue at each level? Which costs could be reduced, and how quickly?
Secure funding early. Arrange or extend facilities while lenders are still willing, and avoid relying on facilities that must be renewed during the likely downturn.
Tighten working capital. Reduce excess stock, collect receivables promptly and review customer credit limits. Cash tied up in stock and receivables is cash unavailable for survival.
Review fixed commitments. Before signing new leases, contracts or hire agreements, consider whether they would still make sense in a downturn.
Diversify where possible. Customers in different industries, regions or segments reduce dependence on any one boom.
Managing through the downturn
When the downturn comes, a few priorities matter most.
Protect cash
Cash is the business’s lifeline in a downturn. A rolling cash forecast, updated weekly, shows how long reserves will last and when pressure points will arrive. Decisions should be guided by their effect on cash, not just on profit.
Act early on costs
Businesses that delay cost reductions, hoping conditions will improve, often have to make deeper cuts later. Reducing flexible capacity first (contractors, overtime, discretionary spending) protects permanent staff and core capabilities for as long as possible.
Look after core customers
Customers who buy for lasting reasons are the foundation of survival and recovery. Maintaining service quality, staying in contact and helping them through difficulties builds loyalty that outlasts the downturn.
Communicate with lenders and suppliers
Lenders and suppliers respond better to early, honest communication than to surprises. If difficulties are likely, raising them early, with a clear plan, often produces more flexible arrangements.
Avoid panic pricing
Deep discounts can win short-term sales but damage margins and customer expectations for years. Targeted offers, flexible terms or changes to the product mix are often better than across-the-board price cuts.
Positioning for the recovery
Downturns create opportunities for businesses that remain strong.
Assets become cheaper. Equipment, premises and even whole businesses become available at sensible prices, sometimes from competitors who overextended during the boom.
Talent becomes available. Skilled people who lost jobs in the downturn may be available to businesses that are still hiring.
Market share can be won. As weaker competitors retreat, customers look for reliable suppliers.
Investment can be timed well. Capacity built during a downturn is ready when demand recovers, and was bought at lower prices.
The principle is the same one described in GoCore’s article Price and patience: those who keep resources in reserve during good times can act when good assets are available at sensible prices.
Keeping a cycle diary
One simple habit helps businesses learn from each cycle: a short record of what happened and when. Note when demand started rising, when lenders loosened or tightened, when input costs spiked, when customers started paying slowly and when competitors expanded or failed. Over the years, this record reveals how your particular business experiences the cycle, which signals came first, and which decisions worked. Memories fade quickly once good times return; a written record does not.
A boom and bust checklist
| Phase | Priorities |
|---|---|
| Boom | Separate trend from boom demand; prefer flexible capacity; avoid boom-price assets; borrow cautiously; build reserves; watch customer credit |
| Turning point | Watch rates, credit, customer behaviour and new capacity; shift to protection mode |
| Preparing | Stress-test; secure funding early; tighten working capital; review commitments; diversify |
| Downturn | Protect cash; act early on costs; look after core customers; communicate; avoid panic pricing |
| Recovery | Buy assets and hire talent sensibly; win market share; invest ahead of demand |
A worked illustration
This is an illustration with two hypothetical businesses.
Two electrical contracting businesses operate in a city experiencing a construction boom. Both double their revenue over three years.
The first expands aggressively. It buys a large warehouse with a substantial mortgage, adds a fleet of financed vehicles, hires twenty permanent staff and takes on a few very large customers on long payment terms.
The second grows more cautiously. It leases a modest warehouse on a short term, uses subcontractors for peak work, keeps a cash reserve equal to three months of costs, and spreads its work across residential, commercial and maintenance customers.
When the boom ends, construction activity falls sharply. One of the first business’s largest customers fails, owing a large sum. Its mortgage and vehicle repayments continue while revenue falls. It is forced to lay off staff and sell assets at depressed prices.
The second business sees revenue fall too, but reduces subcontracted work, draws on its reserve and focuses on maintenance customers. A year into the downturn, it buys vehicles and equipment from a failed competitor at a fraction of their original cost and hires several experienced electricians. When construction recovers, it is the stronger of the two.
Common mistakes
Treating boom demand as the new normal. Plan fixed commitments around ordinary years.
Buying assets at the top. Leasing or waiting is often better.
Borrowing because lenders are generous. Easy credit is a warning sign, not a recommendation.
Waiting too long to adjust. Early, measured action is less painful than late, drastic action.
Neglecting the opportunities in a downturn. Reserves are for using when prices are sensible.
Questions to ask
- How exposed is your business to a boom through customers, inputs, funding, assets and location?
- What would sales look like in an ordinary year, and are your fixed commitments sized for that?
- How long could you operate if sales fell by a third?
- Which costs could you reduce quickly, and which are locked in?
- What would you buy, or who would you hire, if prices and availability improved in a downturn?
Bringing it together
Booms and busts test businesses at both ends. Booms tempt over-expansion, heavy borrowing and boom-price purchases; busts punish all three. Businesses that separate lasting demand from boom demand, favour flexible capacity, borrow from strength and build reserves can enjoy good times without being trapped by them.
When the cycle turns, those same businesses can protect their cash, look after their core customers and act on the opportunities a downturn creates. The aim is not to predict the cycle, which is very hard, but to build a business that does not need to.
Sources: an introductory chapter on asset bubbles written in the mid-2000s and widely used business practice. The worked illustration is hypothetical. This article is general information, not financial or investment advice.
