California & the Central Valley: How do Businesses Navigate the Future?

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by: Jose Blanco, April 2010

For the 18 months ended September 2009, the U.S. economy contracted. This is the worst era of economic decline since the Great Depression of 1929 and the Panic of 1873, where negative economic growth lasted 43 and 65 months, respectively. The U.S. economy has lost 6.5 million jobs and over 3% of its GDP since December 2007, the inception of the current decline.

In California, the economic decline has been particularly pronounced in areas dominated previously by heavy home building and commercial real estate development - Inland Empire, San Joaquin Valley, and Sacramento. These trends impacting California and the Central Valley will likely force entrepreneurs to reassess their business strategies.  Outside of California-specific trends, there are some broader economic developments for the local entrepreneur to be mindful of:

  • China's economy will be about half the size of the U.S. economy by 2013, and approach the same size by the 2030-2040 time period, depending on relative growth rates;
  • Water will be a global issue, as usage and extraction are expected to increase notably - demand will exceed supply in over 40% of the world by 2030;
  • U.S. consumption is expected to be well off the 3-4% growth pace since 1985 - the next 5 years will be influenced by Baby Boomers de-levering their household balance sheets;
  • Government regulation will become more prevalent - "coax rather than curb;"
  • The post-recession consumer will be more focused on simplicity and thrift

These global trends heighten the challenges and opportunities in front of California and the Central Valley. The nature of the current Financial Crisis suggests that the State and Valley may be undergoing permanent once-in-a-century shifts in economic behavior, rather than a temporary correction. If so, then businesses will be confronted by some of the following issues:

  1. Health care will remain a front-burner issue. The government's determination to provide guaranteed coverage for all will shift resources. Not unlike other countries, a two-tier system may emerge whereby basic care is provided by all employers in the first tier, while consumers demand, and go out-of-pocket for, the highest quality services available in the second tier.
  2. Real estate in the Valley may undergo a transformation since families are smaller, baby boomers are aging, and Gen Y likes closer and more social environments. The sprawl era is over for retailers; basic economics dictates a convergence between the current U.S. levels of retail square footage per capita of 20 and the European levels of 4 square feet per capita.
  3. Agricultural commodity prices will remain volatile. Ag producers and processors will look to grow crops (or new varieties thereof) that deliver a higher degree of reliability and food safety.

The 6,000 or so businesses with sales in excess of $3.5M in the Greater Central Valley will need to evolve to accommodate the coming secular changes awaiting business. The implications of the Financial Crisis will further challenge Valley entrepreneurs as they seek capital to finance expansion or undertake strategic acquisitions. This point is highlighted by the national Debt to Capital ratio in 2004 of 2.33, where total corporate debt equaled $12.1 trillion versus $5.2 trillion in corporate equity. This contrasts with the same ratio at the end of 2008 of 1.35, with $9.6 trillion in debt and $7.1 trillion in equity. Themes for California businesses will likely continue to include:

  1. Deleveraging balance sheets in order to deal with a more volatile economic environment and continuing capital scarcity;
  2. Continued focus on cost containment in order to defend profitability and hedge against a deflationary revenue environment (at least over the short term);
  3. More cautious strategic thinking - looking to consolidation and mergers as avenues for growth as opposed to heavy investment in expansion and growth;
  4. Proper capitalization of the balance sheet will become increasingly important in supporting small corporations as they move forward in this environment