Outlook 2006: The Big Squeeze

Economists are forecasting lower U.S. and flat world economic growth for 2006 and substantially slower profit growth for U.S. companies. Savvy CFOs are positioning their company to grow through the coming slowdown.

After a relatively brief period of strong revenue growth and better alignment between costs and pricing, corporations in the United States and abroad are now looking at a decisive downward movement in economic conditions and sharply higher costs without a commensurate increase in pricing power. "With the natural rate of growth slowing, companies will have to execute better and spend limited resources more effectively," says Frank Galioto, vice president at Booz Allen Hamilton in Chicago.

The International Monetary Fund's (IMF's) latest forecast puts world GDP growth at 4.3 percent for both 2005 and 2006, sharply lower than 5.1 percent in 2004. For the United States, the IMF projects 3.5 percent growth in 2005 -- well down from 4.2 percent for 2004 -- slipping to 3.3 percent next year. The euro area should improve slightly, moving from a 1.2 percent increase in 2005 to 1.8 percent growth next year, and Japan is expected to hold steady at 2.0 percent for 2005 and 2006.

The developing Asia area registered an extraordinary GDP increase of 8.2 percent in 2004 and will report 7.8 percent this year and 7.2 percent for 2006. Growth in Russia slowed this year to 5.5 percent after the breakneck pace reported for 2004 and will slip again in 2006 to 5.3 percent. Most of Latin America will see stable or slightly slower growth, according to the IMF. (See World Economic Growth, below.)

PricewaterhouseCoopers' latest survey of CFOs at U.S.-based multinational corporations shows rising pessimism about economic growth and the impact of higher energy costs on revenues and gross margins. Finance executives are bracing for tougher times by making a renewed commitment to trimming costs and reducing their companies' vulnerability to cyclical slowdowns.

Galioto explains how. "Companies are working harder to do more with what they spend," he says. "This goes beyond cost-cutting, where most companies have focused relentlessly on overhead costs but have not always touched the crown jewels of the company that all too often go unchallenged -- R&D in innovation-intensive industries, marketing and trade spend in consumer companies, capital in industrials. The best [organizations] are looking hard at how money is spent and are applying more rigor before, during and after these events so spending behavior changes and improves. Companies that do this rigorously and relentlessly will be at an advantage in a lower-growth environment."