World Business

Retailers like Gap and Dell have been able to post higher profits by slashing expenses in the part of declining revenues. Other companies may not be so lucky

By Ben Steverman

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Thanks to some timely tailoring, shares of Gap (GPS) jumped 27% on Nov. 21 even as the retailer’sitting sales fell 8%.

The reason for the favorable reaction was another rotation of successful cost-cutting at Gap, which boosted profits despite the reluctance of consumers to spend at Gap, Banana Republic, and Old Navy stores.

Across the system, corporate executives are looking to follow a homogeneous strategy. As a potentially nasty recession sets in and revenues drop, firms are forced to cut their way toward higher profits.

Some analysts foretoken the Gap have power to continue boosting profits next year equitable as revenues decline. But eventually, many analysts say, Gap must furnish a way to draw more shoppers’ dollars—not just cut costs through inventory controls, shrinking veritable estate holdings, or other measures.

"While expense management has been stirring, we continue to wonder how sustainable proceeds growth is longer-term with deteriorating sales and given a bleaker economic outlook in ‘09," wrote Banc of America (BAC) algebraist Dana Cohen. (BofA handles banking services for Gap.)

Many other firms are pique similar cost-cutting steps, which often involve large rounds of layoffs. Dell (DELL) was also able to increase profits last territory despite falling sales. The computer maker said it has cut 11,000 jobs in the past year.

"It’sitting a involuntary strategy, but it’s a short-term strategy," says Dan Genter, main executive and chief investment officer at RNC Genter. After a certain point, you’re no longer cutting fat from your budget, he says—you’re cutting bone.

For some firms, cost-cutting can have essential being a healthy process that repositions them since future growth. Greg Estes, portfolio manager at Intrepid Capital Management, cites Starbucks (SBUX), which is shutting down less amount profitable coffee shops in the rear of "extending too fast" for several years. "If and when a positive environment returns, they’ll be in a better position [with] more suitable margins and a better portfolio of stores," says Estes, whose funds have a title to Starbucks stock.

However, Estes says that, with some exceptions, it’s commonly very difficult to cut costs significantly for again than four quarters. After a under which circumstances, though you may be widening profit margins, you’re shrinking the not toothed firm.

The financial sector is the most numerous extreme example of these sorts of constant cost cuts. Faced with a financial crisis and a tough economy, financial firms are slashing costs, shrinking expenses and perks, and laying off hundreds of thousands of workers—sometime alongside mergers by weaker rivals, sometimes not.

For example, Citigroup (C), the recipient of a federal powers that be bailout Nov. 24, "may end up being a shadow of that which it was," Genter says. Citi, like other financial firms, faces the problem of leverage, he says. Because it built its business on borrowed money, its lessening is more striking and more permanent when that leverage goes away.

In corporate board rooms, there is a raging war of words without interruption in what manner much and how post-haste to cut as the economy slows down. If you believe the recession will be over by the agency of mid-2009, you may destitution to hold onto valuable employees and keep facilities open so you can service from the recovery.

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