Rising Gas Prices, Slowing Economy Squeeze Small Businesses

Like much of the country, small business owners have watched helplessly as oil prices have continued to soar. This week prices reached a record $115 a barrel. Pump prices across the nation are now averaging about $3.38 a gallon for gas and $4.11 for diesel, both all-time highs.

In a market like this, the only actions business owners can take is raise prices, cut costs, or operate more efficiently. But small businesses operate on thinner margins than large corporations and have less leverage to negotiate product pricing, transportation, marketing, and labor costs. Because the economy is also slowing, the ability to raise prices is limited. The effects of the squeeze are evident throughout the economy, but small businesses are feeling the most pain.

In recent congressional hearings and in a couple of new studies, experts have begun to document how small businesses are being hurt by higher gas prices specifically, and the downturn in consumer spending in general.

Michael J. Graff, who started Graff Trucking in Pennsylvania 12 years ago, is feeling the effects directly. "I am at the point that I am questioning my ability to continue to operate," he told the House Small Business Committee recently. Fuel, he said, is now the biggest expense for his nine-truck firm. "Operating without a fuel surcharge or increasing prices is no longer an option."

Tim Williford, vice president for finance for Southern Piping in North Carolina, told the committee that one firm in his trade association saw its fuel costs rise to $70,000 last year, up from $45,000 in 2005. If current trends continue, that company expects to spend as much as $88,000 this year.

"Over the last two years, our company fuel costs have nearly tripled. Our monthly usage was $22,000 per month; now it's $55,000," he said. This is all happening when the downward price pressure of the market won't allow us to raise prices. That's $33,000 right off the bottom line every month, [or] $400,000 per year." His firm has 72 trucks. For every 10-cent increase in gasoline, his company's costs rise by $35,000.

In the face of these cost increases, Williford said his company has been forced to cut elsewhere. The company recently shelved plans for a wellness program and is considering reducing contributions to employee retirement plans and raising employee contributions for health insurance. "These are painful reductions. We have to compete very hard for employees coming from a very limited talent pool," he said.

The direct costs of rising fuel prices are painful enough, but the indirect costs are also crippling. Oklahoma City University's Meinders School of Business conducts a regular survey of consumer confidence, which has declined steadily since last October. According to its most recent poll in March, half of those surveyed said the coming year will be bad for business, up from 37 percent in October. Fifty-three percent said they have changed their spending habits because of rising gas prices. This does not bode well for many small businesses.

When gas hits $3 a gallon, consumer discretionary income declines enough to affect the frequency of discretionary spending like dining out, said Vincent F. Orza, Jr., dean of the Meinders School of Business, who presented the survey to the House Small Business Committee. Indeed, casual-themed restaurants have reported losing 10 percent of their customers since gas prices started skyrocketing. Soft good purchases, such as clothing and sundries, mainly from small businesses, have been the next to go. "Thousands of independent merchants are down, along with ticket sales at movie theaters," Orza said.

Although the number of small retailers that have closed is unknown, trends at major chains suggests that the decline in discretionary income is devastating many. Liz Claiborne is closing 54 stores; Ann Taylor is closing 117 of 921 stores, and even Starbucks is struggling with lower sales. Retail vacancy rates have risen 11 straight quarters to the highest level since 1996. "All of this paints a dark picture for small businesses across our nation," Orza said.

Unfortunately, the trend is likely to continue. Many economists believe that oil will probably rise to about $120 a barrel by summer and will hover around that level for the foreseeable future. Even with a significant drop in consumption in the U.S., prices are unlikely to drop significantly because price pressure is coming from growing demand in developing countries and China. That means $4 a gallon gasoline is just around the corner. Last summer, I warned about gas prices in a column, Ready to Pay $4 a Gallon? Now it almost seems quaint. At the time, oil was about $78 dollars a barrel. So, if prices are unlikely to decline, and the slowing economy is limiting the ability to raise prices, what can small businesses do? The only alternative is the third option, operate more efficiently.

The gas crisis is going to be with us for a while, and there is little the government can do about it. Even proposals such as Republican presidential candidate John McCain's to suspend the 18-cent-a-gallon federal gas tax is unlikely to provide much relief. Economists say it will only increase demand in a market where global demand is the principal culprit for rising prices. The new credo for small businesses is get more efficient, or get ready to go out of business.