Since the credit crunch of the summer a recession seems likely. The online retail sector may indeed be booming, but it only represents part of the economy and the other bits of the economy are suffering from a twin dose of cost inflation and asset price deflation.

It seems clear from our work that the news is likely to hit worst the businesses that are doing a bad job. Some trends seems likely to protect businesses:

a) offering a good product with transparent pricing; b) developing a loyal customer base, with strong recommenders; c) offering well informed, responsive customer service; d) having management that understands both the businesses margins and the needs of customers and is responsive to both.

Pricing has to be transparent, because there is no protection from competitors who are one click away (or even on the same price comparison page). Loyal customers are important and recommenders even more so, because shopping decisions are increasingly driven by consumer reviews. Customer service is vital because service is a key driver of recommendations - and a key source of complaint. Service is the most expensive and low-margin part of most businesses, however, so management needs a very good understanding of the business’s costs in order to figure out clever ways of delivering maximum value to both customers and shareholders.

The transparency of information about brands and businesses online is a powerful encouragement for businesses to do a better job. It is like what Adam Smith called the “invisible hand” of the market. It helps consumers (and businesses) make better-informed decisions. It punishes the weak and the opaque.

Companies that will suffer during the recession:

a) businesses selling products who brand appeal is achieved by expensive marketing campaigns, but which have poor reliability and offer poor service; b) service businesses offering unquantifiable benefits around (e.g.) “branding”; c) businesses with high fixed costs in old world distribution models.

The key to prosperity is to use Net Promoters methodology to select stock in businesses with strong word of mouth support, reasonable capitalisation and positioning in areas of the economy where shocks in the value of real estate, fluctuations in the price of raw materials and of labour are less likely to be critical. In fact, I would look for businesses with:

a) low capital requirements; b) the ability to shift costs to lower wage areas; c) the ability to reach a global market with low distribution costs.

(Update Tuesday 4th 12:06)

The fact that Tesco has announced higher profits despite the slowdown bears out some of this thinking. They offer price comparison, have good Net Promoter Score rankings, do a good job of customer service and manage their business with a high understanding of where their costs sit. FULL DISCLOSURE: Tesco are a current client of Market Sentinel.