Ahead of the curve and the recession

Thriving through a recession

The potential for an economic downturn is unwelcome and one appears to be knocking on the door. Over time there have been other downturns such as the 1987 Stock market Crash and the Global Financial Crisis (GFC) in 2008. The backstory to current market conditions is quite different this time which makes for some uncertainty.

We are coming off a 13-year surge in the stock market from the end of the GFC and unprecedented house price gains. As the stock market has come off the boil in the last 6 months this has seen significant declines across all indices and red ink across portfolios. This has spread to other asset classes and combined with climbing interest rates, and government policy settings, has seen residential property prices dip in some areas as well. There is the potential for numerous business failures with headwinds ahead.

State of Play

Some of the economic chickens are coming home to roost. Around the globe Governments printed money, and took on additional borrowing in an attempt to curb the economic impact of the pandemic. The past two years have seen some individuals and businesses flush with money and debt. Due to poor returns elsewhere many more everyday people are now exposed to moves in the investment markets.

Government central banks around the world are aggressively rising interest rates to curb inflation. This is a factor contributing to record levels of inflation with shortages also driving price increases.  Companies’ lines of credit are contracting. As rates rise, investment funds, businesses and consumers are getting spooked. Consumer spending is reducing (in part due to mortgages being more expensive), revenue streams are being hit, and businesses across the board are facing constraints and feeling pain leading to profit margins being hit. The economic uncertainty is leading to tough times, reduced spending and the prospect of a negative financial spiral.

Global factors are also causing headaches. China’s zero tolerance policy to Covid-19 has a magnified impact on the global economy. Lockdowns there affect Chinese demand and have a major impact on the global supply chain. Whenever the Chinese ports are out of action or factories are closed with people in lockdown it is difficult for creation of new goods and the import/export economy. The war in Ukraine is also having an impact on the global energy market. Energy prices have soared. Key commodities are also becoming constrained and general unease abounds.

We are now in the unusual position where there is the potential for stagflation. This happens when high inflation persists even as the economy slows, and unemployment rises. In June, the World Bank warned that above average inflation and below average growth may be likely to persist for several years.

Lessons from the past

In a downturn growth takes a backseat as hunting every dollar becomes critical with margin and cash flow management being key. Businesses respond with four main strategies:

  • Cost-cutting to restore profitability (including switching suppliers and lay-offs)
  • Production adjustments to lower demand levels (also reducing wage bills and improving working capital by having less tied up in inventory)
  • Using alternative sources of liquidity (extending their own payment delays, reducing or suppressing dividends – if any)
  • Postponing investment and expansion plans, when possible.

In the 2022 environment switching suppliers is often risky or impossible. The labour market and demand for talent is such that minor changes and $1 per hour either way can lead to employee flight. And as payment cycles stretch out, the relative buying power of a dollar today is more than a dollar tomorrow, bringing additional complexity to cash flow management.

Business improvements may offer only minimal respite as high inflation erodes margins. Businesses find themselves in the delicate position of trying to pass on cost inflation to customers without impacting sales volumes.

Cash is king

Learning from the GFC

McKinsey Consulting researched the companies most resilient during the Global Financial Crisis who thrived in the upswing post GFC. Starting at similar revenue levels the differences between these companies and their competitors led to them creating a significant gap during the economic recovery and that gap at least doubled post recovery.

The most successful companies managed to:

  • Proactively cut operating costs
  • Invested in improving productivity per employee through technology
  • Worked hard at leverage (in particular) through divestments
  • Invested in the future path ready for fast recovery and market share expansion

Returning to Fundamentals. Prepare to Thrive

Insights on putting your business in the best position to capitalise on opportunities.

Pause and take stock.

Things may get rough but take a breath first. Take a couple of months to get your house in order but try to strike the right balance. Don’t knee-jerk with wild decisions, but you need to be ready and able to move when opportunity arises, and as economic conditions change.

Use this time to ensure the basic business fundamentals are right and watch the market closely to see which way it goes. Take a hard look at your business current financial situation, strategy, marketing, human resources, and the core business in general.

Back to Basics.

When times are good it is easy to lose sight of the ‘good hygiene’ business tasks. Now is a good time to bring them back to front of mind and act on them. Here are some summarised thoughts on what business leaders had to say in relation to the top three points that the McKinsey research highlighted: cutting operating costs, improved productivity through technology and working hard on leverage.

“Reduce costs now. We’re seeing bubbles pop; small tech has already gone so the market is in an aggressive tightening phase. This will only get tighter. Consider what’s coming down the pipeline for your business from an opportunity and risk perspective. Ask yourself and your management team, how do we manage the fundamentals, stay lean and prepare for opportunities? Go deeper, to the core of your business rather than wider.”

Think about these steps for your business:

A. Undertake scenario planning to understand the business impact depending on how the market may turn. Test three scenarios; mild, medium and severe. Look at:

  • Value from current customers
  • Business growth objectives
  • Customers’ needs
  • Business strategies (including growth plans, expected consumer demand, core competencies, expected customer service and key performance indicators)

B. Systematically assess your exposure and vulnerabilities, at a company level and by division or branch. For example:

  • Cash flow
  • Compliance
  • Supply chains
  • Customer loyalty
  • Marketing strategies
  • Cyber security

C. De-leverage your business for better balance sheet resiliency. Strict financial management is key. Think through:

  • Based on the scenarios, what CAPEX or spending is planned that you don’t necessarily need?
  • Consider how best to reduce the debt burden on the business, particularly given rising interest rates.
  • What core business services are ‘nice to’ not ‘need to’ that will retain your loyal customer base?

D. Find efficiencies:

  • What processes can be eliminated or significantly restructured?
  • What technology can you better leverage?
  • Do you really need that new employee, or can you do more with less? Can you outsource for shared cost and less risk?

E. Assess your competitors and look for diversification opportunities:

  • How’s customer experience at competitors compared to yours?
  • Are there new markets you can enter to spread risk?
  • Are your competitors over exposed and ripe for an acquisition?

Prepare for the bounce back

The good news is, there will inevitably be an upswing. Recessions usually last for a maximum of two years and now is the time to prepare and get ready for action.

To paraphrase Sven Smit of McKinsey Consulting: Often in a downturn or in the face of one people ratchet down and become defensive. Waiting too long to ratchet backup and pursue growth can be a missed opportunity. That’s the nuance of timing. Postponing growth initiatives is a good way to think about it because once you know that the recession wasn’t as bad as expected you should put the gas back on. Deciding to put the gas back on is a hard thing.

What not to cut:

With such a major focus on cost cutting and reducing debt it seems counter-intuitive to highlight to business owners that they still need to spend. But here are a few areas that you should consider spending the same or more in.

  • Compliance – Compliance obligations do not disappear in a recession. Regulators have become far more stringent, and the penalties and implications of non-compliance can be severe. This area can be ripe for improvement via technology for some businesses.
  • Marketing – Spend your marketing budget more thoughtfully. Others will be cutting back so continue to invest in this space while there is less noise in the market and customers are open to doing more with less. Speak to the points of productivity gains, revenue growth and customer acquisition.
  • Research & Development -Continue to develop your product or services in a way that adds value to your customers and further differentiates you in the market.
  • Customer Service – Spend time or use technology to identify your more valuable customers and enhance the level of service you offer. Competitors will try and poach your key customers so make it difficult. This is also the time to think hard about any unprofitable or troublesome customers. These need to be turned around or let go.
  • People Development – How can you grow the skill and capability of your team? People are the engine room to your business, and you need them firing on all cylinders and engaged. This may lead to a re-think of how you work. The pandemic has highlighted different ways of working. Now may be the chance to develop a new more effective operating model that works for your business and staff navigating these uncertain times.

Setting up to hit it out of the park and grow

If you have set yourself up well, the period coming out of a recession can be quite a high growth period. Opportunities may also present where competitors are failing or looking to sell. Look for the competitors that are failing but have a unique competitive advantage. They are the ones that you want to absorb. So, make sure that you have the access to capital, that you are running lean and that you have a clear vision around where your business is heading.

 

For advice specific to any of the above or you would like help understanding your business better please speak to your relationship manager or give us a call 0800 282 887, we’re more than happy to help you get the most out of your businesses and set up for success.

 

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