Recessions happen about every nine years, and our global economy is due. As the coronavirus outbreak worsens globally, top analysts warn that recession is looming. Furthermore, U.S. economists point to two other indicators: an inverted yield curve (a negative comparison of 10-year and 2-year Treasury bonds) and precursors to monetary inflation, including low unemployment and rising wages. An August 2019 report by the National Association for Business Economics noted that 72% of economists surveyed believed that a recession is likely to occur by 2021. Likewise, The Wall Street Journal conducted a survey of private-sector economic forecasters, and more than 65% of those surveyed believed that the U.S. manufacturing industry is already there.
There isn’t much we can do to prevent recessions; they are a normal part of a functioning economy. How we prepare for that eventuality, however, is within our control. As explained by Bruce Arntzen and Nima Kazemi, researchers from the MIT Center for Transportation and Logistics, companies tend to become lax during the “good times” of a strong economy. The study, “Recession Readiness in Supply Chains,” compared business practices of 100 firms in 2007, 2009 and 2018 and found that organization leaders tend to stop worrying about a recession after a few years, letting best practices fall to the wayside. It is essential to take this seriously and shore up processes now so that an economic downturn doesn’t equal disaster.
HOW COMPANIES FAIL
During a booming economy, cash flows through a supply chain in several ways, explains Arntzen in an interview for MIT’s MicroMasters program. Money goes to the supplier, to the employees and to fixed business costs. It comes into the company from final customers. In such a scenario, everyone is happy.
When the stock market crashes, however, customers may instantly cancel new orders, try to withdraw existing ones and stop the flow of products into their business. They want to cease spending money immediately. But during a recession, cash is the most important asset a company can have. Without money coming in, that organization must turn to cash reserves. And if those are gone before the recession is over and spending begins again, survival is hopeless. According to a 2012 report by The Business Journals, more than 170,000 businesses closed between 2008 and 2010, during the Great Recession.
As previously noted, during periods of strong economic growth, companies often let their standards drop. Arntzen and Kazemi cite the following mistakes, which make it extremely difficult to prepare for a recession. They include
- relying on “handshake” deals instead of contracts that clearly stipulate a business agreement
- relaxing sales terms, including allowing invoices to stretch from 30 days to 45 or 60, thereby causing a lack of cash when it’s needed most
- neglecting collections for payments owed
- using exciting, high-tech materials or customized designs instead of standard materials in production
- failing to conduct due diligence and check partner financial statements
- bloating the workforce, buying or renting more warehouse space, or acquiring more facilities than necessary.
During the MIT graduate-level-course webinar, Arntzen also warned against allowing too many people in the organization to make purchases: “When the recession hits, everyone has the opinion, ‘Oh yeah, I know there’s a recession, but I just need to buy these extra few little things, and these few little things aren’t going to bring the company down. If you multiply that by everyone in the company, of course it brings the company down.”
To avoid having to make a hasty pivot when the economy starts to falter, prepare now. Karin Bursa, executive vice president of marketing at supply chain planning and analysis solution provider Logility, says her customers who had a plan in place — and a playbook for its implementation — were the most likely to overcome a crisis. She recalls that, during the Great Recession, consumers saved money by switching from name-brand products to private labels. Of course, many private labels are produced by the same companies making the brand names. Bursa says smart decision-makers chose to make more private-label products, thus staying profitable, protecting their brand’s good name and giving cost-conscious consumers what they were looking for.
Bursa says the same concept holds true for the automotive industry: During a recession, consumers are more likely to delay purchasing new vehicles; so, manufacturers might choose to slow production of new cars and trucks and pivot to selling aftermarket parts and performing repairs.
Another important aspect of preparation is taking advantage of new technologies. The amount of consumer data available data in 2008 pales in comparison to what we have now. “Companies can leverage so much more data and gain so much more insight today,” Bursa says.
Businesses have access to more than just receipts and inventory; there are email lists, online search histories, social media connections and much more. Using artificial intelligence, automation and analysis software, supply chain organizations can effectively manage this influx of information — and use it to their benefit when preparing for an economic downturn.
In a 2018 report, Deloitte lists four steps companies should follow to prepare for the next recession:
- Adopt technology and automation to leverage growth. Labor costs are going up while technology costs are going down — a perfect opportunity to restructure, elevate new and existing talent, and automate certain processes.
- Build a “war chest.” As with the MIT study, Deloitte emphasizes how important cash is during a recession. The way to create that cashflow depends upon the business, but reassessing debt levels, making strategic investments and getting rid of underperforming assets are proven methods.
- Embrace partnerships and find ways to combine related departments, including “overlapping supply chains and inventory management efforts, independent product development, and unconnected pricing analysis and markdown planning.”
- Figure out why you matter. Consumers, retailers and wholesalers have a lot of opportunities to buy elsewhere. Give them a reason to choose your business. The researchers emphasize that you should be “crystal clear” on who you serve, how you serve them and why they should care.
Steve Minsky, CEO of risk-management solution provider LogicManager, asserts that a recession is a risk to prepare for, like any other. He suggests looking for personnel gaps and defining needed talent; identifying vulnerable customers; evaluating supply chain weaknesses, including issues with contracts, vendors and advisors; and reviewing potential security and privacy concerns.
“There’s a misconception that core business priorities, shifted by the recession, will bounce back after the recession is over,” Minsky writes in a blog post. “On the contrary, these priorities typically shift permanently as a result, which means preparing for this kind of change earlier rather than later will give you a sharp competitive edge.”
In an April 2019 audio interview for his company’s McKinsey Podcast, Senior Partner Sven Smit cites research findings on businesses that fared better during the Great Recession. The companies that survived the downturn — then thrived — had a few key things in common. First, they built the cash reserves mentioned previously. Second, they proactively cut operating costs, which the nonresilient companies postponed until after the crisis. “The resilient companies also worked hard at leverage, in particular through divestments. They got into a much better cash position that also allowed them to then invest in the future path. That was quite substantial.”
In other words, resilient companies act quickly, putting themselves in a stronger position almost immediately. Furthermore, they don’t lose their focus as the recession continues. This enables them to keep accruing gains while other businesses falter or fall behind.
According to consulting firm Bain & Company, warehouse club Costco made major financial gains in the last decade, despite the recession. Costco chose to restructure its stores to carry less variety of goods, shift the types of products on offer, and reduce storage costs by centralizing prescription centers and increasing its practice of cross-docking.
Costco also doubled down on the thing its customers care about most: discounts. The retailer followed consumers’ desire to switch to a high-quality store brand and invested in its private label, Kirkland Signature. According to Costco’s former CEO, Jim Sinegal, the mass appeal of those store-brand products and Costco’s low prices even led competitors, such as Procter & Gamble and Kraft, to lower their prices.
Bursa recalls a food and beverage client she worked with that survived and thrived not during a recession, but a similarly tricky period: an avian influenza outbreak. Continental Mills creates baking mixes, packaged goods and other food products. The bird flu affects chicken eggs as well as chickens themselves. Of course, eggs are a key ingredient in many baked goods. In order to avoid using potentially tainted product, Continental Mills acted quickly to find alternative sourcing. The company reformulated recipes to replace eggs with other ingredients that provide the same taste and texture. Company leaders also chose to narrow the product line, focusing on the most popular items to help them prioritize what was important to the customer.
“In just a few weeks, they would find a resolution for one of their key product groups, then begin working on another product group,” Bursa explains. “At the same time, they were reworking the production process.”
In the end, the company was able to reduce inventory obsolescence from $1 million per year to almost nothing, improve inventory turns by 20% and reduce forecast error in one division by close to 50%. That significant of a boost to a business’s bottom line — whether necessitated by natural disaster or recession — can make the difference in that company’s survival.
The ability to think and reformulate quickly isn’t possible without having a clear, documented strategy in place. As Bursa urges, “Don’t be caught without a plan and a playbook that forces your team to come together and think through the impact of each decision.”