Recession is always around the corner – but is that corner edging closer?
Here, Guy Strafford, Proxima’s executive vice-president of market engagement, advises what should be done to ensure you are prepared.
The UK’s Brexit-related issues continues to affect growth in 2019, and other economies also appear to be weakening at the same time. In the US, economic growth is slowing and is predicted to slow further through H1 of 2019. The bond yield curve has inverted for the first time in a decade and this, according to the president of the New York Fed, John Williams, has
been a reliable predictor of recession over the past 60 years. History suggests that a flip into recession is not instantaneous, in 2005 it took 28 months, but there were a unique set of prevailing circumstances.
To make it worse, China, the great global growth train of the past 20 years, is not growing at the pace it once was. There have been doubts raised about reported growth figures (Michael Pettis at Carnegie Endowment for International Peace) argues that the true growth may be as low as half of what is reported, but even these point to a slowdown.
In China’s case, growth has been overly funded by investment, rather than consumption, with the Chinese consumption to GDP ratio of 38% lagging far behind the global ratio of 60%. In fact, the debt to GDP ratio has more than doubled in the past decade. China can keep posting positive growth until the debt turns bad, but the scale of, for example, property building that has occurred, may mean that even China cannot deflect the laws of economic gravity and the business cycle for much longer.
We are nearly a decade into a growth cycle. In their book ‘This time is different’, Carmen Reinhart and Ken Rogoff famously diagnosed that almost all financial crash cycles usually look like 10 years of slow growth followed by recession. Sound familiar?
This time, there might be a global slowdown, and not just a national one, fewer government levers will be effective to mitigate the change. Many countries are more heavily indebted than they used to be (and face a public sector pensions and healthcare time bombs); interest rates are already relatively low so offer less room for manoeuvre.
Prepare for battle
Clearly, a recession is bad news for business, pain will be felt and hard decisions will need to be made and many of those decisions will involve suppliers. External suppliers are now 5/6th of the cost base of most large corporates and since 60% of UK procurement functions report into finance, the CFO is undoubtedly accountable for getting ‘recession ready’ from a cost perspective, but also for ensuring that businesses are operationally sound during the downturn. So what should you be thinking about? At its heart, the key question is what sort of business are you going to be during the recession?
Typically, the temptation is to centralise and hunker down, but this carries serious risk in a world increasingly inhabited by agile, growth-oriented competitors. For many the competitive landscape has changed and businesses will need to be smarter to come out the other side in good health and ready to act fast.
Figure 1. US GDP annual growth rate
Figure 2. China GDP annual growth rate
A brand-new way
The challenge for a CFO is to ensure that they cut smart and allocate investment funds to growth areas. Intuitively, this means that the CFO needs to start now by getting a granular understanding of what is spent, with whom and how it impacts key business objectives. Additionally, the CFO must understand taking out costs in all the smart places. Arguably this process is going to involve a new way of looking at spend and one which is common neither in finance nor procurement today. Terms like ‘strategic’, ‘operational’ and ‘tactical’ should be replaced with terms like ‘productivity’, ‘enabling’ and ‘growth’, as we seek to understand the real impact of suppliers and how we can get recession ready and growth ready. This doesn’t mean that we won’t centralise, cut and hunker down; rather, it means that we will be making more informed decisions about ‘the why’ and the effect of doing so.
The challenge for a CFO is to ensure that they cut smart and allocate investment funds to growth areas. Intuitively, this means that the CFO needs to start now by getting a granular understanding of what is spent, with whom and its impact.
CFOs can make a choice now about how to ride the recession. For example, going into a recession with a cash pile and making a deliberate decision to keep investing in marketing to allow yourself to emerge profitably out the other side when others have cut back their market visibility is a good example of one choice to make.
Another important consequence of getting recession ready is that it allows you to consider the nature of the relationships that you want to have with your suppliers. In survival mode, all timelines narrow and tomorrow is another day, but understanding now which suppliers you are willing to bludgeon and whether this matters, is as important as understanding where you need to continue to invest to accelerate and grow. It is better to do this when you are not under pressure and have more time to reflect.
The last thing to ponder on is how might this recession be different to previous ones? How will digital impact for instance?
Shape up and stay afloat
No one loses weight overnight and no one gets fit immediately. Bad habits take a while to stamp out, so start now. You have a choice about how to make the business cost conscious and how to accelerate this.
This will be the time as people do not instantly become commercial animals. It is a journey in any business that has been run for growth during the good years and has acquired questionable habits. There are six habits of recession-ready thinking that will help launch a commercial cost programme. Prepare the business for a big change. Difference can be good, as you tighten the procurement policy decision making and approvals:
- Find out where you are spending your money and on what. Get the spend data and request more detailed expenditure information from your suppliers. It will at the very least put them on notice.
- Find your vulnerabilities now. Which suppliers are overleveraged? (a recent Bank of America Merrill Lynch study showed that 13% of public companies over 10 years old are making less profit than the interest costs on their debts). These are the great beneficiaries of the preservation of commercial businesses that might have otherwise previously gone out of business had capital not been so easily available and interest rates kept so low. However, if these companies are losing money after a relatively benign period, what happens in the downturn? All of these problem suppliers need to be protected, as well as ejected.
- Verification and variability – are you getting what you pay for? Review the contracts and also look for any benchmarking clauses. Do you have the balance between fixed and variable costs right? You may be a smaller business in 18 months, so do you want to have more flex in the cost base?
- Benchmark yourself. Figure out whether you be paying less and buying a lot smarter now?
- Declutter – businesses have a tendency to overcomplicate given half a chance. What can be simplified and removed?
- Speed up – you need to make an impact now so the decision-making architecture needs to be cut short in many businesses. Set up a weekly ‘star chamber’ to review all material new spends being proposed.
Research from McKinsey discovered that “nearly 40% of leading US industrial companies toppled from the first quartile in their sectors during the 2000–01 recession, and a third of leading US banks met the same fate. At the same time, 15% of companies that had not been industry leaders prior to the last recession vaulted into those positions during it”. By and large they did this by being recession ready, with smart allocation of capital to spark growth.
Now is the perfect time to get fitter and leaner.
The original article appeared in Financial Director Europe Publication.