No margin for error: A guide to thriving in a recession

For battle hardened business leaders, an economic downturn is unwelcome. But it’s also familiar. From the Great Depression to the 2008 Great Recession (Global Financial Crisis), this has been seen before.

But this time the market conditions are different.

It’s the end of a 13-year bull market. We’ve seen the fastest stock drop in history with a significant decline across all indices. Every asset class has been bubbled or affected by financial contagion. The potential of unexpected failings is profound.

Current market 101

What makes this latest (expected) crash so unusual is the potential for stagflation. A rarity that happens when high inflation persists even as the economy slows and unemployment rises. The World Bank recently warned that “several years of above-average inflation and below-average growth now seem likely”.

Money to burn and time to kill.

The past two years have seen individuals and businesses awash in money and debt. And thanks to being stuck at home, many more everyday people (retail investors) are now exposed to stock market moves.

This is compounded by cryptocurrency making its move to the mainstream and the collapse of so-called ‘stable coins’. Suddenly we see that a big chunk of the middle income global market is woefully exposed. The world is facing tough economic times.

The response

Central banks are aggressively raising rates. Companies’ lines of credit are contracting. As rates rise, capital funds, businesses and consumers alike are getting spooked. Consumer spending is down, revenue streams are being hit, small business and large companies alike are feeling pain, profit margins are being squeezed. The economic uncertainty is leading to tough times, reduced spending and a negative financial spiral.

Lockdowns and landmines

Adding to this gloomy global mood is the outsized impact of China’s zero tolerance approach to Covid; as of writing, Omicron has just been detected there. Being in lockdown is stifling Chinese demand but also impacting the global supply chain. China is still the world’s factory and with so many people out of action it’s difficult for businesses to import or create the goods for those still willing to buy.

On top of this we have global concern, and real impact, from the war in Ukraine. Energy prices are soaring, key commodities are becoming constrained and general unease is afoot.

Learning from the past.

Show me the money (now)

In a downturn, revenue growth takes a backseat while margin and cash flow defence becomes the priority. In response, businesses employ four key 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.

Here in the 2022 environment, switching suppliers is risky or impossible. The labour market is so tight that minor changes risk employee flight. And as payment cycles stretch out, the relative buying power of a dollar today is more than a dollar in the future, bringing next level complexity to cash flow management.

Even automation and productivity improvements offer minimal help as high inflation erodes margins. Leaving businesses the most delicate task of passing on cost inflation to customers without impacting sales volumes.

Lessons from the GFC

In 2019, McKinsey Consulting released research showing how the most resilient companies not only survived but thrived in the upswing from the GFC.

They noted that pre-recession, the most resilient companies looked similar to others in terms of revenue, but “they created a significant gap through the recovery, and then doubled that gap, or more, post recovery”.

The magic formula

They found that the most successful companies:

• 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.

We gut-checked this advice with a number of local business leaders and have summarised their insights and golden pieces of advice here for clarity.

Pause and take stock.

Things are going to get rough, but take a breath first. Take a couple of months to get your house in order, but be sure to strike the right balance. Do not do wild things, but equally, you need to be ready to move when an opportunity arises as the economic conditions change.

Use this time to get back to basics (see below) and watch the market closely to see which way it goes. Take a hard look at your current financial situation, business strategy, marketing activities, human resources, operational imperatives and your core business in general, in a meaningful way.

Back to basics.

It’s easy during a bull market to let ‘good hygiene’ business tasks fall away. Now is a good time to bring them back to the fore. Here’s what the battle hardened business leaders had to say and how it relates to the top three bullet points McKinsey research highlighted: cutting operating costs, improving productivity through technology, and work hard at 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.”

Consider these steps:

• 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)

• Systematically assess your exposure and vulnerabilities, at a company level and by business unit. For example:
  • Cash flow
  • Compliance
  • Supply chains
  • Cyber security
  • Customer loyalty
  • Marketing strategies 

• 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? 

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

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

Prepare for the upswing

The good news is, there will be an upswing. Recessions usually last for a maximum of two years and according to both McKinsey and our sage business leaders, now is the time to get ready for action.

As McKinsey senior partner Sven Smit explains, ‘Often what happens [in the face of a downturn] is that people ratchet down, and then they wait too long to bring it back up. That’s where the nuance hits. Postponing is a good way to think about it because…once you know [the recession wasn’t as bad as expected] you should put the gas back on. Putting the gas back on is a hard thing.

What not to cut

With all this talk of cost cutting and balance sheet strengthening it seems counterintuitive to remind business leaders they still need to spend. But there are a few areas that you should invest the same or more in:

Compliance

Compliance obligations do not disappear in a recession. In fact, now is the time to optimise for it. With businesses failing, regulators have more time to go deeper and act quicker on marginally compliant organisations. This is an area ripe for improvement through technology.

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.

R&D

Continue to develop your product in a way that adds value to customers and further differentiates you in the market.

Customer service

Further use technology to identify your most valuable customers and level up the service you offer. Competitors will try to poach them, so make it difficult. This is also the time to let go of unprofitable or troublesome customers.

Final thoughts

“If you’ve set yourself up properly, that period coming out of a recession can be quite a high growth period, especially those well positioned for merger and acquisition activity. Look for those competitors that are failing but have a unique competitive advantage. They’re the ones to absorb. So making sure that you do have that capital there, you’re running lean and you have a clear strategic vision around where your business is heading. Those businesses will be the winners.”