Preparing Your Company for Recession

Face it: Financial crises are inevitable. To emerge strong, companies must be quick and smart in their responses.
Tim ReasonJanuary 30, 2008

“At kitchen tables across our country, there is a concern about our economic future,” the President said in his State of the Union address Monday night. He might well have mentioned conference-room tables, too.

Though the president never uttered the word “recession,” his speech came just before news that the Case-Shiller Index of home prices for November showed a year-over-year drop of 7.7 percent. That represents a loss of $1.6 trillion to American households — which have long been a steady buttress of the country’s economy. Recession or not, that’s an economic event that should have companies thinking about how to respond.

A new paper by The Hackett Group notes that financial crises are an inevitable part of the business cycle, and that companies that respond rapidly and wisely often emerge stronger. For Hackett, that involves a three-part strategy: look for cost-savings from long-term structural changes, seek ways to free cash from working capital, and hone your company’s planning and forecasting capabilities.

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Finding Permanent Cost Savings

One of the first and easiest moves a company can make in a downturn is across-the-board cuts. But that’s a mistake, say the researchers at Hackett. While some short-term cuts may make sense, now is the time to take on long-term cost-reduction initiatives, particularly in back-office functions. While “challenging and far from sexy,” Hackett notes, they are “permanent in nature.” Hackett, which classifies certain companies it works with as “world-class” performers, says the gap between the general and administrative (G&A) costs of those companies and their industry peers has increased 33 percent, with world-class companies spending on average $141 million less on G&A.

Long a proponent of shared-service centers and the use of cheaper, off-shore locations, Hackett suggests in its newest paper that companies push hard to move back-office functions — as well as increasingly complex analytical work — to these sorts of environments in the face of a downturn. In a 2007 study of global shared services, Hackett claims that 65 percent of firms implementing shared services saved more than 20 percent on costs, while 27 percent saved more than 40 percent.

As for moving overseas to cheaper locations, the paper says, “Globalization of work is no longer a leading-edge strategy, it should be considered a best practice for any company.”

Squeeze, Squeeze, Squeeze Working Capital
With banks taking it on the chin in the subprime mortgage meltdown, it’s not hard to imagine that financing is likely to dry up. But, as CFO has previously reported, companies have an often untapped internal source of cash available to them in their working capital. REL, the working capital division of Hackett, estimates that a $22 billion company has about $2.9 billion in excess working capital.

REL suggests that companies prepare for recession now by performing an analysis of the entire customer-payment process, beginning with the terms and conditions your company’s salespeople put in place. Understanding why customers pay when they pay is not only an essential step to reducing excess receivables, REL says, but it can also provide a baseline if customer payments slide further as a result of economic hardship.

Likewise, says REL, companies should review their inventory and supply base to avoid excess build-up of inventory. This is particularly critical, since a recession could leave companies holding excess inventory that can be difficult to liquidate. A part of that review, says REL, should be to carefully mull the common strategy of buying products and parts from low-cost regions, particularly Asia.

That’s often an effective way to reduce the cost of goods sold. But Asia, simply put, is very far away. That means companies often find their days of inventory on hand — which, don’t forget, includes inventory traveling slowly across the ocean in the hold of a cargo ship — can increase. So can lead times, which can leave companies stuck with obsolete materials. That’s not to say Asia shouldn’t be a source of products, just that with the cost savings comes a need to manage very carefully.

Measure Your Performance
Hackett admits that “enterprise performance management” is a dangerously overused catchphrase. But it still notes that companies must have the right technologies and processes in place to properly measure their performance — particularly in a recession, when rapid response to changing conditions can make a substantial difference to a company’s fortunes.

What does that mean in practice? First, says Hackett, implement a rolling forecast instead of a calendar-based budget. If that seems too hard, it’s probably because your company is making the forecast too detailed. Likewise, Hackett recommends using predictive modeling and Monte Carlo simulations to keep business units apprised of the larger business’s revenue and cost drivers.

That will help them forecast. At the same time, extend your forecasting systems out to your procurement organization and suppliers. That too, can help your company respond more nimbly to changes in commodity prices, regulatory changes, and competition.