Tension between superpowers. Tariffs. Rising interest rates. Volatile markets. Stagnant wages. Brexit. A flattening yield curve. Most of all, a 10-year run of relatively stable economic growth that is long overdue for a correction.
“There will be a recession because there has to be,” says Robert Alessandrini, finance chief at IT staffing and consulting firm The Judge Group. His peers agree.
However, few expect the downturn, likely beginning this year or next, to resemble the Great Recession of 2008-2009. Then again, before that deep trough hit, few foresaw the degree of financial devastation it would ultimately wreak.
Whatever the depth and duration of the presumed economic slump, CFOs — especially in such vulnerable industries as manufacturing, retail, construction, technology, and travel/hospitality — have decisions to make in advance. What should they do to get ready?
No single strategy stands out. CFOs are mostly blocking and tackling — shoring up balance sheets, locking in credit lines, and shaving costs, while determinedly maintaining investment in key growth initiatives.
But how they choose to execute such strategies, which additional ones they employ, how agile they are in doing so, and the psychology of their response to stressful times may determine how well (or whether) their companies survive the coming storm.
Nip and Tuck
Like many mature companies, toolmaker Stanley Black & Decker strives to keep a low debt-to-EBITDA ratio. The ratio is currently at two, the target number. Historically, in order to finance one of the many acquisitions that have fueled the company’s growth, the company has allowed the ratio to flex up to three, CFO Donald Allan says.
“We wouldn’t want to do that now,” says Allan, noting that the executive team started discussing recession preparations late last summer. By borrowing to finance an acquisition as small as $1 billion, “we’d risk getting into an awkward situation where leverage was too high and liquidity was too low.”
Stanley Black & Decker has already suffered ill effects from the Trump administration’s high tariffs on imports from China. The company sources “a fair amount” of finished product, components, and raw material from Asia’s largest economy.
That Stanley Black & Decker is taking the prospect of a recession seriously is evident from its October announcement of $250 million in cost cuts. About 70% of that amount will be achieved through paring head count by 5%. “We don’t tend to do significant cost-reduction programs when the economy is relatively stable and growing at a healthy rate,” Allan says.
At The Judge Group, a $500 million privately held company, CFO Alessandrini is scrutinizing client relationships. If customers’ orders for IT staff start to fall, presaging an economic downturn, “we will stop doing business with clients that can’t pay us on time, clients in industries with poor cash flow or weakening fundamentals, and clients with sinking credit ratings,” the CFOs says. “And any client we [continue to] do business with, we’ll get more margin out of it” through pricing adjustments.
Alessandrini is also prepared to trim Judge Group’s sales costs. “When times are good, there’s a level of tolerance for poor performers. When times are tough, the bottom 10% to 15% have to go,” Alessandrini says. But there’s something of an art to the winnowing process, he adds. For example, a bottom-15% performer who has been with the company for only six months and whose activity logs show he or she is “putting in the effort” might be spared the ax.
A recent change to Judge’s compensation structure for salespeople, making commissions a greater proportion of their pay, could provide another recession buffer. “In good times they’ll make good money, and when things start to go south they won’t cost us as much,” says Alessandrini.
Alessandrini also has a game plan for one of The Judge Group’s other primary costs: real estate. Because waning market demand pushes rents downward, he may seek to extend lease terms in exchange for getting lower rates over a contract period that may outlast the downturn.
Slowing It Down
Caution is also the watchword for early 2019 at FLIR Systems, a $2 billion manufacturer and distributor of thermal imaging cameras and sensors.
“We’re making sure to start off the year slowly with respect to new types of investments, and challenging ourselves on new hires — do we really need them?” says Carol Lowe, FLIR’s finance chief. “We’ll let the quarter materialize and see how growth goes, and then maybe we can loosen the purse strings a bit. If you start out the year spending at higher levels, it’s harder to rein it in later.”
Where FLIR has the flexibility to do so, it is also working with suppliers to move some of their production out of China to avoid steep tariffs. Lowe also recently instituted more discipline in the process of reviewing internal requests for capital.
Some businesses may have very few levers to pull to improve their situation entering a recession. Alliance Lumber, a $260 million distributor of lumber products in Glendale, Arizona, saw revenue decimated by 90% during the Great Recession. The company laid off all of its hourly employees (the bulk of its workforce) and management took pay cuts.
This time Alliance is expecting only an 8% to 10% revenue pullback, based on leading indicators like a recent dip in new home construction and a gathering trend toward smaller homes being built. But “if there is another recession like 2008, all bets are off,” says CFO David Rau.
The company’s problem is that it’s a commodity-type business. The price of lumber is what the mills charge. Alliance can try to tick pricing upward for its homebuilder customers, but “if we get too out of step with the market we could lose a lot of market share,” Rau notes.
The timing of a recession’s onset, as well as its length and depth, has always been difficult to predict, but perhaps more so today. Data that have historically been leading indicators, such as employment rate, inflation, interest rates, and international trade volume, are generally proving less effective at signaling economic slumps than they have been in the past, says Steven Strammello, managing partner of Crowe Risk Consulting. The distortion may be due partly to today’s geopolitical disruptions and unorthodox public policies, he suggests.
Predicting a recession’s timing may not be all that important, however. “I am finding senior business leaders worried about when the recession will hit, and how long and deep it will be,” Strammello says. “But from a risk management perspective, they should be thinking about their ability to adapt quickly as circumstances change.”
In other words, this downturn will put a premium on agility. CFOs have to be prepared to scale up or dial back the size of businesses based on markets and the economy, Strammello advises. Agile companies will be much better equipped to weather a recession and to come out of it strongly.
Most leaders were not ready for the Great Recession, according to Russell Raath, president of Kotter, a change-management firm. “It takes a bold leader who, after spending decades getting ready to lead and leading, can adapt quickly to the need for a completely new operating model,” he says.
Antidotes to recession are easier to find where an adaptable culture exists. For example, some consumer products companies have discovered important products and even whole new product categories during times of market depression, notes Raath.
During the last recession Procter & Gamble came up with the idea to create scented beads that consumers could toss into washing machines to make clothes smell good for an extended time. After the product was launched in 2011, scent-booster beads became an exploding product category.
“When you realize that the next three quarters are going to be down, it pushes pressure throughout the organization,” Raath says. “You have to create the space for creativity to happen.”
For companies with a call center, one of the best things a leader can do in lean times is visit it, Raath suggests. Talking to the staff about what they’re hearing from customers might just lead to a product opportunity.
At any time, but especially during a recession, a company that aspires to be agile should avoid at all costs the “HIPPO” syndrome, where everybody looks to the “highest-paid person’s opinion.” So says Lars Sudmann, who was appointed CFO of Procter & Gamble Belgium in September 2008, just as the big recession slammed into the world economy.
“Does that one person have all of the right views?” Sudmann, now a university lecturer and an adviser to boards and management teams, asks rhetorically.
It’s why he advocates the use of “brainwriting,” a structured form of brainstorming designed to stimulate creativity and innovation. If a moderator requires, say, six participants to write down three ideas within five minutes, and the exercise is repeated five times, 90 ideas are generated in a half-hour. “It’s very fast, very agile, and can have many, very different results,” Sudmann says.
Other simple but effective tools that he recommends for promoting agility include decision trees and checklists.
“When a crisis hits, the ‘headless chicken’ syndrome kicks in,” Sudmann says. “People run around trying to figure out what to do, and nobody has a plan.” A decision tree maps out in advance what should be done, for example, when sales drop by 5%, or 10% of customers pay 30 days late, or a major competitor slashes its prices.
“Then when that thing happens, you can take out this piece of paper and say ‘Look, we already talked this through.’ It can change the dynamic of a board meeting and was an enormous help to me,” says Sudmann.
Pilots use checklists when a crisis kicks in. Similarly, a recession checklist, prepared during stable economic times, can be helpful to business operations teams, according to Sudmann. It should consist of a manageable number of high-priority items, maybe about 10, to look at in the event of a sudden downturn. Examples might include a new level of reporting on top of standard reporting and the company’s cash position for the last 50 days.
A New Experience
When the previous U.S. recession began more than a decade ago, many of today’s middle managers were in less-responsible positions, or in some cases, not even in the workforce. Many workers also either retired or got new jobs, and at some companies the volume of layoffs was so great that some quality talent was let go.
“It would be easy for any management team to sit back and say they know how to handle this,” says FLIR’s Lowe. However, “we have to remind ourselves that this market softness may be new for a lot of people in key decision-making roles,” she adds. As a result, FLIR is taking the time with inexperienced managers to look at scenario planning, different risk analyses, and, since it’s a global company, the potential impact on currency.
It’s not only internal managers who need to be educated about economic downturns, adds Stanley, Black & Decker’s Allan, noting his frequent interactions with buy-side and sell-side professionals. “Some of those folks are in their 30s or even their 20s,” he says. “Their only experience with recession is what they saw their parents go through or what they’ve read.”
Even executives who wear the battle scars of past recessions, and their companies, can fall into some very common psychological traps in stressful economic times.
For instance, the inexperienced as well as the experienced need to avoid a false sense of confidence. While certain businesses that provide essential products and services are less exposed to economic cycles, few businesses are truly recession-proof, notes Matt Hare, a partner at investment firm Huron Capital.
In the warm climate of the Southwest, for example, “a company that installs and repairs heating and cooling systems provides an essential service,” he says. “But those same businesses must prepare for a slowdown in the construction of new buildings.”
Also, Hare urges, finance executives need to be careful not to deceive themselves into believing a recession hasn’t arrived yet because there haven’t been two consecutive quarterly declines in real GDP. Smart companies, he notes, carefully monitor their performance metrics and are prepared to respond in real time to red flags.
Indeed, convincing a management team that immediate changes are needed before a full-blown recession hits may be what keeps CFOs awake at night in the next few months. There are always holdouts in the ranks, says Tim Raiswell, finance research leader at Gartner, sketching out a scenario. “They say, ‘this isn’t the way value is created’ and ‘cost reductions will only hurt the customer experience.’ ”
CFOs can significantly boost their company’s chances of success, Raiswell stresses, if they can counter this “mental momentum” problem — the internal resistance to change that prevents companies from responding to new market economics.
The need to perform a feat as daunting as reversing mental momentum underscores the likelihood that for many finance chiefs, the next two years may serve up some of the headiest professional challenges they have ever faced. How they respond could do more than influence business results — it could define their careers.
Recession Lesson: Tightening Up Working Capital
The Great Recession provided some harsh lessons about working capital management and supply chain performance. What do they tell us about the likely impact of the next recession on those areas?
An analysis of the auto industry’s response to the previous crisis offers some pointers about how companies can respond. In a downturn carmakers (original equipment manufacturers, in industry parlance) will likely intensify their efforts to enhance working capital performance by shortening inventory conversion periods (the time required to obtain materials all the way until the sale of the finished product) and lengthen supplier payment terms.
In response, other links in the supply chain — raw material suppliers, material specialists, component standardizers, system integrators, and car dealers — may also extend supplier payments and try to accelerate payments from their customers.
Changes like those could reshape auto manufacturing supply chains and ripple through to other industries.
To provide insights into how the auto industry changed after the financial crisis, we compared cash conversion cycles (CCCs) during the periods 2006-2008 and 2012-2014. (The CCC is how fast a company converts cash on hand into inventory and accounts payable, then gets cash back through sales and accounts receivable.)
The average CCC for auto manufacturers before the Great Recession was 106 days, but by 2012-2014 it had shrunk to 35 days. The automotive companies did this through a combination of shortening their inventory conversion period by 21%, accelerating payments from car dealers by 39%, and lengthening payment terms with suppliers by 55%. As a result, the upstream players, from raw material suppliers to system integrators, all extended payment to their suppliers by as much as 30%, while car dealers speeded up payment from end customers by 33%.
Those results reflected the strategy statements published in OEMs’ annual reports at the time. For example, in BMW’s 2014 annual report it stated that “based on experience gained during the financial crisis, a minimum liquidity concept has been developed and is rigorously adhered to. Solvency is assured at all times by maintaining a liquidity reserve and by a broad diversification of refinancing resources.”
Lima Zhao is associate professor of supply chain management at the Ningbo Supply Chain Innovation Institute China. Arnd Huchzermeier is chaired professor of production management at WHU-Otto Beisheim School of Management in Germany.