CFOs can help their companies endure a downturn and prosper in a stronger economy.
Central bankers don’t seem to think a recession is in the cards. Even after the yield curve inverted in May, former Federal Reserve Chair Janet Yellen was preaching calm, saying a yield-curve inversion might not be a good bellwether of recession anymore. “On this occasion, it may be a less-good signal,” Yellen said on Fox Business Networ, explaining that “... a number of other factors … are pushing down long-term yields.”
That’s in stark contrast to the view among the world’s chief financial officers, who have been anticipating a downturn for a while, according to the regular CFO survey by Duke University’s Fuqua School of Business. September’s survey showed global CFO optimism at a three-year low, with negative outlooks across the board. In Africa, 81% of CFOs believe their country will be in recession by Q3 2020, a view echoed by 72% of CFOs in Asia, 69% in Europe and 65% in Latin America. US CFOs were the most optimistic, with only 53% expecting a US recession in the same time frame—although that rises to 67% if the time frame is extended to the fourth quarter, after the presidential election. “Optimism is low in all regions of the world, which exacerbates any slowdown occurring in the US,” commented John Graham, a finance professor at Duke and director of the survey.
Already, corporate planners are struggling with uncertainty about global business conditions, stemming from geopolitical turmoil and mixed policy signals from various central banks. Tightly coordinated supply chains with links to China are being rerouted through new production channels in Vietnam, India and elsewhere in the developing world.
Now, in addition to planning for those contingencies, company leaders must also prepare for the possibility of a broad economic downturn, possibly a severe one—regardless of whether it comes to pass. Experience shows that some companies not only survive recessions; they emerge from them even stronger. How can CFOs lay solid but flexible foundations to be well positioned to benefit if the world economy takes a nosedive?
Playing Offense And Defense
A downturn inevitably presents challenges—yet can also offer opportunities. Certainly, the challenge lies in keeping the business afloat during difficult economic times. But companies that have honed recession-survival strategies and amassed sufficient financial flexibility can take advantage of an economic downturn to enter new markets or acquire less-successful businesses.
Fellman, corporate turnaround consultant: Improving efficiency is especially important when you know a recession might be coming.
No matter how well-oiled a business believes itself to be, it can probably be run more effectively and efficiently, argues Renee Fellman, a corporate turnaround expert based in Portland, Oregon. People, processes and systems must be examined and restructured to reduce costs and increase customer satisfaction—which often leads to increased sales and heightened profitability, even for companies that aren’t in crisis. “Improving efficiency is always important,” Fellman says. “But it’s especially important when you know a recession might be coming.”
Developing effective recession strategies begins with modeling various scenarios. But most companies, at least in the US, game out only three scenarios, according to the Duke CFO survey. Given the rapidly changing macro environment and the range of potential disruptions, that may not be enough.
Dan Fletcher, CFO of financial-planning and analysis software provider Host Analytics, recommends considering many different scenarios for a long-term business downturn: “How will it affect cash flow? Profitability? What levers can you pull to make sure your company remains operational? Should you reduce [operating expenses]? Cut employees? Pull back from some of the markets you’re in? Change your pricing?” No one tactic may be enough to shepherd a company through a recession. “To survive, you have to understand the competitive landscape, how other players are pricing themselves and positioning themselves,” Fletcher explains. “Then you have to position yourself as the alternative.”
Historically, a multipronged approach works best. Take the case of Japanese conglomerate Sony versus US coffeehouse chain Starbucks. During the 2000 downturn, Sony relied on cost reductions to survive. It cut its workforce by 11%, capex by 23% and R&D by 12%. The strategy worked—at first. Profit margins increased, but sales growth dropped from 11% to 1%.
Starbucks took a different tack in the recession that followed the financial crisis of the late-2000s. Yes, it shuttered stores and laid off more than 12,000 employees; but it also improved its surviving locations—increasing food selection, offering free Wi-Fi, and implementing customer-reward programs. Its profits increased from $5.74 billion in 2006 to $14.54 billion in 2018.
People Power and Layoffs
Layoffs are a lagging indicator. Andrew Challenger, VP of operations for outplacement firm Challenger, Gray & Christmas, says they can sometimes follow earlier recession indicators—including a falling stock market and reduced corporate investment—by more than a year. Labor is also the last to recover. Challenger notes that while it didn’t take long for the stock market to start climbing following the Great Recession of more than a decade ago, it is only within the past year or two that the US economy has experienced a shortage of skilled workers. In the interim, companies often find that they’ve fired people who brought actual value to the business. That’s why layoff decisions must be made carefully. “You don’t want to cut indiscriminately,” Challenger warns.
To avoid layoff missteps, companies need to start planning ahead of time—analyzing not just people, but processes. “Smart HR departments are preparing for a potential recession now. They’re doing a lot of legwork, getting a lot of survey data on employees, understanding their functions,” Challenger explains, “so that when a directive does come down, [they will] at least have information on who should stay and who should go. Otherwise, you’re striking out blindly in a difficult situation.”
That kind of preparation tends to be lacking, he and Fellman agree. “Too often, companies just cut personnel without changing the system to accommodate [the reduction], so they have work that needs to be done, and nobody is there to do it,” Fellman explains. “This can have unintended, disastrous consequences.” She says working with an operations expert can help determine how to change processes and reallocate human capital accordingly.
A slowdown presents opportunities to profit and grow by striking deals with rivals that find themselves in dire circumstances. Boston Consulting Group recommends that organizations “assess competitors’ vulnerabilities and pursue mergers and acquisitions where viable.” Toward that end, Fletcher suggests trying to pay down debt and amass cash now. In the latest Duke survey, US CFOs named “maintaining financial flexibility” as the top factor in choosing how much debt to take on—and the main motivations for wanting financial flexibility were to avoid financial distress in a downturn and retain the ability to pursue attractive investment opportunities.
Interest rates have been so low that many organizations have taken advantage of “cheap money,” and some are now overleveraged. “If you’re in a year-over-year decline, if you’re not making enough money to service your debt, if you cannot reorganize and restructure your debt, you’ll be in trouble,” Fletcher says. “You may need to find an acquirer or shutter your doors.” But if you’ve got cash on hand at manageable rates, the scenario is a lot rosier. “Some companies will not be well positioned to survive a recession,” Fletcher says. “You may be able to form a partnership with them. You may be able to acquire them. You may be able to make lemonade out of lemons. But you can’t do any of this if you’re super-low capitalized.”
CFOs can’t implement recession plans on their own; they need to generate corporate buy-in, particularly from the C-suite. Fletcher says one way to get that support is by using financial-planning and analysis software to run different recession scenarios that might include plans for paying down debts, restructuring, revamping operations, or entering into or withdrawing from certain markets.
“It’s really about having the knowledge and data to present to their team. In boom times, no one wants to hear about this. No one wants to hear, ‘Let’s talk about what happens when this all goes down.’ You can feel like an undertaker walking into the room,” Fletcher says. “But if you walk in with data, they’re more willing to listen. If you say, ‘I ran this scenario about what happens if our 10% top-line growth turns to negative 10%,’ people will be more willing to listen. It’s smart to have this conversation; and in a pullback, you can’t afford not to be smart.”