Resilence in 2009

How to thrive in a recession

In times of subdued demand and economic turbulence, companies can fall from the top positions in their sector. Recent examples include Lehman Brothers and Babcock & Brown. At the same time, others thrive, rising to be major players in their industries, as St George Bank, Harvey Norman and Toyota have done. As pressure increases on company directors to steer their companies through turbulent conditions, here are 10 strategies boardrooms must consider.

1. Anticipate change in demand and respond

In a downturn, customers defer spending, change buying criteria and shift preferences towards value products. Demand shifts from one segment to another and new opportunities emerge. This is an opportunity to offer value substitutes and shift focus to alternate segments. For example, telecommunications companies might offer highly discounted bundles to lock in customers. Or banks might offer internet-only accounts as a way for them and their customers to save money.

Questions for the boardroom: Are we confident that our revenue projections account for shifts in customer demand (downside and upside)? How has our marketing strategy been adjusted?

2. Invest in strengths. Divest from cash drainers

Empirical evidence suggests successful companies continue to invest in turbulent times, acquiring assets consistent with their core competencies, often at good prices. With a strong balance sheet, the Commonwealth Bank can acquire BankWest to grow its market presence. Directors should position their companies to exploit turbulent conditions by building a recession war chest. Divest or put on hold speculative investments that might have appeared good in a buoyant economy, but risk becoming cash drainers in a recession.

Questions for the boardroom: Do we have the right corporate portfolio given changes in risk and economic conditions?

3. Focus on cash flow

Can our company afford to weather a 20 per cent decline in sales or a 30 per cent dilution in margin for key products? What happens if five per cent of debtors default? Will your company have adequate cash to cherry-pick distressed assets in a buyer’s market? Research shows Australian primary resource companies carry an average of 14 per cent working capital as a percentage of operating revenue, compared with global best practice of 10 per cent. Cash can also be created in other ways, such as revisiting customer payment terms to reduce receivables and bad-debt risk.

Questions for the boardroom: Have we revised our target cash and inventory levels, given the rising cost of funds and economic outlook, and how do actual levels compare with these targets? How much extra cash can we generate – for example, by selling slow-moving stock?

4. Reduce leverage

Around 25 per cent of the lucrative capital gains achieved by private equity firms during the recent growth period are attributed purely to the strategy of acquiring assets with high leverage. This makes sense because in a buoyant economy it is easier to achieve a return on assets superior to the cost of borrowing. Conversely, in a recession the prospect of achieving returns higher than interest expense diminishes. This explains the problems at Babcock & Brown and other investment banks. A company should adjust debt levels according to its expectations and its continuing capacity to finance the debt. In a recession, reduce debt.

Questions for the boardroom: Do we have the right funding mix and structure in place?

5. Switch to more flexible capacity

Creating flexibility in operating capacity (to handle lower or different demand) means your company will carry fewer fixed costs when recession hits. By operating capacity, we refer to call centres, assembly lines, back-office processing, sales force, logistics and so on. Some of the ways this

strategy might be applied include offering temporary contracts instead of hiring permanent staff, engaging third-party sales channels on a risk-reward basis and negotiating new supply thresholds with suppliers.

Questions for the boardroom: What are the flex options and the magnitude of flex in each of our major operating functions and in terms of product volume and mix?

6. Cost down without damage

Companies that slip in a recession generally fail to recover to the top positions in their sector. This is because across-the-board cuts mandated by the board at the peak of the recession destroy business value and employee morale. Directors must ensure their companies are capable of

trimming costs at the right time, in the right areas while also matching demand. Do this by analysing operations and costs to earmark expenses that might be necessary in good times, but dispensable in difficult times, such as administrative overheads, duplicate management layers and higher-specification raw materials.

Questions for the boardroom: What are our cost reduction contingency plans (these should be surgically specific expenses that don’t damage customer or business value)?

7. Revisit projects for viability and cash-flow effect

Cash is king in a recession. The rising cost of funds changes project hurdle rates and underlying assumptions shift. For these reasons, all projects should be reviewed for their strategic merit under new economic conditions. Some may be accelerated, others deferred. For a bank, this might mean deferring a product-platform upgrade, but accelerating projects aimed at gaining sales productivity in recession-proof segments. For producers such as OneSteel or George Weston Foods, the return on investment for projects to reduce inventory will appreciate vis-a-vis network optimisation projects.

Questions for the boardroom: Has the business case for our portfolio of major projects changed? Should we revisit all projects with an updated set of filters to test viability and strategic fit?

8. Engage employees to adapt

When a recession hits, successful companies engage employees to adapt to new conditions by aligning them to realistic but still aspirational targets, as opposed to berating them for not meeting sales targets. They build confidence in leadership to steer them through tough times. The aim is to engage your best talent to adapt to changes in market, rather than to look for a job elsewhere.

Questions for the boardroom: How have we adapted our employee engagement strategy to navigate through turbulent times to ensure our most talented people stay passionate?

9. Exploit supply conditions

In a recession, desperate CFOs defer payment to suppliers, and suppliers feel the cash squeeze and the cost of increasing debt. Competition intensifies and price wars may erupt among your supplier base. This is an opportunity to revisit supply contracts to lock in lower prices or take advantage of bargains. Conversely, a recession is an opportunity to get closer to strategic suppliers – to negotiate improved quality, preferential treatment, and other sources of competitive advantage.

10. Anticipate desperate competition

Desperate companies employ desperate sales tactics, such as price deals at a loss as they try to generate revenue to cover fixed costs, thereby flooding the market with offers that damage long-term industry profitability. Can your company afford not to follow or can it find higher ground? During difficult conditions, Qantas improved premium services to business customers, against the trend of other airlines, thereby locking in loyalty of its high-value segment. Desperate competitors make across-the-board cuts, damaging customer and employee relationships. This is an opportunity to win market share and recruit the best talent in the marketplace.

Questions for the boardroom: What will the market look like during and after the recession in terms of behaviour and structure? What action can we take to thrive during a recession and realise long-term advantage afterwards?

Preparation, timing and messaging is essential

Preparation for a downturn should not be self-fulfilling – it should not result in a premature slide in revenue, or panic among employees and suppliers. Cutting back variable costs, such as temporary staff in outbound telesales, should happen when recession hits, not before. Board members and executives should be vigilant in their communications, avoiding words such as “recession” and “cutbacks”. Instead, they should use phrases such as “switching to flexible capacity” and “investing in strengths”.

James Lau is a partner at boutique strategy consulting company Business Development Partners .

Reproduced with permission from the Company Director, a publication of the Australian Institute of Directors.