The Economic Slowdown – An Opportunity or a Threat?

RS Raja Gopal Sastry, Chief Financial Officer, WABCO India

Pankaj Vasani RS Raja Gopal Sastry

The Serengeti is possibly the most dramatic representation of the cycle of life on Earth, and one that can be witnessed in a very short span of time. The wildebeest exit the park at the onset of the dry season and travel thousands of kilometres, and the predators struggle to survive the gruelling dry season. Not soon enough, the rains return and the rested and enriched soil immediately turns a lush green, inviting back the wildebeest and other animals. The predators eat again, but do not enjoy the abundance. Rather, they use this time to store strength to survive yet another dry season. In many way, this lifecycle is also true of macro trends seen across the world.

Economies and businesses go through inevitable cycles of growth and recession, or expansion and contraction. While these cycles bring into being a better order of things, there are also casualties in the process. People lose jobs and businesses become obsolete. However, organisations that are resilient manage to use this time to create new revenue streams. Like the earth, the economy, too, becomes fertile after a period of recession, and many new ventures take root and grow quickly. Denial is the first reaction in the face of a slowdown, but the pain caused is undeniably uncomfortable.

What are those symptoms or events that characterise a slowdown, contraction or a recession? Economics says it is technically a recessionary situation when GDP growth is negative for two quarters. It will be evident to us when we see businesses failing, negative growth in production, job losses and growing unemployment. Are we already in the phase of a slowdown? The prolonged strife in the automotive sector, job cuts across sectors, low GDP growth rates, negative IIP growth, all point to a slowing economy. Businesses are witnessing low sales and profitability is affected because of low absorption of overheads. Recession or no recession, it is important to understand as to what would happen to our business and to the economy at large, and what steps we can take to survive it.

As recession takes the economy into its grip, businesses witness declining revenues, and thus shrinking profits. Companies freeze hiring, ‘restructure’ (a euphemism for removing employees to save costs), and defer R&D investments. What were previously considered important spends, like marketing and advertisement, training and development, are suddenly considered discretionary. Metaphorically speaking, businesses facing a slowdown first shed fat, lose muscle, have their bones give way, and in some unfortunate instances, compromise on their souls. More on that later, though!

Before businesses accept low demand and sales and put in place austerity measures, their first priority should be to attempt to improve sales. History is replete with examples of visionary and successful leaders who grew their businesses during recessions. Low demand comes from a low appetite for discretionary spending – which is turn stems from low confidence in sustaining one’s current earnings, and fosters a propensity to save instead of committing future earnings to servicing debt. The marketing workforce, with its intimate knowledge of the consumer, needs a bigger share of the budget that this point, and they should not be spending time planning cost cuts. Groupon, at the peak of recession, made it its business to offer discount coupons of various businesses. This helped generate demand for ‘non-essential products’, and many companies benefited by making sales. Groupon itself grew phenomenally until it was sold. In a recent ‘stress test’ conducted on various banks, Citigroup fared best. This was the result of the high service levels the bank offered, which allowed it to grow its assets during a slowdown.

Firms today should really be scanning their business to discover new opportunities. Some possible areas might include:

a. Offering import substitution in such areas as engineering and supply-chain capabilities

b. Commercialising products that were considered low priority when the high demand ones took precedence

c. Increasing the focus on low-volume, higher-profit customers. Some of these can become potentially strong areas, and being niche, can be a perennial source of demand, too

d. Being sensitive to the cash flow concerns of customers. Reducing the minimum order quantity can help convert even small pockets of demand into sales

e. Spotting the discerning, high-quality buyers and offering them innovations that were considered ahead of their time, or too expensive

f. Redeploying people into service activities and making your presence felt through increased contact points and better service. This can be surprisingly remunerative

g. Energising one’s teams to discover new markets. During the 2008-09 crisis, Lego grew its profits by 63% by tapping new markets.

h. Aligning ones operations with demand via the social media. Starbucks, for instance, pulled itself through the crisis with an unrelenting focus on the consumer

i. Changing – but only cautiously – one’s revenue model, such as from sell to pay-per-use

Numerous ideas are possible by orienting and directing the energies of the organisation towards bringing in the top-line. Ultimately, it is the ecosystem of the business that holds the answers.

Despite the best of efforts, bad times need to be weathered. An opportunity in these times is to take a long and hard look at the inches the business has added to its girth during the good times. Losing a bit of fat can be invigorating. It would return some profitability, and importantly, make the business more agile. Look for spends that have morphed themselves to look like ‘vital spends’. The Pareto approach is an enemy of good governance and cost control. Although it is a very efficient way of managing the business, and will continue to be, it is also a tool that allows inefficiencies to creep in. As is said in military circles, ‘Beware of those flying just below the radar.’ Times like these is when we should shun the Pareto analysis, at least for a brief period. Here are some areas where you may look:

a. Build every expense group from zero. Check as to how they are requisitioned, approved, priced, received, put in inventory, and thence consumed. ‘Aha!’ moments are promised

b. For a manufacturing organisation, feel the products, the bills of material and question:

a. Are the commodity price movements duly captured in purchase prices?

b. Are there arbitrage opportunities in changing the currency used for imports, such as Yuan instead of USD if you are importing from China?

c. If you are not strapped for cash, would early payments help reduce the costs?

d. Are your purchase contracts outdated? Do they include terms and costs that were built in for reasons that may not exist anymore?

e. Are your people negotiating hard to reduce the lot sizes? Recently, one company won an award for implementing something it called, ‘Sell one, Make one, Buy one.’sense to request people to exhaust their accumulated leave until the tide turns? This can reduce the actuarial valuation of accumulated leave, which is a better option than someone losing a job

f. Similarly, can you ask some of your senior executives to become consultants on a retainer, rather than staying on as employees?

g. Do you have expenses that are based on contract for fixed fees per period, and not linked to levels of operations? These include the rent and people working at a warehouse, leased returnable packaging, and transporters that are paid on a per-vehicle basis. Some of these expenses are incurred as a matter of habit, and sometimes, surprisingly, escape attention

The good old principle of looking for non-value adding costs is an open secret. Customers ultimately pay for a service. Even if we sell a product – she is paying for what the product does for her, and not the product itself. Thus costs that do not provide or enhance that service can be dispensed with.

If the slowdown lasts longer than expected, merely losing fat may not suffice. The bulky, good-looking muscles must change their nature too, as they are oxygen-hungry, and not as functionally efficient as the lean, hard ones. During times of prosperity, businesses build and flout muscles, and rightly so – it attracts suitors like business partners, employees and other stakeholders. However, during recessionary times, it is important that these muscles are made to work hard so they lose their exaggerated shape and become tough, flexible and functional. For example:

a.Positions that are ceremonial have to jump into the fray, and should be given revenue-generating or cost-reducing responsibilities b.Offshore dealer meetings and conferences need to wait c.The class of travel, or even travel itself d.Expensive manned warehouses that deliver just-in-time can be substituted with direct delivery

Many more possibilities exist, if one looks at balancing the value generated against cost incurred.

As the slowdown persists, organisations will start feeling the crunch on their cash. The overall working capital cycle will become inefficient and reserves will start coming down. When cash is short, businesses will be left with no choice but to ‘lose their bones’. These are the fundamental assets, human and otherwise, on which organisations build themselves, and when these are lost, the damage can be long-term and sometimes irreversible. Such a situation has to be avoided with all the tenacity one can muster. This is best achieved by ensuring that no money due is left behind, even for the shortest period. All efforts should be made to recover debts and receivables:

  • Every advance, capital or revenue, should be approved by levels at least two layers above what is traditionally followed
  • Negotiate hard with vendors and break the normal lots into ones small enough just to meet demand
  • If there are deals possible in the slump, the sale of slow- and non-moving inventory should be evaluated quickly and executed
  • If you have vendors demanding advance payments, it is useful to convert them to ones that accept letters of credit. They cannot object, because legitimately, they are seeking the security of their money
  • Target a 70% reduction in cash to cash lead time (the time taken between payments to a vendor to receipt of money from the customer)
  • Generate ideas. Ideas are commodities – excellence lies in execution.
  • During times of stress, banks are looking for business, too. Strike a deal with banks to discount your vendor bills. This allows for them to get paid in time and for you enjoy a line of credit with the bank. If such payments are ahead of the accepted credit terms, get a cash discount to compensate for bank charges. Keep it marginally profitable for your business.
  • Ideally, cash flows should be reviewed daily.

No drought is permanent, and similarly, no slowdown is forever. Just as copious rainfall brings an explosion of growth from the fertile earth, a resurgence in confidence will bring back optimism, and with it, heady growth for business. The surviving organisations are lean and agile, and hopefully will not have lost too many ‘bones’ along the way. They are then poised for growth.

But there is one important element of a business’s persona that can easily get compromised during bad times: the soul! If, during these difficult times, the business at any time reports untrue numbers, or has to resort to any measure which cannot be unambiguously said to be compliant (within the control framework of high ethical and moral standards), then that business has a compromised soul. This is a one-way path to destruction, and no recovery is possible. The all-important word of caution to all enterprises, then, is, ‘Please keep a strong watch on governance, and at no stage compromise on the standards of governance, however small or insignificant the issue might be.’ Once a path of least resistance is identified, the flood makes its way through, rapidly!

In conclusion: periods of prosperity, where the challenge is meeting demand, do not allow us time to sit, think, introspect and make the necessary adjustments or changes and take strategic initiatives. If we believe that we will only come out stronger and use a slowdown as an opportunity to drive out inefficiency and bring in efficiency, we can have a fun time.