July 3, 2022

Article 2.4


The U.S. economy has been in a mild recession for all of 1990, and now it is starting to slide deeper and faster. How deep and long will it go is a guess. Given how much personal, corporate, and government debt that is outstanding, it would be wise to have contingency plans for mild, stiff, and heavy scenarios.

Most firms can survive in good times, but tough times often dramatically separate the well-managed, positioned and opportunistic firms from the weak. In downturns, strong firms can actually grow sales, profits and market share by filling the vacuums left by the radically retrenching weak firms; consider how Delta Airlines has been feasting on Eastern. The weak do not technically get in trouble in bad times, they plant the seeds for disaster in the good times by: overextending themselves while going for unfocused volume financed by debt instead of retained earnings; or by harvesting the business instead of reinvesting to create sound and strategically dominant firms.

Besides watching strong firms feeding on weak ones in the current downturn, some strategic guidelines follow for which there is still time to preventatively practice to some degree.

  1. The average firm should sketch out scenarios for a drop in volume and margins over the next 12-18 months for three levels - for example, 5, 10, and 15%. Because distribution firms have a lot of variable costs and assets, it is theoretically possible to downsize cost structure and asset investment in proportion to margin decline. From a timing viewpoint, too many firms wait for the downturn and then reactively slash expenses and investment across the board. It is better to anticipate declines and downsize concurrently and strategically. Don't cut across the board, but prune the losing locations, product lines, customer segments, and people to feed and maintain the 20% that generate 120% or more of the value. Best firms weed their gardens continually, but many need a downturn to stop wishful thinking and swallow pride.
  2. Remember to maximize cashflow and ignore accounting "profits." To preserve working capital to pay bills and pay down debt we need cash. If firms do close poor branches; write-off the 50% of receivables past 90 days that won't be collected; ship back or write-off the inventory that hasn't been requested in the last year; etc.; these measures may generate huge accounting losses, but they all either generate cash in hand or allow a firm to get a check from the government on a tax-loss, carry-back basis. Don't report fictitious profits and pay taxes which is cash flowing out of the company.
  3. Many managers may resist doing steps one and two because they don't want to admit past sins so visibly, but the stated excuse for delaying and tempering cuts is "we don't want to spook employees and bankers." In life the sooner we face the pain, the less it will be; delaying action will just make the cost and trauma greater. It is best to confess our sins, state our economic forecast and plan in a way that we can confidently see light at the end of the tunnel. Most bankers and employees will be relieved and delighted to assist in the plan. They know the news on the economy; they feel the daily pulse of slowing business; they see or sense the deadwood, the fat, the underwater projects around the firm; and they wonder why management doesn't do what it should.
  4. If anticipatory, strategic pruning is necessary, it is best to have an articulated forecast, budget, and action plan, and then do all the cuts quickly. Like removing the Band-Aid, a quick, big tug hurts less than the cumulative anguish and pain of a series of tiny tugs.
  5. For asset management, inventory investment often swells in spite of best intentions for several reasons;
    1. In a declining economy, lead times from manufacturers often drop more quickly than inventory computer models can detect them on their own. Inventory will flow into the warehouse sooner unless the problem is anticipated and reorder point calculations are manually changed.
    2. Demand from different customer segments will often drop more quickly than inventory software can detect it. The replenishment reports instruct buyers to buy more, based on historical demand. Again, the software must be manually overridden to lower reorder quantities and cumulative inventory investment budgets.
    3. Suppliers are quick to offer deals which include discounts and dating; these deals don't seem to threaten cashflow until it becomes apparent that an extra two months of supply is six months because demand is down. And the special price isn't a deal if all competitors loaded up on the same deal and are passing the savings on to the market. Nibble at these offerings and match competitions' prices to your core customers.
  1. Days outstanding for receivables will lengthen during downturns, but this general statistic masks several sub-plots. Well managed firms are good for the cash and most will continue to discount. If a few of them are tempted to stretch suppliers, an on-going, disciplined collection system will nudge them back into prompt pay.
  2. Loose, harvested, or overextended firms will be squeezed and will try to pass the pressure on to their suppliers. For this group, a firm must make a select number of judgement calls. List the customers that have been: historically profitable; a good strategic fit with what you are selling; and somewhat to significantly faithful. Remove from the list any customers that you have doubts about their ability to survive the downturn. And then budget how much financing you are willing to extend and on what terms. By proactively offering some leeway and advice on how to work out of their situation if appropriate, negatives can be turned into long-term positives. But, don't finance all of this category when they are discovered to be past 60 days.

    A third group of customers will have already been slow-paying and a downturn may put them into serious trouble. If these accounts have weak and untruthful management and are not number one or a strong number two within a focused and viable niche in their market, cut losses now to avoid bigger losses and run-arounds later.

  3. Can firms sell or market their way though downturns? It depends. There are several strategies that can work:
    1. A strong, focused firm can target weak head-to-head competitors that are imploding from past sins as in the Delta Airline example mentioned above.
    2. Alternative channels of distribution with less service and lower prices can strip away business from the full-service, higher-priced competitors who can't figure how to unbundle and sell services on a cost-plus basis. For example, small businesses have been switching from local office supply dealers to mail-order houses like Quill or category killer stores.
    3. Some customers can be persuaded to trade-down from high- priced, high-quality goods and services to minimum requirement goods and services.
    4. Promoting lower inventory investment solutions can gain volume, because customers will be looking for cash flow savings. The supplier may have to cut the price creatively by stocking more and delivering smaller quantities more often; if it makes strategic sense, do it.
  1. Selling harder with me-too products, undifferentiated service, and sharper prices or terms backfires. Customers cannot buy more if their demand for product is shrinking. They cannot take care of whining existing suppliers let alone another. If sharper price offerings make them think, they usually give the entrenched supplier last look. If the competitor passes, the aggressor captures new volume with margins that will not cover the cost of taking care of the customer. Volume increases but profits drop, and inventory and receivables grow. Financing empty volume with debt is a disastrous long-term formula.

The best way to grow in good or bad times is to retain the profitable accounts at a greater rate than the competition by not making service mistakes or dropping service levels significantly because of a credit crunch. Remember also that "grow" should apply to profits and return on investment which today is often very independent from growing sales volume. If given last look at a piece of business which will become unprofitable, pass to reinvest resources in other potential profitable business or downsize to better focus on what profitably remains.

We all would like a generous economy, but tough times favor the best-run and strategically opportunistic firms who proactively anticipate economic events. Use these guidelines to turn a negative economic scenario into a positive one or dramatically reduce the losses that could occur.

© Merrifield Consulting Group, Inc., Article 2.4