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Entrepreneurs tend to be optimistic by nature. As the year 2018 ends and 2019 begins, there is ample reason for many entrepreneurs to feel good about the future.
The latest signs of an improving economy were strong enough to help persuade the Federal Reserve to raise interest rates recently—for the first time in nearly a decade. A boom in the valuation of technology-based companies, private as well as public, drove expansive optimism in that sector, only to be curtailed over the last three months by political issues, reduced demand for social media services, and the trade wars.
But storm warnings are already on the horizon with the Chinese stock market down 30% in 2018 and the U.S. stock market off nearly 3,000 points from the 2019 high. Are these early warning signals of an economic downturn?
A recent survey conducted by Duke University concluded that a recession in 2019 was looking “likely.” Nearly half of the executives surveyed believe that the United States will enter a recession by the end of next year, and 82% expect that a recession will happen by the end of 2020.
But how can a recession happen when our economy is experiencing record GDP increases and we have full employment?
Interestingly, a full employment economy can contribute to the likelihood of a recession. Businesses that are labor constrained cannot grow as rapidly, and they encounter a “growth ceiling.” Political policies such as immigration curtailment also affect the labor supply, further reducing growth.
But what if the economy in 2019 begins to weaken as the Duke survey predicts? Extreme pessimists are usually wrong, but so are extreme optimists. A downturn, caused by the natural ebb of the economy or by a shock such as a geopolitical crisis, is always a possibility, bringing back conditions we remember all too well from the years after 2008: declining revenues and margins, excess capacity, anxious employees, and restless investors. Even if a recession doesn’t come to pass, your company might have its own downturn this year, caused by a new competitor or new substitutes for your products and services.
Why not start the new year off with a resolution to do some contingency planning for the possibility of a downturn later this year? Below are four steps to take to prepare your business for a potentially challenging year:
1. Manage profitability
Most companies have a relatively narrow margin for error. A 10% decline in revenue could wipe out the entire bottom line of your company. Having a contingency plan to produce marginal, short-term profit despite a drop in revenues can make all the difference.
Consider doing the following:
- Develop forecasts based on optimistic, realistic, and worst-case revenue scenarios.
- Formulate contingency plans. Make sure your top managers are on board with the plans and are ready to act quickly if revenues decline.
- Agree with your management team on early warning signals, such as a shrinking backlog, a downturn in customer-market indices, or a worsening sales pipeline.
- Be willing to adjust discretionary spending at more frequent intervals; for example, quarterly, or even on a rolling basis.
- Be ready to keep bankers and investors appropriately informed in case of a downturn and to communicate the actions you’re ready to take to limit the damage.
2. Identify and maintain your strengths—and your best customers
Identify the strengths that have enabled your success to date, and those that will be important in the future. Which capabilities and skills are most critical? What distinguishes your ability to serve customers effectively?
Identify your highest-margin customers, and understand what you are doing right for them. Develop a game plan, in the event of a downturn, to protect and build on the strengths that have allowed you to be indispensable to them. In the event of a dip in business, rather than cutting costs across the board, be ready to shift resources to retain these high-margin customers.
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Continue to be creative in how you can add value for your customers without increasing your costs; for example, a professional services firm could add regular briefings to client executives to monetize its intellectual capital.
3. Determine what you could stop doing
Companies that create enduring value typically excel at discontinuing what no longer adds value. Be ready to make changes in cost structure that will hone your value proposition down to what customers really value.
Comb through your cost structure to create a contingency plan for what you would cut. Identify what’s inefficient; what’s nice to have but dispensable; what’s there because of history, inertia, or wishful thinking; what may have worked in the past but doesn’t anymore; and what isn’t creating value as it used to.
Realize the challenges you would face in cutting costs. Most organizations aren’t adept at cutting costs quickly as revenues decline and margins suffer. Even your most hard-headed managers will try to protect their own people first. As your company has grown, your operations have probably become more complex. Be ready to take a knife to any complexity that isn’t compliance-required or value-adding. Consider outsourcing non-strategic company functions such as human resources, accounting, and even finance.
4. Manage liquidity as carefully as profitability
A downturn might force you to deal not only with negative growth but also with liquidity constraints. Trying to maintain liquidity on a smaller revenue base can be crippling.
You would need a plan to turn over every balance sheet dollar faster to contribute to working capital. You’ll need plans to
- Maximize cash flow by narrowing the timing between sales and outlays for costs you incur in advance, such as inventories.
- Collect from customers faster. Consider offering discounts for paying promptly or require deposits from customers.
- Take advantage of increased supplier willingness to share risk and to provide favorable terms.
- Monitor your receivables against your payables and reduce your Cash Conversion Cycle days (time it takes for money to come in from customers against the days when your supplier payments are due).
Be ready to shrink to survive
The list of things a CEO needs to plan out in order to survive a downturn is long and can seem daunting. You must avoid disassembling what has made you successful while accepting the necessity of shrinking your business for the near-term. Navigating your business through such a crisis may require some skills that have been rusting in your managerial toolbox.
In the event of a downturn, you’ll no longer be insulated by growth. Disciplined decision making will be essential. You’ll need to lead with the right proportions of cost-conscious frugality and bold innovation.
Hopefully, 2019 will be a banner year for your company. But just in case it isn’t, invest some time now to plan how you will weather a downturn.
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