Newport Board Group, an Advisory Firm Serving the Middle Market, Advises CEOs to Defy the Laws of Gravity by Preparing Now for the Coming Recession

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5 Steps Companies Should take to Prepare for an Economic Recession

Smart CEOs and boards are now considering steps to take to prepare more a less robust economic economy

While the pace of the economic recovery since the 2008 has been subject to much debate, the fact is that the U.S. has clearly been on a growth trajectory for the last 6 years. Unemployment has dropped from a 2009 high of 10% to 5.9%, negative GDP has reversed and is trending at a 3.5 percent growth rate in 2014. The U.S. stock market is at an all time high and interest rates at near all time lows. By most measurements, the U.S. economy is robust while Europe and other economies such as Japan are lagging. So why be worried?

The U.S. has a cyclical economy, impacted by world events and more importantly the global growth of consumer demand. On the negative side, the growth of consumer demand in China is slowing and wages are rising, Europe is worried about disinflation as consumers are out of the market and U.S. government support for stabilizing the economy appears to be ending. After 6 years of economic recovery, it’s time to think about the inevitable – there will be a recession and it’s not too early to think about how to prepare your company to survive and prosper during tough times.

Smart CEOs and boards are now considering steps to take to prepare more a less robust economic economy. Here are 5 steps to take:

1.    Hedge a Bet!
Companies can turn to commodity derivatives to hedge raw material prices and assure adequate supplies. Commodity derivatives are contracts that draw their value from the price movements of an underlying asset. Companies can hedge the prices of oil, gas, coal, metals, agricultural products and even electricity through commodity derivatives.
If a company is a producer or supplier of these materials, recessions will likely push down prices and forward contracts can lock in your sales price - smart oil companies recently locked in high prices when the price of oil recently dropped from $100 barrel to $80.
The buyer of a futures contract benefits from an increase in the price of the underlying commodity. Contract sellers root for a decline in prices.
Consider seeking advice from experts in hedging transactions as to how to structure transactions to prepare for a decline in prices.

2.    Swim the Channel
One of the most important assets is the company sales channel and existing customers. To position in the coming downturn, consider using that channel to expand sales of new products and services. There are several strategies and methods to increasing sales – consider:

  •     Adjacency Strategy – are there “adjacent” areas around the company’s core products or services that are natural extensions of the core? Examples might include a warranty or expedited delivery service offering to your existing product line.
  •     Extension Strategy – extensions involve the concept of the “extended enterprise.” Consider reaching beyond natural adjacencies to product or service extensions that might position the company for growth beyond the core business.
  •     New Channel Strategy – consider entering new markets through alliances, partnerships, mergers or acquisitions or even franchising the company's product. Alliances and partnerships might be a less capital-intensive way of growing the company without having to make an investment in new production facilities or inventory.

3.    OPM (Other Peoples Money)
Most small businesses have some form of a line of credit, an agreement between a financial institution, generally a bank, and a borrower to provide a certain amount of loans on demand. Many banks today have more money than borrowers and report that only about 40% of the existing lines are drawn. Many businesses do go out of business during a recession and it is for one fact – they run out of capital. Consider increasing the company's line of credit and establish new credit facilities even if the company does not need them now. A large line may come in handy later.

Another strategy for increasing a company’s cash flow, critical in a downturn, is through a change in credit terms from vendors and to customers. For example, if a competitor pays suppliers in 45 days and the company pays 30 days, money is being left on the table. Conversely, if sales terms are overly generous, the company is effectively financing customers cash needs that could be met by better billing and collection practices.

4.    Outsource Everything (that’s not strategic)
Most companies are already a big user of outsourced services. Typically companies probably don’t deliver products directly to customers, companies don’t do their own audits or taxes and don’t self-insure the business. Many companies out source some or all of manufacturing oversees. In an economic downturn, a key strategy is to convert fixed costs to variable costs and outsourcing is one way to do this.

Consider outsourcing everything that is not strategic to the business. This includes human resource support functions, accounting, manufacturing, transportation and even the executive staff. Does the company need a full time CFO or controller or would a “fractional” CFO or controller that is a shared resource with other companies work?

Most HR functions can and should be outsourced for small and mid sized companies. A Professional Employee Organization (PEO) can help process payroll and offer employees a better offering of benefits. In addition, by pooling with other companies through a PEO, companies can get significant pooling discounts on the cost of benefits.

5.    Understand Value
During the last recession, virtually every U.S. car company except one had to be bailed out by the government. The exception, Ford, saw the recession coming and sold and lease backed facilities, creating a war chest of capital to weather the recession. It might be reassuring owning your own real estate but if you are not a real estate company, consider reinvesting the capital tied up in real estate into the production and growth side of the business.

A Sale-Leaseback a transaction between a bank or an investor and a company that sells and leases back it’s real estate or other fixed assets over a long term. More complex than a loan and involves many accounting issues but the company still uses and controls the facilities, effectively turning a non-liquid asset into a liquid asset – an important decision when times are tough.

Of course, the storm clouds of a recession might be long off and far away but being prepared for bad weather is easier than weathering the storm with a leaky ship.

Michael Evans is the National Managing Partner of the Newport Board Group. He is based in Northern California - Michael.evans@newportboardgroup.com

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