There is no better time to prepare for an economic downturn than when times are good. With the memory of the severity of the 2007–2008 financial crisis still fresh in the minds of many directors and executives, how should companies prepare for a downturn in the cool of the day, rather than reacting in crisis mode?
Most business plans do not currently anticipate economic downturns; however, a contingency plan makes good business sense because it positions companies to act decisively when recessionary storm clouds loom on the horizon.
Organizations develop contingency plans to address market opportunities should they arise and document specific action steps that are triggered if certain events occur. Such events might include natural disasters, cybersecurity breaches, terrorist attacks, fire, fraud, theft, or embezzlement. These perils may never occur, but the plan nonetheless stands ready with a response team organized to implement it.
The focus of this discussion is how to prepare for an economic recession that causes revenues to decline below a predefined threshold. It is virtually irrefutable that a recession will occur, which is why it’s wise to create a contingency plan to (a) mitigate the financial impact of a severe economic downturn on earnings and share price and (b) position the company to gain market share during the recovery.
In preparing a contingency plan to accomplish these two objectives, action steps are sequenced, prioritized, and grouped by corporate function and operating unit so that ownership of each step is clear. Targeted cost savings in the current and subsequent projection years should also accompany each action step. Key plan elements for most companies include.
- Headcount and hiring changes. Distressed operating environments present a time for shepherding the talent most critical to retain. Focused retention, objectively determined workforce reductions, and changing hiring practices are often important components of a contingency plan.
- Compensation, benefit, and incentive plan adjustments. Temporary revisions to compensation, benefit, and incentive plans may be necessary to stabilize the firm’s financial condition. Vetting the economic realities of a declining top line and the need for adjustments to the reward system with key personnel before a downturn creates a broader support base for the plan when it is implemented.
- Asset divestitures. Management should categorize the company’s assets—underperforming versus high-performing, strategic versus nonstrategic—so that a plan can be developed for each asset category. The plan should consider the timing and the immediate and long-term financial impact of asset sales, and the need for such sales as signs of extreme economic scenarios appear. Timing can be a critical factor due to the difficulty of selling assets in a depressed market. Sale-leaseback transactions for certain facilities are also an option for raising capital.
- Selling, general and administrative (SG&A) expense cutbacks. SG&A offers many cost reduction opportunities. In the context of a contingency plan, the objective is to adjust the cost structure to support stabilization and preservation of the enterprise.
- Consider other options. Other steps a company can take include:
- Hedge raw material costs and lock in sales prices, thereby stabilizing margins — at least for a time;
- Consider outsourcing non-core activities that are not strategic to the business, if it will reduce costs such as certain human resources support, accounting, manufacturing and transportation activities;
- Focus marketing on sustaining brand awareness during a recession;
- Discontinue underperforming operations; and
- Address the impact of upstream and downstream interconnectivity within the value chain, e.g., what steps would the company take if a major supplier were to go under due to the downturn?
- Hierarchy for cost-savings initiatives. Management should outline a comprehensive menu of prioritized cost-savings initiatives that could be implemented either in part or in its entirety, depending on the severity of the downturn.
- Communications plan. In times of economic uncertainty, timely and open communications are vital to preserving morale so that employees know where they stand, and how they and the organization can get through the crisis. Straight talk and transparency are important because, from an employee perspective, no news does not necessarily mean good news.
An effective plan should determine the metrics to be managed against the enterprise’s specified targets such as net operating income percentage, gross margin percentage, acceptable variance from budget, earnings per share, minimum cash reserves, and maximum debt levels. With targets identified, a financial forecast over an appropriate period should be prepared to establish a baseline. Considering different scenarios—revenue declines of, say, 10 and 20 percent— the costs and expected benefits from the various elements mentioned above should be considered to ascertain specific actions management should take under the circumstances.
Once completed, the plan should be reviewed with and approved by the board. The company then resumes its growth strategy with full knowledge that the contingency plan is ready when the time comes—and, unfortunately, it will come. A vetted, actionable contingency plan saves precious time during a crisis because there is a broader base of support for its execution. Preparedness leads to decisiveness under fire.
Management should review the plan on a regular basis to ensure it remains current and apprise the board of any significant changes made to the plan. Going forward, management should monitor the external and internal economic indicators appropriate to the company, and periodically review the analysis with the board. Once the plan is initiated, a project management office should be designated to drive its implementation. The project management office monitors the achievement of the assigned initiatives and provides status reports to senior executives and the board.
Developing a response plan under sunny skies rather than when the recessionary storm breaks would demonstrate a board’s due care and sound business judgment in discharging its oversight responsibilities to address a credible threat. Further, entering a distressed operating environment without a thoughtful, comprehensive plan can lead to hasty decisions, inefficiencies and costly delays. An organization’s stakeholders deserve better.