The gathering storm

11 March 2008

While economists argue over whether or not the US is technically in recession, the actions of Chancellor Alistair Darling have sparked a mini-boom in at least one part of the UK economy. Throughout the capital city and beyond, entrepreneurs with a good business story to tell are weighing up their options to sell before they get clobbered by the pending capital gains tax increase. But for those who aren’t in a position to cash in – or who simply aren’t ready to – the most immediate priority is more mundane – it’s all about working out what changes they need to make in preparation for tougher times ahead.

According to the recent Deloitte Economic Review, the UK economy is about to experience its toughest period for 15 years, with the risk of recession (technically defined as two successive quarters where the economy shrinks) high. That’s going to affect different sectors in different ways, and for entrepreneurs it can be both a threat and an opportunity. Take a classic retail supply chain, for example. With a dominant player – such as a leading supermarket – at the end of the chain, smaller suppliers are likely to get squeezed on prices as times get tough, and the smallest, who have no one else to squeeze, often feel the effects the worst. But equally, smaller businesses don’t have the overheads of those further up the supply chain, and in theory at least can adapt more quickly to changing circumstances.

Get strong leadership, not management

Anthony Holmes, a turnaround specialist with 20 years experience in restructuring public and private companies (www.anthonyholmes.org ), says problems are likely in the next twelve months based on current indicators, although that may not lead to full-blown recession. A lecturer at London Business School, he will argue in an upcoming book, “A Time to Lead, A Time to Manage”, that turbulent times need strong leaders who make tough decisions, not managers who keep going with the current business plan. In times of crisis, he says the natural inclination of a traditional manager is to go through a series of responses: denial, concealment, discussion and negotiation, confrontation and then collapse.

“Managers respond emotionally to perceptions that are either advantageous or threatening to their corporate survival,” he argues. “Their instinctive response to threatening events tends to be to seek out safe havens and clear vantage points and, in the confrontation stage, to respond irrationally as events spiral out of their control.” By shunning the kind of decisions that need to be taken early on in a crisis, businesses often end up in just the type of crisis management situation they sought to avoid.

Know your customer: are they a good debt?

No two businesses will approach a recession in the same way, but there are some common issues to be addressed. One of the tough decisions many companies will have to make is about customers – and who they want to deal with. “In times of economic turbulence there is a general slowdown in the promptness with which large companies pay small companies, which leads to cash flow difficulties,” says Holmes.  He adds that understandably, smaller businesses are reluctant to cease trading with a good customer who might be a credit risk because they need all the revenue they can get. They often therefore take a risk on not incurring a terminally significant bad debt.

However, Holmes believes that rather than take a one-dimensional risk position based on credit ratings, companies should take into account other factors. Alongside the basic principles of good financial management, he suggests ranking customers in order of the significance your company represents to them as a supplier. “This will tell you the extent to which you have leverage over them and the likelihood that they will pay you, as a key supplier, before they will pay other less important people. You should then ensure that customers at the top of the list are dealt with promptly and professionally in respect of their outstanding accounts by letting them know you will not accept late payment.”

Diversify and, if necessary, relaunch

Another good tactic for lessening the impact of recession is to spread your bets. While it’s not appropriate for everyone, some entrepreneurs that see one line of business struggling may look to develop spin-off businesses that are more likely to bring in revenue and still contribute to their overall strategic direction. A recession can actually be a time of opportunity for start-ups since, without the overheads and legacy of a medium or large business, they can more easily explore new opportunities. At a time when companies start re-examining long-held relationships, for example, it’s sometimes easier to win business off your larger competitors by offering a cut-down version of an existing service that your customer can no longer afford.

Don’t let financing cloud the fundamentals

Some struggling companies that raise extra finance to get them through a tough period may effectively be exacerbating their difficulties, rather than resolving them. As the situation worsens, if they haven’t resolved the operational problems that got them into difficulty in the first place, they can quickly enter a downward spiral. In any situation where repayment of borrowings jumps to the head of the queue, there’s a danger that management becomes obsessed with freeing cash flow to repay debt and longer-term, more strategic decisions are postponed.

Extend the runway

Finally, while people will tell you about the power of positive thinking in tough times, ultimately there’s nothing like a bit of penny pinching – or what Silicon Valley restructuring expert Marty Pitchinson calls “extending the runway” (see 'The Grim Reaper Breathes New Life' ). The theory is simple. If your funding is set to sustain you for the next 12 months, examine ways in which you can make it last 15 months and it might help you reach that decisive breakthrough. Or perhaps by spinning things out longer, you can make it without even needing another round of funding .

It’s not just about cutting overspend. Pitchinson, co-founder of Sherwood Partners (www.shrwood.com ) also advises that companies examine closely what they are spending money on – and how they are spending it. By outsourcing, offshoring and embracing less expensive service offerings and locations, most companies can save significantly.

By David Longworth, Webster Buchanan Research