I recently posted a blog that talked about a recession being a time of great opportunity for business and I thought it might be useful to share some ideas on why this is so and what you can do to take advantage of the situation. I have written this post from the viewpoint of how you might talk to your business clients.
In good times every man and his dog can run a successful business and many will even to be in great shape. But good times hide from view the real weaknesses that exist in so many businesses and they also hide from view underlying strengths. When the going gets tough both the strengths and weaknesses are revealed.
A recession is a time when the business landscape is cleansed. It’s a time in the economic cycle that presents you with an opportunity to lay the groundwork to build your bottom line by addressing the things you should have been doing right irrespective of economic conditions. For already well run business it is a time for them to drive home their advantage by focusing even harder on the things that have made them successful. What follows are some thoughts on how to do that.
Your pricing strategy. Typically people think nothing comes to rest on the bottom line unless it first appears on the top line. That line of thinking leads to the mistaken belief that revenue is the major profit driver and a price reduction enables you to hold or even grow market share and thereby maintain profitability. It isn’t that simple.
If you’re servicing a market where price elasticity is high or at least rising because of the recession (i.e. customers become more price sensitive in tough times) then some price reduction might make sense but if you try this and don’t see an increase in sales (both in terms of revenue and units shipped) then market demand may not be as elastic as you think so don’t continue with it. Furthermore, in tough times customers tend to have smaller order sizes which means your cost of supplying the order is relatively higher (this would be obvious if you used activity based costing) with the result that if you discount your price, your margin shrinks even more.
It’s fair to say that typically customers do become more price sensitive during a recession but not as much as many business people think. However, rather than drop your price it is far smarter to explore ways to introduce a lower priced alternative to your main service or product with some “value” removed. In other words maintain your margin on your main lines and introduce a lower priced alternative to service your price sensitive customers. In other words, give your customers two opportunities to say ‘yes’ instead of either ‘yes’ or ‘no’.
My candid view is do not consider a discounting strategy unless you can introduce an additional lower priced alternative or you have a cost advantage over your competitors and you have available capacity and the demand for the product or service you offer is sensitive to price.
Because price cutting is so transparent it is by far and away the easiest initiative for competitors to copy so the minute you do it you not only lose margin on all your sales but you’ll probably lose some of your physical volume as well. At the end of the day, the game of business is about the bottom line, not the top line.
You should jump on to GamePlan (the pricing & volume calculator in the GamePlan Tools module) to see the impact that a price reduction has on the need for additional sales to maintain gross profit. For example, if your GP% is 30% a price reduction of 10% (a common discount used) will require a 50% increase in sales to maintain your gross profit (it’s even higher than this if your GP% is less than 30%). Quite frankly, it would be amazing to achieve a 50% increase in sales from a 10% price reduction during an economic boom but you’d have to be living with the fairies to believe that would be possible in a recession.
GamePlan’s pricing & volume calculator will also show you that as long as you hold your price (and therefore your margin) your competitors could take 33% of your business before your gross profit declines—this is most unlikely to happen but to the extent you do lose some business you just might find it’s from customers who are not profitable for you in any event—this is discussed below.
This is not to say pricing is irrelevant. Pricing is a critically important issue in any economic environment and there are some pricing and related product bundling strategies that should be especially considered in a recession but I will be spending some time on that at our up-coming training programs in the US later this year so for now let’s move on.
So if price is not the answer, what is?
Identify your very best customers and your most profitable products and/or services then focus all your attention on both of those elements of your business. If you do a thorough analysis of your customer base you will inevitably find that between 10–30% are unprofitable for you, a great starting point for this is to do a Pareto Analysis that will tell you what percentage of your customers contribute 80% of your revenue and a separate analysis of the percentage that contributes 80% of your gross profit. Get rid of the low profit contributors or allow your competitors, who are implementing a price reduction strategy, “win” them. You’ll benefit in two ways: first, your immediate profitability will improve because you are generating quality revenue by ridding yourself of unprofitable business and secondly, you’ll ultimately gain market share when your competitors go out of business as a consequence of them trying to service your bad customers on their lower margins.
Strengthen your balance sheet. Many businesses get away with murder in good times. They have way too much debt that is incorrectly balanced (e.g. too heavily weighted to short term), their shareholder distributions (drawings) are too high and their receivables and inventory are poorly managed. This is a time to clean all of these things up. Dispose of unused or under-utilized assets (and under-performing non-core businesses) and if those assets are required for some aspect of your operations, out-source that service. Even if this ends up costing you a little more, the benefit you will get is some debt retirement (assuming the proceeds for the sale of the assets is used for that purpose) and secondly, a reduction in your break-even point (assuming the increase in variable cost does not out-weigh the effect of the reduction in fixed costs) which give you more capacity to deal with sales volume fluctuations. Use GamePlan to make this assessment.
Improve the quality of your financial reporting and financial management processes. In boom conditions people don’t worry too much about the quality of either their financial reporting system or their financial management. As long as there’s money in the bank to pay the bills everything’s OK. Unfortunately when these bad habits spill over into difficult economic times we you have a recipe for disaster.
You should have a full set of financial that are accurate and available within 3–7 days of the end of each month. This is where Principa’s DashBoard comes into it own. A monthly review meeting with your business coach, with the DashBoard at the center of discussion and supplemented with your GamePlan analysis, can make a dramatic difference by helping you keep focused on the things that need to get done in your key result areas—view a video of Bob Bowley talking about the results he has achieved as a business coach using the DashBoard. In addition, a weekly flash report should be available by COB Friday that shows your sales, receivables, payables, cash, sales pipeline, orders on hand, your primary activity metric (e.g. transaction count) and average transaction value. The KPIs will depend on the business but this is an indicative list.
Focus on your core business and supporting operational processes. Successful businesses have a laser-like focus on their core business. This is what makes them very good at it. In difficult times it often happens that people look for non-core activates to boost revenue which distracts them from their main business, confuses their customers and starves their principal activities of resources. My advice: stick to your knitting and concentrate on improving the productivity of your existing processes.
Don’t cut back on discretionary expenses without good reason. In tough times it’s normal to think we should cut expenses because with a gross margin of say 30% then for each $1 reduction in costs we do not need $3.33 in revenue. This is something that can’t be ignored because these numbers speak for themselves. But simply cutting any expense simply because it’s possible does not make sense even though that may appear to be counter intuitive.
A discretionary expense is one over which management has discretion in the sense of that it can be cut, increased or eliminated. Expenses that fall into this category would include R&D, team training, marketing, customer service initiatives, some team salaries and discretionary bonuses and so on. In contrast, non-discretionary expenses are those expenses in respect of which the business is either contractually obligated or are absolutely necessary to “keep the doors open.”
For the most part, discretionary expenses are associated with activities and initiatives that grow the business or to put that another way, they ensure the business will be vibrant tomorrow. In contrast, non-discretionary expenses are the ones that are associated with what the business must do to meet today’s operational needs. Lazy (or ill-informed) business managers tend to look first at discretionary expenses when they launch a cost cutting exercise which is precisely why a business that is going to come out of a recession stronger than its competitors always employs a different strategy. There are always some discretionary expenses that should be cut or eliminated (even in good times) e.g. business/first air travel for short trips, long lunches and $100+ wine, chauffeured limos … need I go on?
You should not cut any expenses that directly impact the strength of the relationship you have with your profitable customers. Nor should you cut the investment you’re making in developing and delivering your most profitable products and services. You will find that as a result of reducing your unprofitable products and purging your unprofitable customers you will have opportunity to reduce some of you non-discretionary expenses. To keep an eye on how your customers feel about you it would be a great idea to implement the Net Promoter Score customer monitoring system advocated by Fred Reichheld and his colleagues that I wrote about in an earlier blog posting.
The key here is to undertake a customer and product line profitability analysis in conjunction with an ROI review of your expense line items and seek out better suppliers who will offer better service at lower prices (remember, your suppliers are also in a recession). This of course is a strategy that should be in place irrespective of the state of the economic environment but good times breed lazy managers.
Work with your suppliers to find ways that you can help them lower their cost of servicing you. Intuitively, one way to achieve cost reduction would be to put pressure on your suppliers to lower their prices &/or offer better payment terms. That might be possible and should be pursued but it also makes sense to work with your suppliers to find ways to help them achieve cost savings that can be passed on to you as lower prices. Having a good relationship with your suppliers is critical to your continued success when the economy improves and the quality of the relationship you enjoy during tough times will influence that. The last thing you want coming our of a recession is an inability to meet demand because your suppliers are no longer in business or they give preference to your competitors who were kinder to them in the hard times.
Keep your team in the loop. Your team are the key to your success. In a recession people always worry about their job and the last thing you want is your best people jumping ship and joining a more successful so that you’re left with under-performers. Your people need to know what your strategy is and they need to feel confident that their job is not on the line. If they feel secure but at the same time realize that everyone has to pull his/her weight you’ll find they’ll step up to the challenge and you’ll not only be able to grow your bottom line, you’ll build a stronger team that will remain loyal to you for many years to come. You’ll also position yourself nicely to bring on board people who have been retrenched by your competitors so you might want to pick the gems out of that to strengthen your team by letting go people who don’t want to roll up their sleeves and get behind you.
One thought on “How to turn a recession into a time of great opportunity”
It’s interesting how different people react to ideas. I got an email from a person who thinks talk of recession is rubbish—“we’re not in a recession” he says. He’s obviously happy to waddle along in ignorant bliss about what’s going on in the world. Technically a recession is defined by 2 consecutive periods of negative GDP growth and by that definition I concede we are not (yet) in a recession at least in Australia.
However, people are losing jobs, earnings projections are declining, the stock market is being hammered, there is pressure on interest rates …. in short things are not booming and the immediate outlook is not great. But the opportunities to achieve greatness abound.
It is with that scenario in mind that I wrote the blog. Any business manager worth his or her salt should be thinking strategically and tactically about how best to manage during different stages of business cycles.
In boom times it’s hard for a business to build a sustainable competitive advantage but that’s not the case in tough times. This is when the sheep get separated from the goats. It’s a time when smart business advisers are looking to work with smart business clients to help them.
I’d be interested in what other people think.