The Reset Economy

“This economic crisis doesn’t represent a cycle.  It represents a reset,” according to Jeff Immelt, the CEO of General Electric.  “It’s an emotional, social, economic reset,” which will lead to greater government involvement in the economy and business affairs.

For Steve Ballmer, the CEO of Microsoft, the problem with the economy is that it grew for 25 years on unrealistically cheap debt and that era is now over.  “I think that expansion was built on three things: innovation, globalization, and debt, increasing debt.  The private sector of our economy has borrowed too much money, businesses and consumers alike.”

Business leaders are starting to use the term “reset economy” to describe the current environment and the road ahead.  The core idea is that once we rebound from this economic downturn, the worst in 70 years, it will not be business as usual.  We could emerge into a world where:

  • The core growth rate is lower as cheap credit disappears and consumer spending does not fully rebound to pre-recession rates;
  • The costs of regulation are significantly higher;
  • The cost of capital is higher and the ability to apply financial leverage is greatly reduced;
  • Global trade and offshore manufacturing shrinks, as attitudes become more nationalistic and defensive.

Many companies project long term demand using a historical growth line.  When a recession occurs, they ratchet down growth rates, project how long they think the recession will last, and then reapply the historical growth curve on the other side of the recession.  However, the business environment might be far more different moving forward than it has been historically, not just during the recession, but potentially for a decade or more following it.

What does the Reset Economy mean for supply chain organizations? 

  • The core problem will be matching capacity to projected demand over a strategic planning time horizon.
  • The strategic planning group will need a team that includes, or has access to, economists (to develop global growth scenarios by region and industry), industry experts (to project what sorts of capacity investment choices key competitors are making), lobbyists (to track and influence regulations that could impact business decisions), and supply chain strategic planning and risk management analysts.
  • Companies traditionally use a discounted cash flow methodology when deciding what sorts of capital investments to make, like building a new factory. The real options methodology, however, is better suited in environments with great uncertainty. A real option is the right, but not the obligation, to undertake some business decision, typically the option to make a capital investment. This is better than the traditional valuation methodology because it better accommodates the value of flexibility. However, few companies use or understand real options. Further, coming up to speed on this type of valuation methodology takes some time.
  • Network design and multi-echelon inventory analysis tools have a strong role to play in helping the supply chain organization perform the necessary analysis. Infor, IBM, i2 Technologies, Oracle and other solution providers offer these types of tools. For organizations capable of real options analysis, Monte Carlo simulation is a core tool (Oracle has a good solution for this). There are emerging tools (e.g. RiverLogic) that allow supply chain strategic planning scenarios to be combined with the cash flow, balance sheet, and profitability associated with that scenario.
  • People that have the background and experience to use these types of tools are rare. Many companies will need to work with consulting organizations, such as IBM, Chainalytics, and others, to do this type of analysis.
  • Organizations with Integrated Business Planning processes – i.e., rolling quarterly budgets that are connected to monthly Sales and Operations Planning processes – will be better equipped to accommodate a changing macro environment.

Finally, it needs to be pointed out that some companies will emerge from the recession stronger.  They will have the cash reserves or financial stability to continue investing in new technologies and to take advantage of the weaknesses of their competitors.

Crisis also creates opportunities: to overcome cultural resistance; to slash structural costs that are out of line; and to build supply chain agility and have the ability to compete better in a far wider range of economic scenarios.

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