The Next Global Recession

At this point, experts are not saying that China has slipped into recession. But recessions are defined in the rear-view mirror, after they have already occurred. Further clouding the issue is the fact that leading economists have long questioned how accurate China’s GDP data really is. Companies would be well advised to start doing contingency planning assuming that China is in recession.

Further, companies need to also ask not just how a Chinese recession impacts their China business, but whether a Chinese recession, or even just a substantial slow down, will tip the world’s economy into recession. Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management says that a continuation of China’s slowdown in the next years will likely drag global economic growth below two percent, a threshold he defines as a world recession. China accounted for 38 percent of the global growth last year, up from 23 percent in 2010.

Recessions

One of the worst things a company can do when the world is tipping into a recession is to react too slowly. The key process for matching supply to demand is the sales & operations planning (S&OP) process. But if companies are using order history to forecast demand, they will be stuck with too much inventory. Demand driven companies, companies that have visibility to demand at the point of sale (POS), can sense downturns in demand much, much quicker. But accessing POS data is difficult in the US, only a few very large retailers provide this data. Accessing it in China will be all but impossible for many companies.

Companies that can spin their S&OP process more quickly will be better positioned to deal with a downturn. Many companies, do S&OP on a monthly basis. Increasing numbers of companies are beginning to do this process on a weekly basis. A few companies, actually match supply to demand in leading product segments on a daily basis.

Daily S&OP is beyond what many companies can do. But at an inflection point like this, some sort of daily planning is imperative. After the last global recession, I talked to one company that had implemented daily inventory planning meetings. In December 2008, it told all of its suppliers to stop all shipments for four weeks until it had a chance to recalibrate its demand plan. The company also moved quickly to resize the company by laying off workers, slowing production, and shutting some factories. As a result of these actions and its new supply chain applications, the company was able to come within five percent of its financial plan every quarter, even during the worst of the downturn. The company’s stock price, like many others, tumbled with the recession. But following the recession, the company’s fiscal discipline led to much stronger stock performance that its peers.

The next generation of S&OP is called integrated business planning. It is focused more tightly than traditional S&OP on how particular demand/supply balancing decisions impact revenues, profits, and cash flows. But during a recession, “Cash is King.” The cash conversion metric becomes an increasingly important KPI for the global supply chain team. To be successful, a Cash is King Initiative needs to drive performance not only in the global supply chain organization but also across the sales and finance teams. This end-to-end effort helps to insure that Inventory turns, Days Sales Outstanding, and Days Payables Outstanding targets are met with a goal of driving down the cash conversion cycle.

But in a recession, you have to be careful about this kind of initiative’s impact on key suppliers. If you slow down how fast you pay them, their financial integrity may be impacted. In a recession, companies have more to worry about than just demand. They also need to carefully monitor the financial health of their suppliers. One fairly simple tool companies use is a two by two matrix where on the vertical axis, a company places suppliers in boxes based on total product revenues linked to specific supplier components, the degree to which key components are single sourced, and the geopolitical and environmental risks associated with where a supplier operates. On the horizontal axis, the company assesses the financial robustness of its partners. If suppliers are placed in the top right hand corner of the matrix (high supply risk/high financial risk), procurement executives should require these suppliers to develop and present business continuity plans. And like with demand, companies should be monitoring these companies’ financials more frequently.

In conclusion, companies with flexible, responsive supply chains will weather a global recession better. These companies will be posed to buy distressed assets at bargain basement prices, grab market share when the recession ends, and outperform their competition in financial markets.