COVID-19 economy update: Karen Harris, Bain & Company's head of Global Macro Trends Group, provides a glimpse into how the Coronavirus pandemic has affected the U.S. economy and manufacturers. ITR Economics shares its projections for how the economy will rebound, as well as strategic tips on how to handle black swan events in the economy. Scroll down to the bottom of this article to read both of these updates.
As we enter the tenth cycle of the economy, the U.S. has recorded the largest uninterrupted economic growth in the country’s history, according to the U.S. Chamber of Commerce. But it’s been 10 years since The Great Recession pummeled the manufacturing industry, and manufacturers are anxiously awaiting the inevitable as economists say, “What goes up, must come down.” An impending recession was hinted at during PMMI’s Executive Leadership Conference last year in April, and it’s been the talk of the industry ever since.
“When we hear the word ‘recession,’ we all think of 2008 and 2009,” says Taylor St. Germain, an analyst for ITR Economics, an economic trend reporting firm. “But that is certainly not the case for what manufacturers are about to experience.”
However, the pressure and fears OEMs are experiencing aren’t without warrant. September 2019 marked the first time U.S. manufacturers experienced a contraction as large as the ones toward the end of The Great Recession in 2009. According to The Institute for Supply Management, the manufacturing index fell to 47.8% that September in 2019 from 49.1% the prior month. The report states that machinery manufacturers cited, “Dealer inventories have rebounded, and the overall customer market has softened, resulting in corrections to near-term production schedules and a tentative forecast outlook.” Today, it’s the trade war with China that has wreaked havoc as it causes uncertainty in the economy—a common trigger for a recession. According to the report, many manufacturers cited losing new and existing customers over costs associated with tariffs.
While these numbers indicate that the manufacturing industry may be in trouble, ITR’s St. Germain says the current economic situation is the mildest recession recorded in 100 years for the U.S. industrial production sector. ITR relies on the U.S. gross domestic product (GDP) and U.S. industrial benchmarks to forecast economic events like a recession, and the company found that the pressure U.S. manufacturers are currently experiencing is the result of a minor downturn, which started at the tail end of 2019, and will only last until mid-2020. While ITR says U.S. manufacturers may be feeling tiny contractions throughout 2020, there isn’t a strong case for a recession until 2022.
Aside from gearing up for a recession in two years, global management consulting firm Bain & Company is also predicting that a technology boom will continue and likely accelerate coming out of the next downturn. Bain partner Jeff Katzin says that manufacturers should be doing everything they can to position themselves to be on the right side of the technology boom, which means being open to progressive innovation and concepts.
“We actually think the downturn is going to mark the starting gun of what could be a fundamentally different business cycle with accelerated adoption of emerging technologies and automation,” Katzin says.
For this reason, manufacturers shouldn’t rush to scale down and cut back just yet—despite the uncertainties around trade, tariffs, and the economy. In a recession, many companies may lay off employees, cut down on R&D, and scale back on sales and marketing, but given the unique position manufacturers are in with the upcoming technology boom and current workforce crisis, this isn’t the move.
Plus, Katzin says there is so much to gain from a downturn, especially for manufacturers, because this kind of contraction in the economy can flip the playing field upside down, making it easier to pass competitors.
“While a downturn period could cause some concern, it’s also a period where there is a lot of opportunity if you have a downturn strategy and are getting an early start,” Katzin says. “There can be ‘winners’ in a recession or downturn, you just have to position your company to be one of them.”
Last year, Bain extensively analyzed 3,900 companies and focused on what the successful ones—who gained market share and grew at a 17% compound annual growth rate (CAGR)—did differently than those companies that didn’t grow at all or were worse off after the 2009 Great Recession. In their research, Bain found that the “winners” excelled in four main areas prior to and during the recession, which kept their growth accelerating after the recession at 13% CAGR, while the “losers” only continued to grow at 1% CAGR.
Four ways manufacturers can win in a recession
“The challenge is when downturns happen, the temptation can be a knee-jerk reaction, and you really want to have a series of chess moves planned out across sectors and within sectors during a downturn,” Katzin says. “By having a strategy, we see companies that are able to sustain that growth coming out of the downturn while also inviting new growth.”
Here are four things manufacturers can do today to weather the current downturn, as well as prepare for the projected 2022 recession.
Take a hard look at costs. There is a common misconception that in a downturn environment, companies think they need to “burn the furniture,” Katzin says. But the danger with cutting back is that sometimes companies can cut too deeply by ruling out investments and acquisitions, cutting out R&D, and scaling back on sales and marketing. Those companies who came out on top of The Great Recession acted early on costs but did it in a way that analyzed the assets they need to protect, and not scaling back too deeply in those areas.
Put the rest of the financial house in order. It’s critical that OEMs be more mindful of managing liquidity and the balance sheet beyond thinking about profit and loss efficiencies. Winning companies managed the working capital and capital expenditure strategy in an aggressive way to increase cash flow and identify which investments were going to have a higher return in line with their strategic vision. Katzin says this strategy helped one heavy equipment manufacturer see an increase of 40% on its return on investment in 2008, which was up from -5% in 2001.
Play offense with investments. Think about how to drive efficiency and how to reinvest in the business today and tomorrow. With the end of this downturn spurring a different economic cycle and technology boom, companies should invest in important capabilities and technology that they are going to need three to five years down the line. And OEMs need to start making those investments now, which means they need to see how they can free up the resources and capacity as an organization to be able to make those investments and have fast growth on the backend of a difficult economic environment.
Pursue a proactive merger and acquisition (M&A) pipeline. In the midst of the recession environment in 2009, company valuations were lower across all sectors and industries, making some acquisitions very attractive and opportunistic, Katzin says. Acquirers were able to purchase new product lines, customer segments, and capabilities at lower prices. So, if OEMs have the capacity and the financial capability to look aggressively at M&A, it could help them add capabilities and enter into new markets.
On top of these tactics, ITR’s St. Germain says downturns can be a good time for OEMs to evaluate their strategy for the future.
“Take advantage of slower activity during the first half of the year because as we move into the second half and into 2021, we are forecasting a pretty fantastic growth year for the U.S. It’s time to train your people, make capex investments, automate when possible, and have your people and process ready for what’s to come.”
Anytime financial best practices
In a downturn, everything becomes cheaper—from people to materials, which is why St. Germain says OEMs can turn these economic hard times into profitable phases. In order to capitalize on the benefits of an economic downturn, manufacturers must create financial habits around these four practices, which will also serve them well through any economic phase:
Track rates of change: ITR’s St. Germain advises OEMs to constantly track their rates of change so that they can better identify when they should expect slow and busy periods. Builders should also be monitoring commodity prices, which are currently relatively low. St. Germain advises buying the commodities in bulk now because the cost will be rising by the end of 2020.
Identify counter cyclical markets: During a downturn, OEMs should also be taking advantage of counter cyclical markets that will be performing well while other main markets will be down.
Build cash: Manufacturers should always be trying to build their cash capital so that they can invest in companies, people, materials, and other strategic items at the bottom of the cycle when everything is cheaper. St. Germain says, “Buy low, sell high.”
Retain talent: Because the manufacturing industry is currently experiencing a workforce crisis, St. Germain advises OEMs to hold onto their talent, as layoffs could come back to hurt a company more than the downturn itself.
“This tight labor market we are feeling right now, it’s here to stay for the next few years,” St. Germain says. “It’s important that we keep those A and B players in our business right now. As things pick up, we are going to need those people in our business because it’s tough to find them as it is right now.”
Your recession defense starts here
No matter how much data is kept and analyzed, it can be difficult to predict and pinpoint a recession and its severity, Katzin says. While this may not give many peace of mind as they plan for an uncertain future, there are steps that OEMs can take right now to at least start the dialogue of how they plan to withstand a recession and how they can place their company in a strong position.
“When you talk about the future of your company start with the end in mind. What is the aspiration of an organization three to five years from now?” Katzin says. “Ask yourself where you need to win with your customers versus peers, and where do you need to innovate?”
Secondly, Katzin recommends that OEMs stress test the balance sheet for some different scenarios. Create a plan and strategy for the serious moves, both on the offense and defense, depending on what the world looks like. “I think the challenge is when things happen sometimes the temptation is more of a knee-jerk type of reaction, and you really want to have a series of chess moves planned out across some of those stress test environments as well as profit and loss, cash flow, and a balance sheet through different downturn scenarios. Whether it’s a shallow or deeper recession, I think having these discussions early and seeing where there are ways to make sustainable changes to the business to free up capacity and resources to reinvest is what companies should be thinking about now.”