Recession Reboot: Which Supply Chains Are Ready?
By: Mit Ctl
Tags: Recession, Thought Leadership, Forecasting, Supply Chain, MIT

Written by: Ken Cottrill

More than a decade after the 2008 Great Recession, what have companies learned about preparing for a severe economic downturn and how many of these lessons have they put into practice? Dr. Bruce Arntzen and Dr. Nima Kazemi at the MIT Center for Transportation & Logistics (MIT CTL) analyzed the profiles of 100 manufacturers to get a sense of where they stand today compared to 2007 and 2009 in terms of their recession readiness. Their conclusions, summarized in a two-part series in Supply Chain Management Review, are sobering.

Uncertain outlook

The ghost of the 2008 financial meltdown is still with us, but growth, record stock market performances and low unemployment over recent years have pushed it into the background.

Yet, on average economic crashes occur at roughly nine-year intervals, which means that the next one is already overdue. And as Arntzen and Kazemi note, “Good times are dangerous: Business managers are under constant pressure to bend the rules, be flexible and agree to policies during good times that will cause great pain and suffering when the economy goes south.”

Some warning signs have become evident of late. Volatility has returned to the stock market, and a host of threats such as a trade war with China and rising interest rates could trigger a downturn.

Well-known economist Nouriel Roubini, a professor at New York University’s Stern School of Business, recently characterized 2019 as a mixed economic bag. “There may be enough positive factors to make this a relatively decent, if mediocre, year for the global economy,” says Roubini. But a number of negative scenarios cloud the economic outlook, and if some of them materialize “the synchronized slowdown of 2019 could lead to a global growth stall and sharp market downturn in 2020.”

Negative consequences

While history does not repeat itself, the experience gained during previous downturns — and especially the 2008 debacle — can teach companies much about surviving the next one.

Arntzen and Kazemi describe seven ways in which supply chains feel the impact of downturns.

1. Customer orders fall off a cliff. As customers feel the full force of the economic headwinds, they cancel or delay orders and trade down by buying less expensive items in smaller quantities. Possible countervailing measures include introducing risk-aware contracts that allow for long lead-times and collaborating with customers on ways to share the risk.

2. Customer payments dry up. This is the most hurtful outcome. It’s important that companies keep a tight rein on salespersons who prioritize their earnings above the company’s best interests. Being diligent about collections helps to counter customer tactics such as attempts to change payment terms.

3. Expensive raw materials become a millstone. Using high-end raw materials might be the preferred option when times are good, but when a recession hits companies need to scale back in this area. Switching to standard parts can make it easier to cancel orders because it’s easier for suppliers to sell these parts elsewhere.

4. Payments to suppliers drain your reserves. Honoring supplier contracts becomes more difficult during a downturn. Adopting supplier management practices such as monitoring the financial health of suppliers and qualifying second sources of supply, helps companies to rationalize supplier networks during a downturn.

5. Supporting pre-recession headcount becomes a problem. While employees may be your most valuable resource, they can become a cost burden when the economy goes south. A more flexible labor cost structure, such as using contract manufacturers, might be a better option.

6. Lax indirect spending practices become unsustainable. Indirect spending covers myriad items such as computers, lunches, and even bottled water. These may not be considered mainstream purchases and hence not subject to the usual oversight. Such laxness needs to be addressed when the company is financially stressed.

7. Fixed costs become onerous too. These include outgoings such as rent and monthly payments on equipment. Again, a lack of discipline in this area can’t be tolerated when the company is battling recession.

Implementing measures to address these problem areas when times are good can enable companies to avoid much of the pain of a downturn, and ultimately come out of the crisis in reasonable shape to rebound quickly.

Lack of preparation

Unfortunately, a study of 100 publicly traded small- to medium-sized manufacturers (average revenues of $3.3 billion) based in the US carried out by Arntzen and Kazemi, suggests that many companies are ill-prepared for the next recession.

A horizontal analysis compared the average value of eight metrics — selected or created because they are indicators of good/bad supply chain practices — in 2007, 2009 and 2018 to determine whether the sample companies did better or worse in each year.

The companies appear to be stronger in 2018 than in 2017 on only one metric: revenues. On some measures such as profitability, they are slightly weaker, while they are significantly weaker on variable cost structure, revenue per employee, and number of employees metrics.

In addition, a vertical analysis was conducted. The authors compared each company to itself over time by looking at all the metrics for each individual company. They calculated the percentage change in each metric for 2007 vs. 2009 and 2007 vs. 2018, to get a sense of how each company fared during the big recession and how they stand today.

Interestingly. the analysis reveals that 19% of the companies did significantly well during the 2008 meltdown. Some 27% are in much better shape today to withstand a recession, and 29% of the sample are little changed today. But one-third of companies fared badly during the recession, and 19% are in worse shape now in terms of their recession readiness.

Overcoming inertia

The authors acknowledge that a study of 1,000 companies would yield findings that are statistically significant. However, the results of the 100-company study offer much food for thought for companies that are looking to prepare for the next downturn.

As Arntzen and Kazemi note, “we do not see a large movement of the metrics or the individual companies in the right direction for recession preparedness. Human nature and the drug of good times are likely too powerful to overcome.”

Dr. Bruce Arntzen is Executive Director of the MIT Supply Chain Management Program. He can be contacted at barntzen@mit.edu. Dr. Nima Kazemi is a Postdoctoral Associate at MIT CTL. He can be contacted at nimakzm@mit.edu. Contacts the authors for more information on their recession readiness research.