Confronted with a pandemic, we’ve seen global supply chains struggle to cope with the consequences of isolation and work-from-home orders. The outbreak has completely changed buying behaviours and patterns. In many industries, demand has dropped off substantially or moved online.
With recession looming in several economies we thought it timely to share guidance on:
Key recession indicators to look out for
Recessions are defined as two consecutive quarters of negative economic growth. This can be caused by geopolitical shocks, financial panics, falling consumer confidence, and many other interacting factors.
In the past economic downturns have occurred at approximately nine-year intervals. The last global recession was in 2008, leading some economists to believe the next one is overdue. Forecasting a global recession is tricky, but here are three indicators economists look out for.
1. Recession indicators: Factory slow-down
The health of manufacturers is a good indicator of the health of the economy. To measure this, we turn to the Purchasing Managers Index (PMI). A PMI score above 50 means manufacturing is growing. When it falls below 50, it means factory activity is shrinking; a reading below 45 hints at a recession. Economists regard the PMI as a leading indicator of economic conditions.
As countries fight the Covid-19 outbreak by staying in their bubbles, business levels have collapsed. While some producers are busier, a majority of industries are reporting a rapid fall in demand and production. Global manufacturing data shows the pandemic impact:
- US manufacturing PMI fell to 48.5 in March 2020, down from 50.7 in February
- UK manufacturing PMI fell to a three-month low of 47.8, down from 51.7 in February 2020
- Eurozone manufacturing PMI crashed to 44.5 in March 2020, down from 49.2 in February
- Japan manufacturing PMI fell to 44.8 in March 2020, down from 47.8 in February
Check out the table below to see how other countries’ manufacturing PMIs are faring in light of the pandemic:
Covid-19 has impacted manufacturing across the globe. Source.
2. Recession indicators: Businesses holding more stock/make fewer sales
The inventory to sales ratio, also known as inventory turnover, measures the amount of inventory in your store compared to the number of sales you’re fulfilling.
On a larger scale, it takes into account the stock of all the businesses in the country. A high ratio indicates sales are down, and that businesses are accumulating a stockpile of goods. Typically seen as a lagging indicator of a recession, an increasing inventory to sales ratio could be the result of a decrease in sales, meaning less revenue for businesses, or an increase in the companies’ inventory and the associated costs of maintaining the extra stock. It may also indicate supply and demand are imbalanced.
3. Recession indicators: Investors buy more long-term bonds
One of the most closely watched indicators of a recession is the yield curve on bonds. Bonds have differing maturities — some bonds mature in three months, others after 30 years.
Normally 10-year bonds have a higher yield, because the issuers have to price in a higher return to make it worth the risk for investors. After all, tying up your money for 10 years leaves you much more exposed to risk – who knows what your money will buy in 10 years time?
However, that yield can fluctuate as bonds are traded on the secondary market. If demand for short-term bonds is low, then the price goes down, which in turn makes the overall yield of the bond higher (because you’ve paid less for something that delivers a fixed return).
The yield curve, then, measures the difference in yield between US 10-year Treasury bonds, and 3-month bonds, as that changes over time.
But why is that a predictor of recession?
Basically it’s a thermometer for risk. If the yield curve goes down, it means people are competing for longer-term investments, presumably because they think the short-term economic situation is going pear-shaped.
The yield curve has inverted before every U.S. recession since 1955. Source.
An inverted yield curve does not predict the length or severity of a downturn. Nonetheless, economists look out for an inversion to warn of an impending recession. For the last 50 years, the US yield curve has inverted ahead of a recession.
How to build a resilient supply chain in the face of a recession
Developing a strong supply chain response to the coronavirus outbreak is extremely challenging, given the scale of the crisis and the rate at which it is evolving. This is not dissimilar to the impacts of a recession.
We’ve taken some tips from Ernst & Young on how you can build a resilient supply chain that can withstand disruption.
Focus on being agile
Waning demand is often the biggest effect of a recession in the supply chain, imposing immediate risk of excess inventory stock. Agile supply chains are more capable of matching supply to demand when demand falls quickly.
Many supply chain leaders struggle to identify the right course of action and key demand planning applications aren’t always correct in a recession. Traditional demand forecasting relies on sales history to build a forecast. However, past sales can be a poor predictor of future sales when real-word events such as a pandemic, weather changes, natural disasters or other abrupt market shifts happen.
Under traditional demand forecasting methods, businesses will be stuck with too much inventory stock when demand suddenly falls. When stock begins to pile up in warehouses costs can rise significantly relative to revenues.
How can your business stay agile?
- Evaluate and adjust priorities. Working in shorter time frames can keep you nimble; regularly review how well you’re meeting your goals and adjust them as you go
- Introduce digital procurement technology. Technology such as crowdsourcing and predictive analytics can make your supply chain seamless and provide insight for strategic planning
- Invest in more collaborative and agile planning and fulfilment capabilities. From IoT devices for demand sensing and product movement tracking, to advanced forecasting solutions, these tools and technology significantly impact how companies understand demand signals and how quickly they can react to them
Shorten planning cycles
Business planning typically happens on a monthly basis. For smaller businesses, it might not even happen as frequently, or as thoroughly, as it should.
Integrated Business Planning (IBP) is the planning process that extends the principles of Sales and Operations Planning (S&OP) throughout the supply chain, product portfolios, customer demand and strategic planning, to deliver one seamless management process. Source
Conducting smart and regular business planning while keeping an eye on economic indicators will put business owners on solid footing when the next downturn arrives.
During a recession, many companies shorten their monthly business planning cycles to a weekly basis to understand and react quickly to demand signals. The longer the planning cycle, the more likely a business will get stuck with excess inventory stock in a recession.
Make cashflow paramount
In uncertain economic times, there are fewer sales and therefore less cash to fund operations. Surviving a downturn requires deft financial management. To be successful, supply chain teams and sales and finance teams need to prioritise cashflow.
- Shift the focus from the income statement to the balance sheet. Among payables, receivables and inventory, supply chain executives tend to focus on inventory. But to minimise working capital requirements during a recession, it’s important to apply a coordinated approach across all three areas
- Manage receivables. Focus on customer-specific payment performance. Getting the basics right, such as timely and accurate invoicing, can help. Any errors in your billing process can lead to costly delays in receiving payment.
Look after your suppliers
In a recession, companies have more to worry about than just demand. Companies need to also carefully monitor the financial health of their suppliers. Reducing the negative effects of a recession on your suppliers will help negate the flow-on effects impacting your business. Consider whether supplier management software would help this process.
- Be mindful about the impact of slowing down payments. For your key suppliers, their financial reliability may be impacted and cause trouble. In addition, paying small suppliers more slowly could cause them to go out of business. Both scenarios have serious consequences on your business
- Review your risk. How quickly can your business react to a supplier going out of business? One best practice is to identify which suppliers offer components that go into a high percentage of revenues and are a single source that no one else can supply. You can also look at the financial health of a supplier using their financial statements
- Communicate transparently. You may need to ask your supplier what their contingency plans are and what you can do to help. After all, you will need them again to full capacity once the economic situation begins to turn around
Check out the full list on Ernst & Young.
Coming out of a recession
Few progressive business leaders have a master plan when they enter a recession. Instead, they work nimbly to discover what works. This agility, along with long-term growth and profitability, will see businesses make it through a recession.