Lean is Mean in a Recession

by Rene T. Domingo

You cannot stop an economic crisis, but you can stop it from causing a corporate crisis. The economy will always change from bad to better – the question is whether your company will still be around when it does. It’s time for defensive management, to quickly prepare and execute plans under the worst scenarios. Don’t waste time listening to others analyze what went wrong with the global economy and who’s to blame. When the silent tsunami makes landfall, the least prepared and those still in denial will be washed away with their illusions of invincibility and good management. The point is to survive the bottom of the economic cycle and wait out the storm. Economic downswings are usually rapid, and the upswings are slow. Staying power is therefore key.

As companies scramble for cash and prop up liquidity in an economic slowdown, serious threats would come more from creditors and customers, than from the traditionally feared competitors. Companies used to sparring only with competitors during good times, will find it difficult to spar this time with creditors and customers for survival. Creditors like banks may limit and stop credit lines and customers may stop or delay payments to conserve cash. Highly leveraged corporate borrowers and cash-strapped suppliers, particularly those at the bottom of the supply chain or food chain, suddenly become endangered species.

Big companies increase their risk by raising their breakeven sales through reckless expansion, thinking that the economy will never falter. Warren Buffet warns us of this weakness of seemingly powerful companies: “It's only when the tide goes out that you learn who's been swimming naked.” If your breakeven sales is more than 75% of your current sales, you are a bankruptcy waiting to happen in an economic meltdown. Initial recession data show that sales across industries plunge from 20% - 50%, and get worse as news of pay and hiring freeze, layoffs, shutdowns, closures, bankruptcy filings mount. If you are not confident your company can survive this dismal level for at least a year, its time to switch gears to survival mode. To cut breakeven sales, cut costs, but not any cost. Cut fixed costs first. When sales drop, variable costs also drop, but not fixed costs. In a crunch, fixed costs are much more threatening than variable costs and are often the root cause of liquidity problems and bankruptcy. But don’t cut any fixed cost mindlessly - cut only the unnecessary fixed costs. Cut the right costs with the right amount. For example, don’t cut fixed costs that may reduce sales and alienate your few remaining liquid customers - e.g. front-liners and customer service facilities. Don’t cut fixed costs that assure the quality that defines your product, services, and brand. The last thing you want do is shoot yourself in the foot by cutting costs and losing more sales as a consequence. The few remaining viable customers and buyers want great respect and almost royal attention when they knock on your doors, visit your showroom, call you or send you an email. They know their bargaining power in times of crisis and will not be amused when you send them shoddy goods or when nobody pays instant attention to their needs and inquiries because you have dramatically downsized your frontline personnel.

Downsize to cut capacity. Close underperforming branches and stores and perennially subsidized businesses. Normally, in downsizing, many companies release their new employees first using the LIFO principle (Last in First out) and/or those at the bottom of the competency list. Any list will always have a bottom, so it is just a question which names will unfortunately be pushed down there. By convention, we actually reward loyal and productive people by letting them keep their jobs. You may also want to consider an alternative strategy: letting go of the good employees first. This may sound counterintuitive but actually it makes a lot of sense from my experience in studying an assembly plant in Asia. In the first place, why keep these over-qualified highly paid people do mostly repetitive work remaining in a trimmed down company. Why not let the less skilled ones do these routine tasks? Now what you want to do is set up a new company with a new value proposition that these displaced talents can profitably run and manage. They can partner with their original employer in setting up this venture. So you shoot two birds with one stone by firing the good guys: you significantly cut the manpower cost of the company, and increase its sales and profits, courtesy of the newly formed affiliate run by former employees. The director of the assembly plant I mentioned trimmed its workforce not by reducing the semi-skilled assembly workers but by letting go its highly skilled mechanics in its mould making department. The company then helped these mechanics set up a new mould making venture that eventually supplied moulds to the assembly plant and third parties as customers.

Cut waste and be a firm believer this time in doing so, and not just a casual reader of those Toyota books. Better yet, be paranoid about wastes. Andy Grove’s battle cry was "Only the Paranoid Survives" when he was turning around Intel during its mid-80’s crisis due to Japanese competition. To survive the recession, companies must become lean and fast like Pacquiao who must shed pounds quickly to qualify for a boxing match category or else lose by default on fight night. All forms of waste must be identified and eliminated – low hanging or otherwise. We are not just talking about operational wastefulness, but also strategic wastefulness. Operational wastes include excess people, inventory, equipment, and excessive use of resources that are hidden by high sales during boom times. Strategic wastes are unprofitable products, divisions, business units, ventures, investments, and affiliates that are hidden by subsidies coming from high sales of core businesses. Companies guilty of strategic wastefulness are those which over-diversify, over-expand, over-invest without much thought and deliberation. Being cash rich, they think they can always afford to make expensive mistakes from these ventures and adventures. They unwittingly increase their breakeven sales which would eventually haunt them when sales subside. When there is a two-digit drop in sales, as in a recession, these mistakes and vulnerability are quickly exposed. Toyota uses the water analogy to explain this unmasking principle: Only when the level of water in a stream comes down can you see the rocks. Water here is sales, and rocks are the hidden wastes primarily in the form of excess production, inventory, or investments. This reminds us of Warren Buffet’s “swimming naked” analogy and the old saying “Anybody can steer a ship in calm waters.”

All-out company-wide waste elimination and prevention should not be just a project and program for the duration of the crisis. It should continue and develop into a permanent culture and way of life even after the recession is over and the economy has recovered. A sustainable waste-conscious culture serves to crisis-proof your organization against the impact of future economic downturns. It is your insurance. Lean companies are recession proof or, at the very least, recession resistant. Lean companies would most likely weather the recession. Keep in mind that lean times demand lean thinking and lean living.

Rene T. Domingo is a professor and management consultant. Please send comments to rtd@aim.edu.

Source: www.rtdonline.com