In Recession, 3 KPIs You Must Have Under Control to Survive

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At the early stage of my career, working for Italian multinational organizations, I used to think that the inability to plan for future unexpected events was a peculiarity of the Italian culture. When a problem arose, I got used to colleagues saying, “We aren’t great in planning for these events, but we excel in firefighting.” Similarly, when risk management actions were needed, the same colleagues used to say, “We’ll cross that bridge when we get there.”

Geert Hofstede, the Dutch social psychologist, explained this cultural trait with the concept of “uncertainty avoidance” as part of his six dimensions model of national culture. It doesn’t come as a surprise that Italy doesn’t list among the high uncertainty avoidance countries. The real surprise for me came a few years later when I started my international career. Despite working with European and American colleagues, the attitude toward unplanned events hasn’t changed. I even heard the same two sentences, just in a different language!

Surely no one could predict the current COVID-19 crisis, but supply chain leaders could have done more in terms of “uncertainty avoidance” to prepare for this situation. In August 2019, the yield on 10-year U.S. Treasury bonds plunged below the two-year Treasury yield. This situation, called an inversion of the yield curve, has historically been considered a recession indicator as it preceded all nine major U.S. recessions since 1950.

For supply chain professionals, this news was meant to be the call to arms. Yet, nine months down the road, we are in the middle of the worst recession since the Great Depression, and most organizations are finding themselves utterly unprepared. So, here we are, but what’s next? Supply chain professionals may need answers to the two following questions.

What’s the difference between managing a supply chain during a recession versus business as usual?

In times of economic growth, most organizations adopt customer-centric approaches, trading-off cash and cost performance to ensure that their service levels are satisfactory for customers. During a recession, organizations need to review their value propositions and divert their attention away from customer service to focus on costs, and most importantly on cash. If you run out of cash, you go bust.

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Which performance areas should a supply chain professional focus on?

Supply chain professionals seeking to identify the key areas of attention for their organizations should start from the hierarchy of metrics (HoM), a tiered system of metrics which covers the end-to-end supply chain. During a recession, the cash conversion metric becomes an increasingly important KPI, as cash preservation becomes the business priority. A second area of interest for supply chain professionals willing to protect the profitability of their business is cost reduction.

Finally, during a recession, companies do need to monitor the performance of their suppliers, as they may be an indication of the suppliers’ poor financial health. Firms experiencing financial problems often exhibit warning signals that can indicate a greater risk of insolvency. A study by RapidRatings found that suppliers in poor financial health are twice as likely to experience major issues with product quality and 2.6 times more likely to offer very poor service levels, when compared to healthy suppliers.

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Cash: The priority for any organization facing a recession is to preserve cash. Cash initiatives should aim to drive down the cash conversion cycle, focusing on optimizing account payable, inventory and accounts receivable. Often, the room to maneuver to extend days sales outstanding or reduce days payables outstanding is limited as supplier and customers may be facing similar liquidity issues. In relation to inventory optimization, supply chain professionals should, in the short-term:

  • Reassess safety stock positions to align with the reviewed service level objectives
  • Reduce order quantities for lower cycle stock

Costs: In the initial phase of a crisis, most organizations react quickly and initiate short-term measures like discretionary spend cuts and temporary workforce reductions. Successful businesses should look for ways to streamline their operations by focusing on the processes which don’t deliver value. Supply chain professionals should start with mapping current workflows, then look for efficiency opportunities. It’s important to note that functional efficiency does not add up to cost optimization. To be effective, cost reduction initiatives must involve cross-functional teams that are able to assess the broader implications for the whole business.

Supplier performance: During a recession, organizations must review how quickly they can detect risks created by suppliers going out of business. While supplier performance could represent an initial indication about suppliers’ financial health issues, successful organizations should implement a structured approach to identify and manage suppliers with the highest profile risk. Profile risk is a function of:

  • Importance of the supplier, based on revenues at risk and whether the supplier is a single source
  • Supplier financial health, to be monitored using solvency and business viability metrics

In conclusion, while most organizations failed to take any actions to prepare for the current recession, it’s never too late to start building supply chain reliance in preparation for the next one!

Marco Sandrone,
Senior Director Analyst,
Gartner Supply Chain
[email protected]

 

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