ASSESSING REVENUE AT RISK WHAT THE CRISIS MAY DO TO YOUR COMPANY AND HOW TO REACT BY JESPER SKRIVER FRANDSEN 5TH JANUARY 2009
ASSESSING REVENUE AT RISK AND ITS IMPLICATIONS… ON THE BRINK OF WHAT IS LIKELY TO BECOME A SEVERE ECONOMIC DOWNTURN COCOCO FINDS IT CRITICAL TO SUSTAIN LEADERSHIP WITHIN THE BUSINESS DESPITE SUBSTANTIAL UNCERTAINTY. IT IS IMPORTANT TO SPARK A SENSE OF CONTROL AMONG MANAGERS OF THE BUSINESS WHO WILL BECOME CRITICAL FOR NAVIGATING SUCCESSFULLY THROUGH THIS CRISIS AND EVENTING NEW REVENUE STREAMS AND WORK METHODS.
WE HAVE TO ACT IN SPITE OF UNCERTAINTY
Many industries and companies already see contracting demand and beginning negative impact on earnings. Soon, companies will have to struggle for survival, others will have to optimise their businesses and for some this represents an excellent opportunity to surpass rivals. If the company liquidity evaporates so does the room for manoeuvring successfully through the crisis. And if only solid liquidity becomes the objective then the company risks losing the battle on the other side of the crisis due to insufficient investments.
WE ANTICIPATE THAT A LOT OF MANAGERS NEED AN OVERVIEW OF THE CRISIS AND THE IMPACT ON THEIR BUSINESS. IN THIS COCOCO VIEWPOINT WE SUGGEST TO (1) APPLY THREE REALISTIC MACROECONOMIC SCENARIOS TO THE BUSINESS TO ANALYSE SALES EFFECTS ON A PRODUCT/SEGMENT/COUNTRY LEVEL; (2) TO ANALYSE THE LIQUIDITY SITUATION SUBJECT TO THOSE THREE SCENARIOS TO ASSESS THE ROOM FOR MANOEUVRING THE BUSINESS. THIS VIEWPOINT AIMS TO HELP BRIDGE THE CORPORATE AGENDA FROM BOARD RISK CONTROL TO BUSINESS MANAGEMENT INVOLVEMENT AND DEPLOYMENT.
The proper response to all this is a mixture of protecting the ability to work smart and sustain long-term competitiveness if possible. CoCoCo suggests three main themes on the corporate agenda for this phase of the crisis: • • •
Revenue at risk Short-term action Long-term sustainability
ON THE EDGE OF A DEPRESSION
The financial crisis is quickly transforming into an economic recession. An outright depression is on the cards depending on political leaders’ ability to initiate mitigating economic stimulus in due time. That was at least the message from the Nobel winning economist Paul Krugmann when he visited Copenhagen on a cold December day last year. And as we wait for international political leadership risk increases that consumers become too frightened and stall consumption. The jury is out and meanwhile uncertainty easily leads to irresolution when action is very much demanded. As in the famous quote:
MANAGING MULTIPLE AGENDAS
Uncertainty will prevail for at least half a year. CoCoCo senses a paramount need to discuss both short and long-term issues between the board of directors and executive management. And so is the need to involve high-level managers in the process of assembling detailed data, compiling a list of initiatives and eventually deploying actions. We need language, tools and acceptance within the entire management organisation to plan despite uncertainty, to choose a path to follow that may prove wrong four months down the execution program, and in that case to make swift corrections.
“A mind troubled by doubt cannot focus on the course to victory”
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(1) US GDP GROWTH AND SAVINGS QUOTA (Q)
It is both necessary to reduce operating costs and to stimulate creative thinking in order to produce new revenue streams. Cost reduction tends to produce fear within the organisation and creativity demand, among other things, focus and sense of reward and trust. All in all, that calls for organisational preparedness well above what has been demanded of most industries during the recent 15 years or so.
8
%
6
4
2
UNDERSTAND YOUR COMPANY IN THIS CRISIS
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THERE WILL BE NO QUICK WAY OUT
The core of the crisis is excess spending in the US since the mid 90s and low savings rates (graph 1). This was financed by mortgage lending and the US consumer perceived increasing wealth due to surging housing prices (graph 2) that again led to further lending for consumption and geared investment.
-2
GDP growth, yoy Privat savings ratio (% of income) -4
Q1 1990
Q2 2008
Source: US Census Bureau
This cycle was empowered by an unusual period of low interest rates and massive availability of liquidity.
(2) HOUSING PRICE INDEX OF USA AND DK 240
Eventually, this led to a financial crisis and the declining housing prices is a vicious spiral as powerful as the boom. And Europeans do not have much to blame the US in that respect.
Index US comp. DK total
200
-21%
The financial crisis is quickly spreading into an economic crisis, as they always do. 160
However, it is not all black. Help is on the way as politicians begin to create large stimulus packages. However, they work against the clock to reverse the negative psychology of the consumer.
120
This crisis is something new in the sense that most managers cannot draw on relevant past operational experience. And the past 15 years of learning to the organisation is that of growing the business and extrapolating past year’s budget. Substantial economic stress has no knee-jerk reaction to call upon.
80
Jan 1990
July 2008
Source: S&P/Case-Shiller Index (US, total), Statistics Denmark (single family houses)
This may revitalise the virtues of change management.
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highly turbulent environment. This emphasises the need for scenarios. CHALLENGING SCENARIOS WILL HELP SCOPE YOUR EFFORTS
We recommend three scenarios: 1. Rebound – a mild break on consumption and investments that over the course of a year removes excesses and prompt businesses to reorganise. In most developed countries that constitute zero GDP growth in 2009. We see a fainting chance of this scenario and suggest a prolonged period of sub-trend growth while the economic excesses are gradually removed.
Macroeconomic forecasting through a downturn is no exact science, and it does not catch the uncertainty. We recommend three macro scenarios to challenge conventional thinking; here, spanning the challenge is more important than precision. For instance, the Nordic countries will suffer the most during 2009 like the US, but not to the same extent. And the Nordic countries will not be equally affected (graph 3).
2. Restoring balance – this scenario constitutes most developed economies to contract in 2009, surging unemployment, companies return to the core business, and we see 1-2 years of recovering to the longterm growth rate; currently this is somewhat the scenario that most economists ascribe to though it is absolutely no safe bet.
When the financial crisis exploded autumn this year, it triggered analysts to massively downgrade their GDP growth expectations for 2009 by horrifying 2% points on average. (3) NORDIC GDP CONSENSUS FORECASTS AND RECENT 3 MONTHS CHANGES TO THE 2009 EST. Current consensus forecasts 2009-2011
3,0
2009 consensus forecast, recent 3 months
3. Crash and burn – This is a depressionlike scenario that constitutes double digit unemployment, economy contraction in ’09 and ‘10, substantial restructuring of many companies and a long recovery period of perhaps 3-4 years (who knows?).
% GROWTH, YOY
2,5
SE NO
2,0
DK
1,5 EXAMINE YOUR INDUSTRY AND MARKET RISK CLOSELY
1,0
The assessment of the macroeconomic impact on sales has to be sufficiently detailed to initiate local and precise initiatives - the economic crisis may be global but affects country markets differently.
0,5 NO 0,0 2009
2010
2011
SEP
OCT
-0,5
NOV
Thus, for every country we apply the three scenarios and recommend assessing the sales effect for all significant products/segments subject to these three effects:
SE DK
-1,0 Source: CoCoCo sample of public available estimates
• • •
A 1% point slide in GDP means that some industries and companies are going to operate in a
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Customer spending (size of wallet) Product substitution (your share of wallet) Peer response (passive, defensive, offensive, aggressive… capacity to compete)
(5) EX FROM RETAIL (SELECTED): HISTORIC EARNINGS MARGIN VS. SALES GROWTH
BUSINESS MODEL AND MARKET EXPOSURE MATTERS
Understanding your industry within the crisis is critical. For an example, imagine how producers of PCs can be exposed both to the investment dynamics of corporate customers and the segments of private consumers that in terms of timing and behaviour will act quite differently during this crisis; or imagine a producer of small capital goods that may both embrace the oil industry and the chemical industry.
EBIT margin ’07 35
Bjorn Borg
30 25
Abercrombie & Fitch Company Esprit
H&M
20
Inditex Urban Outfitters
15
The illustration below (graph 4) shows selected industries and their sales and earnings (before tax) sensitivity to the crisis. That is, companies of equal sales sensitivity do not necessarily hold the same risk to earnings; definitely an important notion when assessing whether your company in this crisis faces a battle of survival, optimisation, or expansion on behalf of weak competitors or peers.
Hugo Boss
10
Flugger
Boconcept Holding
5 0
8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23
60
Historic sales growth (3Y CAGR %)
Source: CoCoCo analysis, ThomsonReuters data
(4) TOP LINE AND BOTTOM LINE SENSITIVITY FOR SELECTED INDUSTRIES Selected industries
Downturn effect on revenue
Generally, companies have spent up to 15 years growing with no material interruption; with a few industries excepted the millennium crisis was quite soft and quick. With such an experience in growth there is a temptation to branch out and away from the core business to end up embracing various industries and business models.
EBT effect of 1% uncompensated loss of sales (%)
1
Medico
-4
2
Shipping
-5
3
Banking*
-6
4
IT Hardware & Software
-7
5
Alternative Energy
-8
6
Newspapers
-10
7
Construction
-11
8
Aviation
-14
9
Retail
-16
Subcontractor, cars
-33
For example in branded retail sales we see tremendous performance differences for various business models (Illustration 5). Some of them suffer substantial declines in volume when the business cycle turns down, others react contra cyclical due to their fashion style vs. price, and others hardly see the crisis due to rapid customer base growth.
CASH IS KING
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This old phrase seems to revitalise on any economic downturn. In this crisis your company may either struggle for survival, need to reorganise or aggressively explore growth opportunities in the absence of competitive resistance. In any case your pace and room to manoeuvre is closely related to access to cash.
Note: selected EU industries based on 1500 companies Source: CoCoCo analysis, ThomsonReuters data
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of protecting the distribution network and subcontractors
Your liquidity situation, which is somewhat more complex than assessing your current cash position, may be hit by poor performance of the business, or your bank’s inability to offer you lending, or even withdrawal of previous committed credit lines; or something else. For your understanding of your cash situation, you have to analyse these four parameters for each of your three scenarios: •
Earnings (level and development)
•
Liquidity (free cash flow from operation and current cash position)
•
Distribution (cost of protecting your distribution network)
•
THE OUTCOME SHOULD BE SOMETHING LIKE
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An estimate of the sales effect of significant products/segments/markets within each of the scenarios
•
Analysis of the liquidity situation within each of the scenarios including operational cash flow, capital expenditure, working capital, lending, lending facilities and issue of capital
•
A list of high-level initiatives as a guidance to detailed management group workshops
Subcontractors (cost of protecting your critical subcontractors) THAT WILL ENABLE YOU TO
PLAN AND EXECUTE
To put this CoCoCo viewpoint in brief, we face a serious economic downturn and yet we see substantial uncertainty as to what is actually going to happen. In order to navigate your company through this crisis, you will gain a lot from preparing yourself, your organisation and your board on the basis of macroeconomic scenarios and an assessment of their effect on your business.
COCOCO SUGGESTS THE FIRST STEPS TO BE
•
Develop three realistic macroeconomic scenarios that form different and likely external shock to your business
•
Identify relevant revenue impact drivers for your business including an assessment of competitive reactions
•
Assess the revenue impact on products/segments per scenario
•
Analyse the earnings impact of each scenario and assess the corresponding liquidity position including strategic costs
•
Discuss scenarios, mitigating actions, liquidity thresholds and restructuring initiatives
•
Sustain leadership subject to substantial uncertainty by mentally preparing the group of managers on a critical path and possible reasons and causes for that to change
•
Involve the group of managers in developing and deploying detailed actions
EXECUTE
There is no need to emphasise the need to execute on the process and the actions prompted by it. Managing several agendas in the organisation is complex and important in order to keep momentum and create the sense of control that is critical for the motivation of the employees that have to become engaged in finding solutions and perhaps invent new revenue streams.
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IF YOU WANT TO KNOW MORE… Copenhagen Consulting Company in brief CoCoCo is a Nordic management consulting company with global reach and one of the fastest growing in the Nordic region. Based in Copenhagen and with offices in Oslo and Dubai a significant share of our business is based abroad, mainly in the Nordic countries. CoCoCo works for large Nordic and international companies within a range of industries with spikes in retail/FMCG, media, transportation and telecommunication. We have 60 dedicated management consultants whereof 16 partners and 15 analysts and research staff.
Our services Our range of services fall into these service lines • • • • •
For further information please visit our website on http://www.cococo.dk
We have built valuable experience through the projects we have managed together with our Nordic and global customers.
CONTACT THE EDITOR OF THIS ARTICLE DIRECTLY:
Jesper Skriver Frandsen +45 61 61 30 89 jesper.frandsen@cococo.dk Jesper co-heads CoCoCo’s Corporate Finance practice along with working in the CoCoCo Strategy Development service line. For 10 years he worked with equity markets and corporate finance. Since 2003 Jesper has worked with strategy and project management, and within CoCoCo Jesper has worked with strategy execution, operational strategy and commercial due diligence across multiple industries.
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