Preparing for Recession: Steps to Protect a Business
October 26, 2022
Editor’s Note: This is part of a series of The One Brief articles examining various impacts a recession might have on organizations and how they can prepare.
With concerns growing over the possibility of a recession — and indications that some regions of the world might already be there — many businesses are looking to prepare themselves for the impact of an economic downturn.
The depth and length of a recession might vary by region and industry, and while the next slump may not have the intensity or depth of the economic turmoil sparked by either COVID-19 or the global financial crisis, it’s something that needs to be considered by every organization. Even those businesses least susceptible to a recession, such as software companies with low marginal costs on their developed products, are likely to feel some of the impacts.
While you can’t totally recession-proof an organization, businesses can prepare, says Jas Thandi, partner, North America, Investment at Aon. They can evaluate such factors as the size of the workforce, markets and investment, determining what’s appropriate and perhaps deferring what might wait until better times.
“At the end of the day, no matter where your business is in a value chain, somebody’s consuming something,” Thandi says. “A recession, essentially, reduces consumption, which will eventually flow back through to your business.”
By definition, a recession is a temporary decline in economic activity during which trade and industrial activity are reduced.
One complication in the current economic environment is that as economic activity is slowing, the rate of inflation remains high in economies worldwide. That raises the risk of stagflation, a combination of slow economic growth, high levels of unemployment and rising prices seen in the 1970s.
The depth of a recession is likely to vary by region.
Europe is facing an energy crisis related to the Russia-Ukraine conflict that raises the risk of a deeper recession compared with North America. Europe also has a significant economic exposure to China, which is experiencing its own economic issues stemming from COVID-19 lockdowns. Last month the Organization for Economic Co- operation and Development predicted a 0.3 percent growth for Europe in 2023, with Germany expected to slip into recession.
The UK is similarly exposed to the energy crisis, though the government recently unveiled a £40 billion energy bailout plan for businesses. Due to spiraling energy prices, inflation in the UK currently stands at 9.9 percent. British Chambers of Commerce has forecast that the UK will go into recession before the end of this year.
While the U.S. might avoid a recession, inflation, which is 8.5 percent, and the U.S. Federal Reserve’s interest-raising efforts to cool the economy suggest the recession risk exists.
The impact of the recession will also vary by industry. Businesses that are lighter on physical assets and have a lower marginal cost of production like many technology companies are likely to feel less of an impact than manufacturers, Thandi suggests.
Retail, leisure and hospitality and real estate are also likely to feel a greater impact, while providers of necessities like grocery stores and healthcare services will likely fare better.
The Wage Challenge
For many businesses, that combination of slowing growth and rising prices is complicating their recession preparation in a critical area: wages.
“One of the big risks out there right now is wages increasing at a time when growth is slowing,” says Thandi. “This is potentially quite a big problem for companies because you can’t grow your top line, yet your bottom line is being eaten up by wage growth. So, your margins compress and your earnings shrink.”
Employees, naturally, want their wages to keep up with inflation. Meanwhile, businesses should take steps to determine the appropriate wage levels to attract and retain necessary talent. They should look at wage levels across their industries and determine what their competitors are paying and benchmark against those competitors.
“Companies should understand what they need to do to retain talent in this environment,” says Thandi. “Ultimately, it becomes a question of: what should you be paying? What increases should you be offering your employees? What is competitive? And that is not one broad number across the economy.”
Addressing Funding Needs
Businesses looking to prepare for a recession also should determine what their funding needs will be. “You don’t want to be at the mercy of the market during a recession,” Thandi says.
Businesses should look to retire debt where possible, and ensure that they have sufficient funds to service any existing debt so that it won’t be necessary to refinance debt during a recession. “Some companies actually fail because they can’t refinance in a recession,” says Thandi.
Publicly traded companies should also consider whether they should pull back on stock buybacks in this environment. Such moves, however, could carry some baggage of their own.
In the U.S., buybacks have come to be seen as “quasi-dividends,” a means of returning cash to shareholders. A company reducing buybacks to prepare for a recession needs to send the appropriate messages to those shareholders to avoid a negative impact on equity prices.
A More Typical Recession
If the U.S. economy does dip into recession, it won’t be like the recession in the early months of the COVID-19 pandemic as businesses shut down, or the recession resulting from the global financial crisis of 2008, says Thandi.
“It’s more like your run-of-the-mill recession,” Thandi says. “The problem with that is that everyone is very anchored to a recency-bias to the last two recessions, which were actually horrific. No one’s actually seen what a general garden-variety recession actually looks like for a long time.”
Because there won’t be a complete collapse of economic growth, businesses shouldn’t have to take extraordinary steps to prepare for a possible recession. For many businesses, the solution might involve controlling costs and, as they budget for the year ahead, create a basic budget as well as a “stress budget” that can allow the organization to address a more severe economic downturn.
“You essentially need to make a bet on what defenses are enough so that it doesn’t cost too much if a recession doesn’t happen,” says Thandi. “Recession-proofing isn’t free. You’re giving up something to do it, so how much do you want to give up? And that comes down to how bad do you think a recession is going to be and how soon is it coming. And those determinations will vary, company by company.”
We recently surveyed 800 C-Suite level executives from around the world about preparing for a coming recession. Learn more in the report: Making Better Decisions in Uncertain Times: Aon’s 2022 Executive Risk Survey.