The last nine recessions have been preceded by a yield rate inversion where the yield on 10-year Treasury bonds dipped below the 2-year Treasury. The stock market tumbled 800 points, or almost 3.1%, to 25,579 on Wednesday. This was due in large part to recession fears sparked by the inverted yield curve. The yield curve inverts roughly 14 months before a recession.
For supply chain professionals, this is a signal that they need to work to make their supply chains more agile. Agile supply chains are better able to match supply to demand in environments when demand is growing quickly, or as in the current situation, when it may fall quickly.
One of the worst things a company can do when the world is tipping into a recession is to react too slowly. The key process for matching supply to demand is the sales & operations planning (S&OP) process. But if companies are using order history to forecast demand, they will be stuck with too much inventory. Demand driven companies, companies that have visibility to demand at the point of sale (POS), can sense downturns in demand much, much quicker.
Companies that can spin their integrated business planning (IBP) process more quickly will be better positioned to deal with a downturn. Many companies do IBP on a monthly basis. Increasing numbers of companies are beginning to do this process on a weekly basis. A few companies actually match supply to demand in leading product segments on a daily basis. The longer the planning cycle, the more likely a company will get stuck with excess and obsolete inventory in a recession.
Daily IBP is beyond what many companies can do. But at an inflection point like this, some sort of daily planning is imperative. When demand actually begins to falter significantly, a company must be prepared to respond. After one recession, I talked to one company that had implemented daily inventory planning meetings. The company told all of its suppliers to stop all shipments for four weeks until it had a chance to recalibrate its demand plan. The company also moved quickly to resize the company by laying off workers, slowing production, and shutting some factories. As a result of these actions, the company was able to come within five percent of its financial plan every quarter, even during the worst of the downturn. The company’s stock price, like many others, tumbled with the recession. But following the recession, the company’s fiscal discipline led to much stronger stock performance that its peers.
Historically, the process companies used to match supply to demand was sales and operations planning(S&OP). IBP is focused more tightly than traditional S&OP on how particular demand/supply balancing decisions impact revenues, profits, and cash flows. During a recession, “Cash is King.” The cash conversion metric becomes an increasingly important KPI for the global supply chain team. To be successful, a Cash is King Initiative needs to drive performance not only in the global supply chain organization but also across the sales and finance teams. This end-to-end effort helps to insure that Inventory turns, Days Sales Outstanding, and Days Payables Outstanding targets are met with a goal of driving down the cash conversion cycle.
In a recession, manufacturers have to be careful about the impact of slowing down payments to key suppliers. If you slow down how fast you pay them, their financial integrity may be impacted. Many global supply chains rely on Chinese suppliers and contract manufacturers. China’s industrial output slumped 4.8% in July, for its’ weakest reading in 17 years. Paying small suppliers more slowly in at risk economies could tip them out of business.
Nevertheless, in a recession, companies do have more to worry about than just demand. Companies do need to carefully monitor the financial health of their suppliers. A looming recession is a good time to review how quickly a company can react to the risk created by suppliers going out of business. There are real-time supply chain risk tools, and tools that use machine learning to forecast supplier problems, that put companies at a competitive advantage to slower moving competitors.
One fairly simple tool companies use is a two by two matrix where on the vertical axis, a company places suppliers in boxes based on total product revenues linked to specific supplier components, the degree to which key components are single sourced, and the geopolitical and environmental risks associated with where a supplier operates. On the horizontal axis, the company assesses the financial robustness of its partners. If suppliers are placed in the top right-hand corner of the matrix (high supply risk/high financial risk), procurement executives should require these suppliers to develop and present business continuity plans. And like with demand, companies should be monitoring these companies’ financials more frequently.
The recession does not always follow a yield curve inversion. There are false positives. But recent economic history suggests that the predictive power of inversions has increased. This is a good time for global manufacturers to be working to become more agile.