February 28, 2019
Seven Watch-Outs If You Are in a Cyclical Industry
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Many conversations arise around the ups and downs of cyclical businesses. How do you manage through the downside? How do you remain competitive when the market whips back quickly? How do you ensure adequate resources on all sides of the market cycles? The trick is to be nimble in riding the ups and downs of the market cycles and adjusting as necessary.
In this article, I’ll outline seven watch outs if you are in a cyclical industry. I’ve spent most of my career in cyclical businesses and have found commonalities across industries. While the actions needed may be different depending upon the nature of the business, the need to plan, monitor and quickly act is critical at each point of the cycle.
There aren't too many industries that have no market cycles. Some are more significant than others. The market always turns at some point and if not addressed, the business may go out of business due to high fixed costs and lack of market insight in a downturn, or it may lose market share by not keeping pace in an upturn.
The key is to have a well thought through plan that can be quickly executed when the markets turn. The plan should include:
You never know when the market is going to turn, so acting with a sense of urgency as if the market turn is today or tomorrow, will position the company well for when it actually does turn.
Many companies are internally focused and miss the external indicators that indicate the market is turning. For some industries, it may be interest rates or housing starts, for others, it may be the price of oil. The key is to understand what signal the market is putting out that tells you when to ramp your business up or down.
With a lack of market insight, the company will miss the market signals that indicate it is time to adjust the business as the market demand starts to drop. With a high-cost structure, the company may not have enough time to adjust before it runs out of cash, thus becoming another company that doesn't make it through a market cycle.
One of the tricks to forecasting in a cyclical business is understanding the peaks and troughs. In many industries, going into the market downturn, memory becomes short or doesn’t exist from the last cycle. So, the tendency is to miss how significant the downturn will be and as a result, not shed costs fast enough. The converse is true on the upside. The miss there tends to be not forecasting the upturn and losing market share to competitors that are more prepared.
The perspective should include several years of history to understand the magnitude of swings through data. Additionally, a volume level should be tracked alongside to understand the outside indicator and the internal volume correlation.
The relevant metric should be reviewed at least monthly, and in highly cyclical businesses, even more than that. It should be part of regular conversations and the trigger to start adjusting the business as necessary.
Lots of good ideas and good people exist in the world. The ability to turn them into a product or service that is valued and sought after in the marketplace is many times a function of pace. Pace, speed, sense of urgency. It's all pretty much the same thing. It is what sets high performing companies apart from average or below average performers.
So what is pace? It is the ability to make decisions quickly, the ability to adjust to changing market conditions before the competition, it is a workforce that knows the goal and starts shifting before being asked because conditions have changed. You see it walking around- people move quickly, conversations are focused and action-oriented, you feel the energy and buzz just by walking in the room.
This is critical in a highly cyclical market. People need to be able to shift to new conditions quickly. Companies that have figured out how to move quickly and have a fast pace have a better chance of success than those that don't. They know how to quickly adjust the business up or down to meet the market needs.
Companies don’t go out of business because their earnings are too low. They go out of business because they run out of cash. The distinction is, many things can chew up cash that
How do cycles impact cash? When the cycle starts heading down, costs may be high relative to the sales pipelines that no longer supports that level of volume. Cash is being consumed at a rapid rate and customers may start stretching out their payments. The key here is to not build inventory more than is needed and to reduce the cost structure to match the anticipated volume.
When the market comes back, there is typically a significant need for cash – either to build inventory or to provide services, many times in advance of payments being received. Ideally, cash would be paid in advance, but that is not always possible, so adequate cash to fund the upturn is necessary.
The key is to understand the cash needs through the downturn, the down market, then the upturn. No-one ever knows how deep and how wide the market cycle will be, so adequate preparation for cash needs is imperative to survival.
One of the classic mistakes people make in looking at the cost structure of a business is to classify fixed costs as variable costs. It can start out innocently- just a few line items on the financial statements that show up as variable costs. Over time, it can become a real problem if the true fixed costs are not viewed separately from the variable costs.
So, what are these costs? Many times labor falls into this category. The theory is that people can be added or subtracted based on the level of the business. The problem is, that many times labor cannot be easily adjusted. Maybe there are union contracts that govern how labor is adjusted, or there are significant severance costs that make adjustments quickly difficult. If certain activities such as IT or subassembly manufacturing are outsourced, there can be times when costs are guaranteed for a period of time.
The danger is that thought processes become anchored into thinking that the costs are variable when they are not. They are actually fixed. The people that provide information for decision-making and those that make decisions in the business need to understand the true cost structure in the business and what it takes to adjust should it be necessary.
As a decision maker, take the time to make as few costs fixed as possible. Keep the core competency areas
Managing cash flow in a cyclical business takes finesse and focus. There are times when the market is up and in a well-run business, cash flow is significant. The challenge is when the market is down. The levers must be able to be pulled quickly to maintain
This can be difficult if there are significant lease costs for land and buildings, especially in a manufacturing environment where the footprint and equipment are fairly fixed. In a
The opposite is true in
Understanding the business structure and needs can have a significant ability to flex space and maintain an appropriate flow of cash. In both cases, these situations can minimize the cash
There is always a point in time in business where market forces create tension in the business. It may be the loss of a significant customer, a cyclical downturn, or maybe the introduction of a new competitor or product. The point is, you now have something putting pressure on your business demanding immediate attention. This is a gift – it is a reason to come together as a company and do something different. It is the case for change.
The biggest change in market share typically happens when the market is moving up or down, not when it is in a steady state. Market-based changes give you the biggest ability to make a dramatic change because the market has made the case for you. Whether it is refocusing the business or adjusting the cost structure, don’t let a good crisis go to waste.
The key in cyclical business is understanding where you are in a market cycle and adjusting appropriately. By having the right market intelligence and a plan that allows for a flexible cost structure, you can not only survive a market
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