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A Forbes 30-Under-30 Honoree Has Some Tips for Small and Medium Businesses During the Pandemic

The key idea is to prepare.
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One of the key points I’ve always been telling other business owners and my employees is that most problems are solved problems. And the same goes with a recession. There have been countless recessions, stagflations economic depressions before—1930s, 1970s, Japan in the 1990s, and more. There have been proven methods before and it will continue to work today.

I’ve spent time reading some recession or crisis-related stories, such as Accelerating out of the Great Recession (BCG), Only the Paranoid Survive (Andy Grove), Getting to Plan B (John Mullins & Randy Komisar), and briefs from Bain & McKinsey. I’ll also share some strategies I’ve used when I had my own business crisis in 2017.

I’ve consolidated these resources into a framework that will hopefully help SMEs tide over the crisis. I’ll also use this framework to make important changes with how I’ll lead my business.

Photo by Kenn Costales.
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The resources I used cover 90 companies during the Great Depression of the 1930s, 5,000 companies during Japan’s Lost Decade of the 1990s, and 3,900 companies during the Global Financial Crisis of 2007–2012. They’ve dug deeply to find the outperformers and understood why they’ve established a strong competitive position during turbulent times.

Despite the general malaise and fear that surrounds an upcoming recession, do realize that it’s an equalizer. Bloated, over-staffed market leaders will lay off staff, companies that have taken on too much debt will start to being defensive.

This gives the frugal and prudent company the opportunity to catch up. A classic example of this is 1929 and after, when IBM turned from a small business to a market leader of accounting machines (punched cards). They anticipated the need for companies wanting to convert labor into more efficient labor with the aid of accounting punched cards.

Beyond IBM surviving the Great Depression, companies such as General Motors at that time were profitable every single year using the methodologies I’ve outlined below.

The key idea is to prepare. You’re not alone in facing a recession, and history is your tool to help you win.

Let’s start with the big picture.

Monolith’s 5-Model Recession Growth Framework

All businesses have 5 levers towards driving better company value, whether big or small:

1| Working Capital Model (Helps you get more cash)

2| Organizational Model (Helps your team drive the right strategy)

3| Cost Model (How to manage your fixed & variable costs)

4| Innovation Model (Helps you get repeat customers & get word-of-mouth)

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5| Revenue Model (How to find the right positioning for your company)

For each of these levers, let’s break it down into its component pieces and see what are the best actions to take in a recession.

I. Working Capital Model: Manage your Balance Sheet, Not your P&L

Most small businesses are happy with signing large contracts. But it won’t matter if your situation is like this:

  • Contract Value: 10 million (due in 3 months)
  • Cash on Hand: 1 million
  • Incoming expense: 2 million (next month)

You’ll need to work on making sure that you convert contracts into cash fast. But how? Let’s break down working capital first:

1| Cash on Hand

2| Inventory

3| Accounts Receivable (money that clients owe you)

4| Cash Expenses

5| Accounts Payable (money that you owe suppliers)

From that 5 item list, you need to reduce non-cash working capital, which means:

1| Minimize inventory

2| Minimize accounts receivable

3| Maximize accounts payable

Minimize Inventory

Minimizing inventory is important as it frees up short-term cash that can be used for something else. In a recession period, it’s much more important to have an out-of-stock problem than wasted cash on spoilage. While it might limit your upside in terms of revenue, the same action limits your downside.

For example, if you’re in the food business, using the out-of-stock case:

  • Let’s say you pay P1 million worth of inventory for beef, pork, and fish
  • The sales value of this inventory is P2 million
  • Demand is good, so you go out of stock. Your cash balance is P1 million.

Now using a scenario where you stock up:

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  • You pay P2 million worth of inventory of beef, pork, and fish
  • The sales value is P4 million
  • Demand covers 2.5 million in sales, which was the actual demand
  • Your cash balance is P500,000

While stocking up helped you maximize the upside, you are still left with less cash than just letting yourself go out of stock.

The implication here as a retailer or if you’re in consumer goods is to 1) be very good at forecasting demand per SKU and 2) make sure that you stock “just right” to maximize cash on hand.

Minimize Accounts Receivable

Minimizing accounts receivable is more straightforward. But it implies perceived sacrifices as lower revenue.

Let’s say you’re a B2B service provider. In a typical negotiation scenario, a prospect might claim that the “standard terms” for a P10,000,000 contract is spread out across 12 months, with only 10 percent downpayment on the first month, then 50 percent on the 6th month, then the balance after there is proof-of-performance.

How I would respond to that situation is to offer a steep discount for upfront payment. It could be 10 percent or more, something that will please Business Directors, whose bonuses are based on the profit margin. If I am the only player in the market with proprietary technology, I would go even further and present it as a deal or no-deal type of situation: it’s either they take the discount or be left with an inferior or no supplier.

And once I do close the deal, I look to over-deliver on the promise and start to sell value-added services to make up for the loss in the discounts.

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But even then, I don’t think it matters even if you “lost” P1 million. You have P9 million cash in January in a deal with a steep discount as compared to only P1 million cash with “great profit margin.” I’m sure you can think of something to make the services efficient enough to make the lesser revenue work within 12 months.

Maximize Accounts Payable

This is the inverse of minimizing accounts receivable in the sense that instead of offering a discount on a deal, you now offer interest for due payments to suppliers.

Using the same B2B deal earlier, let’s say you owe a supplier P2 million. You can say that you can pay the supplier in six months but with 10 percent interest. If the supplier has enough cash balance, the supplier’s CFO will appreciate it, especially if you have a good relationship.

Now, apart from the P9 million in cash that you got from the “bad” deal with the client, now you have extra P2 million in cash from deferring a payment. Your profit will be worse (for now), but you have P11 million to figure out your profit problems in six months.

That extra P11 million can be spent to capture seasonal demand through short-term advertising and extra inventory, or it can be reinvested in equipment to make your operational expenses cheaper in the long-run. Any of those two short-term projects can help you catch up to your target profit margins while still maximizing cash.

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In a low profit margin environment such as a recession, the importance of managing your balance sheet will be more important than ever.

Apart from maximizing your cash, you’ll also need to set up your organization for profitable growth. Let’s now dive into the organizational model.

II. Organizational Model — Restructure the Organization Around R&D, Marketing, and Sales

Most small businesses just cut cost blindly across all departments. This gets worse when you blindly follow an average accountant, who will just say to cut “discretionary expenses,” or expenses that are not related to day-to-day operations.

But instead of looking at things through an “operations” and “non-operations” lens, it’s best to evaluate functions based on “ROI-generating” and “non-ROI generating.” Peter Drucker coins these as Profit Center and Cost Center.

As a general rule, Profit Center expenses should be the same or higher than before and Cost Center expenses should definitely be lower.

Let’s start with how a Cost Center optimization would look like.

Where to Layoff (If you really need to): Admin, Manufacturing, IT, Non-Performing Assets

Driving down costs is not easy, especially in a crisis, but when the organization’s back is against the wall (and thus affects everyone), what will need to be cut first is:

  • Non-performing assets (i.e. products / plants / equipment that’s not selling)
  • Administration
  • Accounting
  • IT
  • Manufacturing

If you’re a retailer or food business that buys a wide spectrum of supplies, apart from the ones above, you might need to cull the high-end and middle-market products as consumers will veer towards a better value option.

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But you can’t just cut; otherwise, you won’t be set up for success against more aggressive competition. You’ll need to divert the newfound cash somewhere else.

Where to Build Extra Staff: R&D, Sales, and Marketing

To maintain or improve customer loyalty and drive new customers during down periods, these three elements are your lifeblood. There is no business without sales and good products; so these are the departments that must be kept as much as possible.

I’ll dive into the details how to maximize R&D, Sales, and Marketing for my fourth and fifth points; but do know that your main KPI (key perfromance initiative) when it comes to an organizational restructure is that Marketing/Sales/R&D salaries, as a percentage of total salaries, should be higher than pre-recession periods.

The best case study of a company doing this is Samsung in 2009. In that period, which was in the middle of a recession, they 2x’d R&D investments and pirated the best marketing talent from L’Oreal and other FMCG firms.

That said, now that you know how to get extra cash in Part I, know where to staff up in Part II, let’s now discuss how to recover your profit margin through optimizing your value chain.

III. Cost Model: Flexible Value Chain — More Variable Costs & Outsourcing vs Fixed Costs & Vertical Integration

The core idea of this section is that you need to maximize your variable cost and minimize your fixed cost. The basic idea is to evaluate your supply chain or value chain (if you’re in food / retail / manufacturing) or evaluate your fulfillment process (if you’re in the service business), and what you need to do is to outsource as much as possible.

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The benefit here is that it allows you to be more flexible in the short-term and not get into situations where you have unproductive assets when demand fluctuates and falls down.

The Value Chain of Most Retail and Food Businesses

For example, you own a butchery with this value chain:

  • Rented space where you sell
  • Everyone’s a full-time employee in your space
  • 100 percent of your products are manufactured on site
  • 90 percent of your products are sourced from your farm

The above has very high costs and is generally “vertically integrated,” meaning that you own most, if not all, of the parts of the value chain and none is outsourced.

One core idea in the “Accelerating out of the Great Recession” book that I mentioned is that you need to “minimize backwards integration,” which is another way of saying that you need to outsource parts of your value chain and you need to use more part-time workers.

How to Limit Backwards Integration for a Food and Retail Business

Using the butchery example:

  • Instead of a rented space, you do online delivery and attend bazaars. This lowers the fixed cost and changes it to 100 percent variable cost.
  • Instead of full-time employees, use part-time employees and hand them an operations manual.
  • 50 percent or less of your products are manufactured on site, meaning that you may have to order from other butcheries which has the same quality
  • 50 percent or less of your products are sourced from your farm

The net effect of all the activities above is more cash and profits, because:

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  • You get more cash as you don’t have to pay rental advances anymore, you have more profit margin with online delivery, and you can experiment and test which areas have more demand
  • During tough months, you can easily reduce your part-time employees to maximize your profit margin, and you’re not locked into limiting labor laws
  • Since fewer products are manufactured on site, that also lowers the capacity requirements of your butchery, allowing you to get more profit margin by reducing part-time staff
  • Since your farm now has fewer capacity requirements, you don’t need to keep buying animal feeds or calves to meet requirements

While such a drastic shift in your value chain can cause worry about your operations, I would rather lose sleep trying to figure out my operations instead of losing sleep about not being able to pay my bills. It’s going to be tough; but proactive stress is better than reactive stress.

Your KPI in this scenario is simply to figure out how much variable costs you have relative to total cost. You’d want to maximize your variable cost percentage as much as possible.

Now that you’ve figured out how to improve your cash and your profit margin, what’s next? You’ll need to look into offering innovative & high-value products.

IV. Innovation Model: Product Innovation Focused on Superior Customer Value

All of your cost restructuring wasn’t for naught. It is all a setup for a product innovation; specifically a low-cost business model. This is important as customers, given that they have less income to work with, they will look for high value options.

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Uniqlo is the most famous example of a high-value, yet accessible brand that evolved right after Japan’s Lost Decade in the 1990s. In 1997, they pursued a private label model, outsourcing their manufacturing operations to China while hiring a brand consultancy in the US to create their designs. Their low-cost goods, new retail layouts, and great designs proved to be popular for Japanese consumers who were deep in recession at the time.

Thus, one innovation area is to offer an “accessible” version of your product while using strong branding to drive up the perception of quality. The best Philippine example for this is Sunnies Studios. Their innovation is in the design. The build quality isn’t great; but they provide the highest value eyewear at the P300 to P 999 price point.

Deconstruct your Product or Service into Components, then Find Where You Can Be Better in with the Right Price Points

The central idea between the Uniqlo and Sunnies Studios examples is the concept of finding where you can provide a tangible “value add.” For both these companies, it was branding.

For our butchery example, they can use the extra cash to reinvest into new, low-cost product innovations such as:

1| Ready-to-heat meat, all packaged with marinade, to be sold to consumers

2| Ready-to-cook meat to be sold to convenience stores with microwaves

3| Ready-to-eat meat, if they invest in something like a Beef Jerky maker

4| Buy 1, Get 1 Promos, which are now profitable given their cost optimization work

If you’re a CPA lawyer, you can modify the way you deliver your service through these low-cost innovations:

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1| Teaching people how to render the service through live workshops (example: consultingforlegals.com)

2| Transforming your process into a software solution (example: zegal.com)

3| Creating mini courses (example: accountingtax.com)

The KPI for any of the activities above is the same as you would treat a franchise investment: payback period. To determine whether your low-cost innovation is a success or not, simply get the onetime costs of developers, machinery, or brand consultants, measure when you’ll get your money back, and it’s all profit from there.

But remember that just because you built it; it won’t mean customers will automatically come. You’ll need to promote your regular and new products through marketing.

V. Revenue Model: Aggressive & Innovative Marketing & Advertising

Because of the recession, the prices of marketing & advertising will dip by quite a lot. Based on what I’m seeing so far, the cost per clicks have dropped by 40 percent to 60 percent. That’s because marketing costs work in an auction; if there are fewer bidders, then the lower the price.

For companies who are able to save enough cash, recessions are the best period to increase visibility and a better return on their marketing than before.

From 1935 to 1937, Procter & Gamble doubled their spend on radio advertising, then doubled it again from 1937 to 1939. This was despite the fact that advertising spending for the rest of the country was declining. As a result, they gained market leadership for their core brands at that time.

Marketing spending’s effectivity is measured through Return on Ad Spend. Especially in digital, where there are tracking codes installed on the payment gateways of ecommerce platforms, you can get to see how much each dollar of advertising spend is generating.

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Position your Product or Service around idea of Price Anchoring. Offer long-term value through club subscriptions, bundles, and service leasing.

That said, the way you advertise also matters. In a recession period, you need to play the “value-for-money” angle. The formal marketing term is price anchoring. This is true regardless of whether you’re a luxury brand or a cheap brand. Examples:

1| If you’re selling bamboo bed sheets, you can position it by saying that it’s as good as PHP 15,000 hotel sheets… but it only costs PHP 5,000.

2| If you’re selling an enhanced glutathione capsule, you can position it by saying that it’s as good as PHP 20,000 IV treatments… but it only costs PHP 1,500.

3| In 1931, Chrysler launched the Plymouth PA model, which claimed the “smoothness of an 8-cylinder, but with the economy of a 4-cylinder”

4| In 1993, Asahi, which had low market share at that time, distributed their products at discount stores, and changed their manufacturing process into non-heat treated beer so that they can position themselves with “?1 Non-Heat Treated Beer”. And they established that non-heat treated means “freshest possible beer”.

5| Bundles and larger canisters with discounts

6| Club subscriptions that create loyalty and also gives customers special discounts

7| Lease ERP software with serial code licenses instead of forcing business owners to pay everything upfront. IBM did a similar model for their expensive punching card accounting machines in the 1930s.

In a recession period, the price anchoring strategy will work better than ever, and this is especially true if your product or solution fixes an expensive problem as outlined above.

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Summary of the 5 Ways to Drive Growth in a Recession

These five elements should comprise your business strategy during a recession. In short:

1| Build a cash reserve by minimizing your non-cash working capital

2| Restructure your company around Marketing, Sales, and R&D

3| Improve profit margin by limiting backwards integration and by outsourcing

4| Reinvest into low-cost, high-value product or service offerings

5| Establish value-for-money perception through increased marketing and advertising

This piece was originally published on medium.

Kenn Costales is the founder and CEO of Monolith Growth Ventures, a performance marketing firm with offices in Singapore and Manila. Costales founded the company in 2016 after years of working for Procter & Gamble, and his firm has grown rapidly to 15 full-time staff. They service leading global brands such as Fitness First, The Boston Consulting Group, Sonos, and Klipsch. In 2019, he was one of the honorees of Forbes Asia's 30 under 30. 

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