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March 2009
Survival and Revival
A Primer for the Global Recession
Keith Bedell-Pearce
Chairman, 4D Data Centres Ltd
Keith Bedell-Pearce
Keith Bedell-Pearce has more than 40 years’ experience of managing businesses in turbulent economic conditions. Given his background as a successful businessman and an academic, it’s not surprising that he now finds himself being asked on a daily basis about the recession, when things are going to get better and how businesses can survive in such difficult times. In January of this year, he gave an informal presentation to the directors of the Willis Partnership about these issues. As the issues around the recession are very relevant to the future success of many of the businesses that are clients of his privately owned business, 4D Data Centres Ltd, he decided to turn the presentation topics into a short briefing paper for 4D’s clients. The result is “Survival and Revival”. Given the Willis Partnership’s original involvement in this, Keith has agreed that we might circulate the paper to interested parties.
Keith would welcome comments, questions and suggestions on any of the points raised in his note. His email is kbp@4d-dc.com
Keith’s recent appointments:
• Former executive director of Prudential plc
• Former chairman of the Student Loans Company Ltd
• Chairman of Norwich & Peterborough Building Society
• Chairman of Directgov
• Chairman of 4D Data Centres Ltd
• Senior independent director of F&C Asset Management plc
• Member of the Investment Advisory Committee of the Royal Society
• Honorary Professor, Warwick Business School, University of Warwick
The Basics
An anatomy of the 2009 Global Recession
This is a synchronised game of two halves. Instant global communications and the interlinking of financial systems in the developed world have made this the first truly synchronised recession. This also means that the recovery, when it comes, will also, to some degree, be synchronised. The recovery will certainly depend on a number of global structural issues in credit markets and banking being addressed or fixed. The rates of recovery will differ within different economies. Those willing to deal with the hard issues quickly and determinedly will see a faster and more robust climb out of the depths of the recession. The same applies to businesses.
Phase 1: meltdown of credit markets and the global banking system
Phase 1 is not over yet. Unless the issue of the banks’ and other lending institutions’ toxic assets is dealt with decisively, credit markets will remain paralysed, national and global trade will contract and there is a good chance that the recession will become a prolonged depression (see “What shape is your recession?” below). There is still a trillion dollars of what is known as “Alt-A” mortgages (a US variation of self-certified mortgages) to be written off. None of the UK lending institutions will lend to each other until they are sure all the toxic assets have been flushed out. They haven’t yet. A state operated bad bank may be the best solution.
Phase 2: the impact of Phase 1 on the real economy
– Jobs lost
– Businesses going bust
– Prolonged loss of business and consumer confidence
– Consumer confidence in UK is the key: 2% of the 2.5% average growth of GDP over past 20 years was down to consumer expenditure – most of it using credit
– Credit is currently out of fashion or unavailable. This is one of the reasons why the Bank of England has reduced base rates to ½%. At this stage no one is offering cheap loans (or really any type of loan except to prime mortgage borrowers with low loan to value ratios) but low base rates mean spending power is released into the economy as mortgage rates for existing borrowers come down and savers eventually decide to spend rather than receive a paltry ½% or less on their deposits. At this stage of the recession, equity markets and corporate bonds are only for the brave.
What shape is your recession?
– L, V or U?
– L: Japan 1990 – and still suffering. The Japanese pulled all the right levers but did not deal with the fundamental weaknesses of their banking system. The recession went on and on. The effects are still being felt today. Saving became so grooved into the national psyche – even at zero interest rates – that the spending habit was lost.
– V: this is what the Chancellor desperately wants: sharp drop, sharp recovery. It’s not going to happen.
– U: What we will mostly likely get; the only alternative is L. The question is how broad is the bottom of the U and the steepness of slope out.
Has the Government done enough?
– The UK Government and the Bank of England have pulled all the right technical levers resulting in the potentially benign combination of low interest rates, low inflation and a relatively stable exchange rate.
– Low interest rates: see comments under Phase 2 above
– Low inflation: this should encourage consumer expenditure when confidence returns
– Stable exchange rate. Stable for the moment but after a dramatic devaluation against the Euro and Dollar. This makes exports cheaper but imports dearer. Oil is priced in US$. So are many electronic products and components. Buy your 40” LCD screen now while stocks, purchased at $2 to the £, last.
– The latest technical lever to be pulled is Quantitative Easing: £75bn in the next three months, another £75bn later if needed. This puts more cash into the economy which (the Chancellor hopes) will trickle down and end up as consumer expenditure, possibly easing credit markets on the way. The test for seeing if this is working is to see if what is known as “broad money” (M4) begins to grow faster than the 2.9% that it had fallen to by the end of 2008. You will be hearing a lot about QE and M4 in the next few months.
What’s necessary for a sustained UK recovery?
– Stabilisation of both US and UK Housing Markets. Stabilisation of the US housing market is a condition precedent to any form of global recovery. This will be more intractable than the case of the UK housing market. The reason: “jingle mail”. US mortgage borrowers can just put their keys in a Jiffy Bag, pop it in the post and walk away from their former house with no personal liability. With house prices still dropping, there will continue to be a run on Jiffy Bags. In the UK, houses (and their value as perceived by their owners) is the key to consumer credit and consumer confidence.
– Normalisation (but not back to “2007 Normal”) of banking systems: the foundation of banking’s future has to be simplicity, transparency and trust. A UK bad bank to hold the toxic assets or complete nationalisation of the main players may be the only short term solution.
– Significant reductions of short term consumer debt. This is already happening big time. A good proportion of the money saved on mortgage payments is going straight to pay off large credit card balances. Only when these are reduced to levels that consumers feel comfortable with, will consumer confidence to spend return.
– Freeing-up of credit markets both for businesses and consumers. No credit = no recovery.
What will be the signs of recovery?
– Stabilisation of the US Housing Market and the same in the UK for the UK economy
– Banks start lending on sound risks. Ditto Mortgage lenders. Monthly mortgage approvals start to increase
– Spreads on fixed interest securities narrow
– Investors’ risk appetites grow
– M&A activity based on loan finance re-starts (lots of cheap assets up for grabs: Private Equity a likely winner)
– Savings rates stabilise at 5% in UK
– UK consumers spend largely out of income
– A sustained recovery of FTSE 100 and FTSE 250 (the main indices usually anticipate the recovery by around 18 months)
– Growth in M4 approaching 8%
– Upswing in innovation: the digital age really begins here. As part of their survival strategy, many businesses will be looking to new (and cheaper/more efficient) ways of doing things. There is likely to be an even greater growth in the use of digital distribution methods for intangibles than we have seen in the past five years and those consumers who are still spending will be looking for even better value than before. First port
of call will be Google. Buying online will be the only retail growth area during the recession. The Green Age also really begins here. Green strategies almost always lead to lower long term costs.
...and now the question you’ve all been waiting for:
When?
– When does GDP growth turn positive again? 2009: definitely not: a slim chance of zero growth in Q4 (“slim” here is a number approaching zero)
2010: possibly but not before Q3 and it may be later
– Business plans must assume a minimum of 18 – 24 months before the upturn
Who will be the winners & losers?
– Reminder: this recession in the UK will see a negative swing of GDP of at least 5%. 2009 GDP will be 95% or so of 2008. The vast majority of large to medium sized businesses will survive and so will most small businesses. Most will emerge fitter and more productive. Business failures make good bad news but not everyone is going to go bust.
– The impact in the UK will be differential
– The South East will be the least affected by the end of Phase 2 despite Financial Services job losses
– Retail will be badly hit. The High Street will never look
the same again.
– IT and Technology least affected: may even see growth
in some areas
– Government funding will be skewed to Green agenda
– Public sector support businesses well placed
– Banking will have to re-invent itself (simplicity, transparency and trust)
A Survival and Revival Plan
What can you manage?
– In reality, the only things you can manage are:
• costs
• finances, with absolute focus on cash flow
• activity
Costs
– 10% cut is easy (and has probably already been done)
– Now produce realistic revenue forecast to the end of 2010
– Prepare budget and business plan to deliver that budget
– If costs > revenue
• decide what you are going to cut and/or
• do things differently
– If a loss is the price of survival, funding for the loss must be in place
Finances
– If you haven’t done so, prepare a realistic financial plan/budget on the basis that the recovery will not start until 2011 at the earliest
– Managing cash flow should be the cornerstone of your financial planning
– Managing debtors should be the first item of weekly management meeting agenda
– Credit check clients at least once a week (automated services are available); be realistic about what proportion of your client base will survive
– Push your bank about guaranteed business finance
– Maintain your business credit rating: pay on time (for more on Finances, see Assess the Health of your Business on www.businesslink.gov.uk )
Activity
– The ultimate aim is to generate new business but sales can’t be managed, only the activity that produces sales.
– Hang on to the customers and clients that you already have. You may be able to help them without giving away the shop.
– The Economist Intelligence Unit says that 37% of CEOs surveyed said they would increase spend on marketing and sales during recession. GOOD CALL
– Audit the intellectual capital of your business. Prepare a matrix of individual skills & competencies of your senior team. How can these be used in concert to supplement your core business? Creative thinking is the activity that will deliver the greatest returns in this environment.
– Identify target market sectors
• For duration of recession
• Post recession
Revival: Preparing for post recession
– One of the great urban myths is that the Chinese word for “crisis” is made up of the symbols for danger and opportunity (wei + ji). “Wei” does indeed mean “danger” but “ji” is not “opportunity” but “crucial point”, that is, when something begins or changes. In other words, what mathematicians call an “inflection point”. This is when the sign of a curve changes. This recession is a major inflection point both for the world economy and for individual businesses. It is probably the economic event that will condition what happens on a global economic scale for most of the rest of this century. For some businesses, the inflection point will have a negative sign which will mean the slippery slope of the downward curve, for others life may well go on much as before the recession – but I suspect these will be in the minority – and for the majority, to a greater or lesser degree, their business world will change forever. The recession is a forest fire that will clear away the dead wood and undergrowth. Looking into the future to try to see how your business world might be different in the upswing of the recovery is the key to catch the strong updraft of economic activity as the right-hand arm of the U turns north.
– Anticipate the recovery
• Envisage the UK economy in 2011-2012
• Collect the views of others
• Identify likely winners (sectors and businesses)
• Build new relationships for post recession business on the basis of your analysis
• Maintain existing relationships (most will survive)
• Increase Activity (even more)
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