We have never been so close to the next financial crisis. The purpose of this article and video is not to frighten you but to anticipate it and know how best to prepare for it, especially in Supply Chain and Inventory Management.
(How to prepare your Supply Chain for the next crisis video / Please activate the automatics subtitle in English)
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Are we close to the next financial crisis?
If we look at the crises of the last 64 years, we have had 9 economic crises, an average of one crisis every 7 years.
Financial crises are part of an economic cycle with growth and decline phases. The last known one took place of course in 2008-2009 with the subprime crisis.
What is important to remember is that the last crisis took place 11 years ago (2008-2019) and that we are therefore well above the average of one crisis every 7 years. We can, therefore, consider that we are getting closer and closer to a new cycle.
Profit rates and crisis cycles – USA, 1951-2018
In any case, many signals are indicating the end of an economic cycle:
- Extremely low-interest rates
- Too much liquidity in the markets
- Very high levels of debt in Europe and the United States (States, individuals, companies, etc.)
- Strong banking deregulation in the USA
- Tensions in Europe
- Signs of weakening in China
- Rising raw material prices
Will this cycle take 1, 2 or 3 years to arrive? Impossible to know, but it is very important to be prepared for it.
Warren Buffett, who is one of the richest men in the world, recently said he keeps a lot of cash, to be able to invest in the next economic cycle because the best investments are made during economic crises. It did this very well during the subprime crisis and the Internet crisis, so it is a good indicator to monitor.
This is also why many companies are keeping reserves and a lot of cash to be able to invest when prices will finally fall completely.
What will happen concretely for you during the crisis?
For all professions related to supply chain, inventory management or corporate finance, you will surely see your boss arrive in your office telling you to stop everything and cut off all your orders.
More concretely, we are going to have a drop in demand. Households and even businesses out of fear at first will stop consuming. You will have a product offer on the market that will be higher than the demand with too much stock. As a result, inventory levels will increase and as you will have too much inventory, the company will have to lower prices at some point, which will lead to a decrease in profit.
At the same time, you will have an increase in interest rates because banks will have much fewer reserves and much less cash available. Rising interest rates will also cause cash flow problems as it will become more difficult to borrow money, which will also impact profits and investments.
Since there will be less investment in marketing, advertising or innovation, for example, you will also have a drop in demand that restarts the previous vicious circle. This is called a snowball effect.
Wrong inventory management in times of crisis
Here is a classic example of poor inventory management in the event of a crisis.
Your sales will suddenly drop during the crisis and it will take you far too long to react. You’re going to have a huge overstock for maybe several years. Of course, when the activity starts up again, you will have disruptions because you will react too late to the demand.
We can see on this graph that we already had overstock before the crisis and inevitably when your demand falls, by 20, 30, 40 or even 50%, it will generate considerable stocks that will take you several months or even several years to liquidate. And when the activity starts again, you will soon fall apart.
Example: Automotive Industry in the US
Here you can see the price of car sales in the United States. Nearly 17 million cars were sold before the 2008 crisis. During the crisis, sales fell by almost half to reach 8 million sales over the year. Sales have been halved and are reviewing these parking images full of new cars, which had once again caused a drop in prices and a snowball effect.
How to prepare your inventory management for the crisis: 3 steps
At the moment, everyone is accumulating cash or cash in anticipation of a crisis.
The goal will be to optimize your cash flow as much as possible before the next activity drop.
In any case, a company that is well managed before the crisis will be more resilient during the crisis.
Returning to this graph, we can distinguish 3 very important steps:
1) The most important one will be before preparing for the crisis. We will have to try to have the healthiest possible business management, especially in terms of stock levels by trying to reduce them as much as possible.
2) During the crisis, it will be necessary to be very reactive to limit the gap between demand and your stock as much as possible
3) Finally, in the aftermath of the crisis, it will be necessary to be able to accelerate very quickly to meet demand or at least faster than its competitors
Good inventory management in case of crisis : 3 steps
1. Before the crisis, to reduce your inventory you must:
- Measure your performance with indicators/KPIs and objectives that are very clear (See our article on 10 key supply chain indicators)
- Manage your inventory according to risk (ABC XYZ). I advise you to set up an ABC XYZ analyze.
- Clean as many products as possible that are old, obsolete, dormant or outdated to reduce your inventory level and generate cash flow
- If possible reduce your number of references, reduce your offer to have fewer products in your catalog by eliminating those that are not essential.
- Favor an approach known as full cost. This approach will improve cash flow. For example, if you buy from China with a 3-month lead-time where you have to pay in advance, you may gain at the purchase price but you will lose a lot in cash. It can be very interesting for your mobility and cash flow to have shorter supply times even if it means paying a little more for your products.
- Increase your flexibility. It is better in some periods to have much shorter payment and logistical deadlines to be much more responsive to a demand that is rising or falling.
- Be very attentive in the coming weeks/years to market signals to be able to react as quickly as possible and review your sales and purchase forecasts
2. During crisis :
- Reduce your supplies as quickly as possible
- Review your prices to support demand and limit the decline in demand
- Review your sales forecasts very regularly. However, a classic mistake will be to spend too much time reviewing prices and forecasts.
- Continue to invest in your flagship products, your key products so as not to be out of stock on your most important products for your customers in codes A and B (See our article on ABC analysis)
- Review your product mix. The product mix is the composition of the products offered by the company. For example, Renault probably sold a lot more SUVs, 4x4s or at least large cars with rather high costs before the crisis. However, as we saw during the last crisis in 2008-2012, we had many more sales of small cars like the Twingo’s and with many more people who would keep their cars instead of exchanging them. When it comes to product mix, your sales behavior for your products will change. Generally what happens is that you will sell many cheaper products and you will also have much more maintenance instead of buying new products.
3. In the aftermath of the crisis :
- Revise your forecasts upwards as soon as possible
- Supply your customers as quickly as possible. A classic mistake is that companies take too long to react, also because they no longer have the resources to react.
- You will, therefore, have to reinvest before your competitors in terms of innovation, inventory, recruitment and possibly software or machines.
- Of course, it will also be necessary to maintain this sound management after the recovery so as not to fall back into defects and problems in inventory management.
The aim will, therefore, be to try to stick as much as possible to the demand in terms of inventory. It will never be perfect but by applying the previous points, you will get closer to it.
Opportunities to take during a crisis:
Remember that there are always opportunities in times of crisis:
- A drop in demand in value will cause an increase in demand for first prices
- A decrease in investments also means an increase in maintenance
- A decrease in cash flow/profit means less competition and therefore more market share
- If you have a management that is healthier and also less competitive, you will also be able to recruit more talent more easily
You always have opportunities. As we have also seen with Warren Buffett, take advantage of these opportunities to develop and buy companies amid a crisis at a very low cost.
Action Plan: Reduce your inventory before a crisis
- Analyze what had happened before in the last crises in terms of sales if you have the data to try to understand the product mix and the very important opportunities
- It is essential to try to reduce your inventory by 10 to 20% on your risky products, if not even by 10 to 20% on your total inventory.
- Try to increase your flexibility as much as possible, both in terms of production deadlines and also in terms of demand with your customers
- Try to reduce your payment delays to improve your cash flow and cash flow
- Define three priorities that are very simple and clear
- Raise awareness in all your departments
If you want to go further, I invite you to read the book on Warren Buffett “Snowball”, that is, the “snowball effect”. And you will understand its very long-term logic and its logic of economic cycles.
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