Stress Testing and Strategic Cost Reduction During the Pandemic – Value Creation Strategy #11
We’ve been tracking weekly sales in our Pandemic Revenue Index, in which distributors are reporting double-digit declines week over week. A lot of distribution companies have been handling the COVID-19 crisis moment to moment, with barely a chance to catch their breath.
Despite the frenzied activity, distributors can put guardrails around their next steps to start to make the uncertain a little more certain. Even without a transition plan, distributors can look ahead and develop a near-term strategy to move forward.
Start with a stress test.
Stress testing measures a business’s resilience when subjected to unexpected shock, such as the pandemic, to the system. The key is cash flow. Look at what your business needs and what it can afford when you’re bringing in only a portion of the revenue you expected.
Most stress tests begin with a series of questions:
- What is a range of revenue or margin decline that could conceivably happen? For a realistic starting place, consider a range that goes down to 60%. Look at three scenarios: optimistic, realistic and pessimistic.
- How long will the conditions last? Put some hypotheticals into place, such as six, nine and 12 months.
- How comprehensive and effective is your cost reduction program? Read on to learn more about how you can reduce outgoing cash quickly.
This is a process typically done with senior executives: that is, laying out the balance sheets, payroll and debts to see how a viable path may be forged for the future given current conditions. It is important to have the key players at the table when making decisions like this, as you’ll need strong leadership in this challenging time.
Come up with a cost reduction plan.
In an ideal world, a business will have already performed a stress test and put together a cost reduction strategy. A cost reduction strategy includes the strategic actions a business will take to reduce its operating costs in a time of economic stress.
Most firms develop their cost reduction plans in tiers that are triggered by progressively worse operating conditions. These tiers can also be seen as a series of concentric circles that collapse as conditions worsen.
Consider the first circle or tier as the what you’ll tackle first as a means of cost reduction, and the next circle or tier as what you’ll do next, if you must.
Unfortunately, the biggest piece in any business’s cost structure tends to be payroll. How much cash do you allocate to payroll, and how much can you reduce? You don’t necessarily need to jump to layoffs right away. Instead, first look at other ways to reduce payroll cost. Maybe shortening the work week, or having your managers take a salary reduction. What costs can you minimize without affecting customer service, such as removing a 401(k) matching benefit, removing floating holidays or decreasing educational expense?
When looking at payroll, identify your most essential employees — and look outside your leadership team. Typically, if you can get rid of one senior executive position, you’re saving three hourly workers that may be in critical functions. Focus on what will help the business be strongest when it emerges from this crisis.
Beyond payroll, consider renegotiating your lease, or renegotiating terms with suppliers. What costs can you support right now, and which ones can be reduced or put on hold?
Don’t wait until it’s too late to perform a stress test or line up your cost reduction strategies. However, even if you’re already hurting, there are still ways to stop the bleeding and reduce costs going forward.
For more information about stress testing and cost reduction in the face of a pandemic, including free resources, visit ircg.com/stress-testing.