Think:Act Magazine "Journey to the future"
Ram Charan on surviving stagflation
Noted CEO coach Ram Charan offers guidelines for the best way forward during stagflation
by Ram Charan
Illustration by Jacques Kleynhans
Choppy economic waters and challenging financial headwinds lie ahead. Finding opportunity and the best way forward requires a different way of thinking about business – here are some guidelines to bear in mind.
Every day now we are hearing the drumbeat that a recession is coming and will likely spill into stagflation. And stagflation is ugly: The cycle of rising prices, declining demand and increasing layoffs eats at the core of humanity. People lose self-respect.
Central banks are compelled to keep increasing interest rates to break this cycle, but expect a painful process. Chair of the US Federal Reserve Jerome Powell acknowledged the challenge at a press conference in early November 2022, saying "the longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched." Sustained rate increases and rising costs will force companies to make deeper cuts in 2023 and layoffs will spread. The psychology of hunkering down will take hold. It will be hard to break. It could last two or three years.
With adversity already hitting some countries hard – think Turkey, Argentina, Italy and the Netherlands – the time is now to get ready for what's coming. Business leaders will have to make some bold moves to get through the downturn. At the same time, they should prepare for a return to growth, because the depth and duration of the downturn are impossible to predict.
Sustaining through such a period of high inflation, recession and stagflation requires an intense focus on cash. In a growth scenario, the focus tends to be on profit margin in percentage terms. Now it should be on cash – cash gross margin, in particular. When inflation reared up, companies moved quickly to secure access to cash borrowing. Now they should look at every aspect of cash that is coming in and how it is being used. That analysis will indicate when making incremental cuts is not enough. That's when it's time to lop off whole geographies, businesses or product lines to become a smaller, stronger company.
More insights still will come from analyzing individual customers' use of cash. Do they require you to hold excess inventory? Are they extending payment terms? When one company evaluated individual customers' impact on cash, management was surprised by the wide variation in the discounts and payment terms they offered. They took corrective actions to get the outliers in line. Customers' own cash situations bear watching as well. Maybe you can help a customer face the economic realities, but if their cash situation is teetering, look out.
When cash is critical and borrowing is costly, usage must be razor sharp. Remember that recent shifts in the economy make many linear projections of costs and interest rates unreliable. Predictions about market and consumer behavior may be unreliable too if they're based on historical patterns. Under new assumptions, some projects that are consuming cash may have to go.
Another reason to evaluate current projects is to shift cash to projects that have new urgency. Some small-scale, fast-return digitalization projects could become a high priority to offset rising costs. A new generation of third-party vendors can create and even implement applications targeted at specific problem areas. I have personally seen companies reap financial benefits in six or seven months at relatively low cost. Speeding up payments processing, for example, is a relatively quick fix that cuts costs and conserves cash. Digitalizing inventory management is also a targeted, time-bound project that can free up cash return in a matter of months.
The hardest cuts to make, of course, are people. While earnings may have been strong through 2022, forward projections likely tell a different story and leaders should make necessary adjustments ahead of the drop in demand and take care in how they treat people. Be clear about why layoffs are necessary. Laying out the facts of the external reality will build credibility and set a positive tone for the people who remain. People will be less fearful if they understand why layoffs have occurred and how the company plans to get through this trying period.
Communication is a big part of leadership in adversity. When much of the economic information people pick up outside work is negative, leaders should communicate as directly and as often as possible to counter it. Help people understand exactly how the macrotrends are affecting the company. Comparisons can be encouraging or downright depressing, so beware of comparing this year's performance numbers with pre-inflation numbers. Instead, show how the company plans to make gains in the emerging environment.
People who remain in their jobs will expect salary increases to keep up with inflation. The war for talent will not stop. Retaining those with specialized skills or expertise means keeping up with the market for that talent, but a positive work environment also helps. There's simply no way around the fact that companies will continue to compete for top talent, so you will have to fight to retain those with the skills and expertise you need.
We are now in a world where actions – and reactions – change the landscape almost daily and noneconomic forces wreak havoc on the economy. Geopolitics is suddenly a huge economic disruptor. Russia's war against Ukraine is an obvious example. As are President Xi's increasingly hostile rhetoric toward the West and President Biden's actions to block the flow of technology to China.
The world economy is in flux, but if we look far enough out, we know that growth will resume. New needs and new businesses will be created in what could be a $30 trillion global GDP 10 years from now. The bright side can't be found in numbers alone. Spotting it requires a different way of thinking about the business. It's a matter of looking at the external landscape from the outside in. It's a qualitative exercise that requires intuitive thinking.
Identifying the gaps in the market and needs that will increase when the economy stabilizes allow businesses time to build whatever capability is missing. Operational discipline and sufficient cash supply will position a company to pounce on opportunities as things open up. It takes a new kind of leadership skill to keep people energized through tough times and show them the pathway forward. Adversity will come, but there can be a new future of innovation, growth and prosperity. Overcome the psychological barriers and prepare for both.