How Sensitive is My Business to an Economic Downturn?

If you’re the type of person who pays attention to the economy, you’re probably familiar with the grumblings of an economic downturn making its rounds through the financial media in recent months. Treatment of the issue can range from dismissive to downright apocalyptic, depending on who you ask, what they do for a living, and how they’re feeling that day. But regardless of the tone, the staggering volume of chatter about economic woes can leave a small business owner feeling uneasy. By Google’s count, nearly 50,000 articles have hit the web in the past day alone containing the menacing keyword, “recession.”

First of all, don’t panic. Just because there’s a buzz about a recession doesn’t necessarily mean there will be one, as the experts have at best a spotty record for predicting these things. Also, resist the urge to use the stock market as an indicator; things are usually not as bad—or as good—as fluctuations in the S&P 500 would indicate. But this exercise is really about the ‘what if’’. What would happen to revenues? Would you need to make wholesale changes to the way you operate? Coming from a background in equity analysis, I answered these types of questions for the public companies I covered. Here are some key things to think about when evaluating your own company’s sensitivity to the overall economy:

1)      Know your product. Is your product truly mission-critical or is it a luxury? Whether B2B or B2C, if your customer can’t go about their daily business without you, your sales are going to be pretty durable in the event of a downturn. Note that just because your product is a luxury doesn’t mean it’s a bad product. De Beers, BMW, and Louis Vuitton have all done pretty well for themselves selling products that (most of) their customers can survive without buying. But if you are selling a luxury item, you’d better plan for more cyclicality in your business.

2)      Consider the competition. A few lucky companies can make the claim that they don’t have any direct competitors. The rest of us have to realize that there are alternatives to our products and should understand exactly where we sit in the spectrum of cost effectiveness. If your solution is the cheapest, you might actually cannibalize your competition’s customers when they look to save money.  If your product has tons of cheaper alternatives, you’ll be hit harder when budgets shrink and belts tighten.

3)      Know your customer. If your company is B2C, what is the buyer persona’s economic situation? If you’re selling to other businesses, who are their clients? Knowing your client and their sensitivity to the economy will go a long way in telling you about yours. Selling to other small businesses, for example, will be much tougher in a recession than if your biggest client is the government.

4)       Take a hard look at expenditures. If your revenues fell by 20% tomorrow, what are three things you would cut? If you’re having a lot of trouble answering this question, it probably means you’ve got a fixed cost structure and few discretionary expenses. A fixed cost structure can provide operating leverage and big profits when times are good, but it’s a double-edged sword that will make your company more susceptible to an economic downturn. The last thing you want is to find yourself cutting infrastructure and slashing payrolls. The resources you spent recruiting and training those employees aren’t coming back and it’s not going to help morale either. Ideally, you should come up with a buffer of expenses which serve a purpose but could be scaled down without too much disruption.

5)       Anticipate your capital needs. I can’t tell you how many earnings conference calls I’ve been on where CEOs of established, growing companies lament about their inability to raise capital due a bad economic environment, even though their business is humming. When the economy turns down, capital can dry up fast, even for companies that find themselves relatively unaffected. That’s because the decision to tighten capital is made in large part at the asset class level, with investors allocating fewer funds towards “riskier” assets such as small business loans and venture capital, and allocating more to fixed income. Just because your product and customers are likely to be recession-resistant doesn’t mean your financing will be. Raise capital when you can, not when you need to.

If you’re an entrepreneur, it’s part of your DNA to think big and aim high. You can’t be successful without being aggressive and taking advantage of every opportunity. But it still pays to think about the possibility of a slowdown, and if you think your company might be vulnerable, it might make sense to do some contingency planning. If you are young and you haven’t yet managed your company through a recession, the steps I’ve outlined above should serve as a good first step in evaluating how your company would be affected in an economic downturn. The next step is to cross your fingers and hope you’ll never need to use that knowledge.