Seasoned executives have weathered the ups and downs of multiple economic cycles, shepherding their companies through periods of business contraction and expansion. But it's been over a century since company leaders had to manage through post-pandemic times and many decades since the high inflation of the 1980s receded, so even the veterans should be feeling some level of anxiety around the uncertainty of 2022. Economic experts at the World Economic Forum project that the entire global economy will be 2.3% smaller by 2024 than it would have been without the pandemic, which is just one of many statistics fueling business leaders' concern about the rising risk of recession.
Managing recession risk in 2022 will require a balance of tried-and-true past strategies and innovative thinking, supported by the advanced technologies available today. Whether you're a new entrepreneur running an emerging business or a corporate veteran, it's a good time to review the importance of risk management policies and practices to get a head start on recession preparedness.
What Is Recession Risk Management?
Risk management, in general, includes identifying risks, analyzing risks, planning and executing risk mitigation and monitoring risk. When a recession happens, the only thing within business leaders' control is how your company responds, so it's important to be prepared. Risk management is best done proactively, rather than mid-crisis. Recession risk management, in particular, is about developing strategies and tactics that are ready to implement if certain economic trigger events, like a severe supply chain disruption or sudden falloff in customer demand, occur. It's a bit like blending scenario analysis and contingency planning, but with a primary focus on how to successfully mitigate the impact on profitability of declining revenue caused by the depressed customer demand that a recession will bring.
Companies that are prepared with a recession risk management plan may even thrive during a recession, rather than simply survive.
- Risk management is a process for identifying, analyzing, mitigating and monitoring risks.
- The goal of recession risk management is to reduce the impact of declining revenue, profit and cash flow caused by a recession.
- Preparedness, more than many other factors, can influence how well a company emerges from a recession.
- Early and continuous planning allows the right systems, processes and plans to be in place before conditions start changing.
- Consider the 10 common risk management practices below and ask yourself the 10 analytical questions in the accompanying download to help determine your organization's recession risk — and how to prepare for it.
Recession Risk Management Explained
Recession risk management is more than just preparing a document — it's a framework for handling issues that arise from a contracting economy. The framework should include predetermined strategies, as well as the processes necessary to implement them and communicate them to employees, customers and other stakeholders. A key aspect of recession risk management is to establish a cross-functional risk committee to lead the task of developing options to be taken if certain bad economic conditions emerge, and establishing operating and approval protocols to execute those options. Committee members scan the economic environment for scenarios that could have an adverse effect on the company and lead the development of steps a company might take to reduce or avoid their impact.
If this sounds a little like business continuity planning (BCP), that's partially true. BCP is a part of risk management that focuses on worst-case scenarios, while enterprise risk management is the umbrella for analyzing all risks — both negative and positive, since, in theory, at least, it includes upside risk. In practice, risk management focuses on potentially damaging issues, such as infrequent natural disasters, political instability, key customer losses — and economic recessions.
What Is an Economic Recession?
The National Bureau of Economic Research (NBER) defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months (unofficially, many assume two quarters). Recessions are characterized by falling gross domestic product (GDP), real income, employment, industrial production and wholesale-retail sales. They are cyclical periods of contraction that follow and are followed by expansion, and the NBER has measured 12 recessions in the U.S. since World War II. Some recessions last longer than others — the shortest on record was two months, February to April 2020, while the longest ones lasted several years — and some are deeper than others.
There are certain generally accepted recession indicators, but a recession's length and depth are usually unpredictable — and that unpredictability is in itself a significant factor for risk management teams.
The Impact of a Recession on Businesses
Some business models are innately recession-proof, due to declining revenue from weakened customer demand and its impact on profitability and cash flow. The chain reaction of recessionary erosions in consumer confidence and reduced consumer and business spending, as well as tightening of business and personal credit, manifests in lost business profit and slower cash flow. Businesses without cash reserves and those that haven't prepared to adjust operations can face dire consequences, including bankruptcy or closure.
Companies often take an assortment of actions to recession-proof their businesses, including laying off employees, cutting spending, reducing investment and even adjusting their products/services. Recessions cause businesses to face similar challenges regardless of size and across most industries, although some industries are considered "recession-proof," such as health care and utilities. Generally, a company's level of preparedness is a strong predictor of its ability to weather a recession.
The Importance of Risk Management Policies for Businesses
During periods of economic uncertainty, business leaders must frequently make quick, level-headed decisions. Preestablished risk management policies reduce the potential for errors caused by haste and can spell the difference between a business’s success and failure. For example, pre-identifying cash-negative projects that can be delayed without impairing continuing operations will be a big benefit should a company's cash flow slow suddenly, forcing it to make changes quickly. Additionally, “what if” scenarios can uncover potential threats to operations, such as overreliance on certain suppliers or talented employees. With those threats in full view before a crisis hits, a company has time to explore alternative solutions in advance and will be far better prepared if a key supplier goes bankrupt or a certain employee departs.
For these reasons, risk management policies and plans are best developed in advance of a crisis like a recession, and then updated periodically. Moreover, risk management policy development often uncovers opportunities to save money or operate more efficiently that can be put into practice immediately, increasing profits — some of which can be set aside as cash reserves against future risk.
10 Recession Preparation and Risk Management Practices
Only rarely do the harbingers of recession make themselves known well in advance, as appears to be the case in early 2022. Therefore, business leaders should take this unusual opportunity to prepare their companies for or even finding opportunities in the next possible recession now, before it arrives. The following list of 10 risk management practices are proven strategies that have worked successfully in past recessions. They won't all apply to your company, but it would be wise to consider how each of them might apply to your business and then pursue the ones that make the most sense.
Create a risk committee.
A risk committee is a group of company leaders who help identify a business's key risks and create strategies for monitoring and mitigating those risks. Even creating a risk committee is a sign that a company is prioritizing advanced preparedness. Risk committees should be continuously active, monitoring the external business environment for risks and updating alternative mitigation plans. A risk committee's responsibility regarding recessions is to lead scenario analysis and contingency planning efforts. Often, members are also tapped to be at the forefront of the company during emergencies.
Revise processes for more agile decision-making.
Operational flexibility and streamlined decision-making and approval processes are pluses for businesses at any time. When a recession is on the horizon, they're even more important — and still more so once it hits. Changing market conditions frequently require rapid adjustments in the way a company does business if it hopes to reduce the impact of declining revenue. Sometimes these changes need to be "called on the field," so to speak, which might mean empowering employees who are closest to the customer to make real-time, revenue-saving decisions. At the same time, management needs the most current information to inform decisions about when/whether to trigger the appropriate parts of the company's risk management plans.
Review business continuity plans.
Ideally, BCPs are refreshed periodically, but it is common for them to go stale. Before a recession hits, it's a good idea to review the company's BCP. In the unfortunate event that a worst-case scenario comes into play, having a current, viable plan can keep the business running.
Improve customer satisfaction.
When money gets tight during a recession, customers typically pursue a flight to quality and durability. Customers who perceive a decline in product quality or customer service may be more apt to switch brands during a recession. Staying close to customers and improving customer service becomes even more essential, reducing the risk of customer defections that would exacerbate the expected recession-related revenue decline.
Assess your workforce.
Since labor tends to be a large cost for most businesses, it is also one of the first places that businesses look to cut costs. Pre-identifying essential positions can help management make tough choices faster than they otherwise might when a recession hits and layoffs become necessary. Additionally, evaluating the talent and skills within the workforce in advance will accelerate your action if employees need to be redeployed as part of a pivot in company operations. After assessing the workforce, it is common to create a multitiered layoff plan the company can trigger at various stages of a recession, if necessary.
Refocus business priorities.
It is said that a rising tide lifts all boats; conversely, a recession can expose underperforming assets. Refocusing a business on its core, essential and valuable assets can be a good strategy to maximize cash flow and profitability. At the same time, selling off nonessential or underperforming assets can fund cash reserves and eliminate cash flow drains. While the main point is to set up processes to provide needed information during a recession, this is the kind of analysis that can improve business performance even if a recession never materializes.
Harness your competitive advantages.
Risk committees monitor the competitive environment as part of their charter to identify risks, and in that process can pinpoint competitive advantages that make the most difference. Promoting a company's competitive advantages during a recession may help mitigate revenue loss and may even result in market share increases. Understanding which advantages matter most to customers, from product quality and features to price, can also help inform operational decisions, such as shifting inventory purchases to best-selling items.
Move costly initiatives to the back burner.
Focusing on cash flow is a key part of risk management during a recession because inflows from revenue will be falling off. Business leaders frequently find themselves balancing current cash demands against the need to spend on long-term initiatives, leading to delaying or freezing those costly initiatives after spending has begun. When deciding what to table or put on the back burner, analyzing whether your company fits the 80/20 rule, where 80% of business comes from 20% of customers or products, may be helpful in managing working capital during a recession.
Make a list of cost-saving options.
Businesses typically need to reduce costs to offset lost revenue during a recession. Preparing a list of cost-saving options in advance allows management to collect and analyze data to make more thoughtful changes. It also offers the benefit of time to begin implementing or testing changes. Some examples of typical cost-saving options include renegotiating terms with suppliers, changing distribution methods and cutting personnel costs, such as some employee benefits.
Investigate key person insurance.
"Key people" are those whose departure would have an adverse effect on a business. Key-person insurance policies are meant to provide funds to bridge the time between a key person's departure and the recruitment, training and coming-up-to-speed of a new person, plus helping make up for lost business from the disruption. Key-person insurance policies commonly have several requirements, limitations and tax implications that call for analysis and advice not only from the risk management committee, but also from insurance, legal and tax professionals. Nonetheless, they may be part of an appropriate risk management strategy for your organization.
Download: 10 Questions to Determine Your Recession Risk
Recessions impact businesses differently. Certain industries are more recession-proof than others, and some companies are structured in a way that withstands recession better than others. Understanding the possible impact of a recession on a specific company requires an in-depth analysis of that company's unique circumstances.
Efficiently Manage Your Financial Processes With NetSuite Financial Management
Managing and mitigating risk begins with having the right information to identify company vulnerabilities. In the case of recessions, when demand-side softening poses risk to a company's profitability, availability of the right revenue and customer data can be helpful when creating a plan to stem revenue losses. Similarly, sourcing insights and analyses of supplier data can highlight potential supply-chain weaknesses. NetSuite Financial Management can provide real-time, accurate information managers can use to make quick, better-informed decisions, which is especially critical during times of uncertainty, like a recession.
Many economic experts believe a recession is looming, due to high inflation and the supply-chain disruptions brought on by the COVID-19 pandemic. Recession risk management is most effective when done in advance of an economic decline and then continually updated. Some businesses can withstand a recession better than others, especially those with the foresight to establish cash reserves and to incorporate the 10 suggested preparations and risk management practices outlined above into their continuing risk management processes.
Recession Risk Management FAQs
How do you mitigate recession risk?
There are many ways to mitigate recession risks like reduced revenue, weakened profitability and slower cash flow. An important first step is to establish a risk committee tasked with identifying recession risks and leading the development of countering strategies. Often these practices include cost-cutting, labor reductions and delaying costly investments. Other approaches are enhancing customer satisfaction, exploiting competitive advantages and adding flexibility to the decision-making process for more nimble operations.
What type of risk is a recession?
Recessions bring financial risk to most companies. As customer demand softens, revenue can decline, putting pressure on profits and cash flow. Recessions are temporary and are followed by expansion. Companies that are better prepared for recessions have better outcomes than those that make hasty, ill-considered changes during the recession. Such companies often suffer long-term consequences.
What are the key components of a recession?
The National Bureau of Economic Research (NBER) defines a recession as a significant decline in economic activity spread across the economy and lasting more than a few months. Recessions are characterized by declines in gross domestic product (GDP), real income, employment, industrial production and wholesale-retail sales.
How do you prepare for a severe recession?
At the beginning of a recession, its duration and severity are unknown, so it's important to be prepared with a plan. Recession risk management is the process of developing a set of strategies and tactics to implement if certain economic trigger events occur. It primarily focuses on ways to mitigate the impact on profitability and cash flow from revenue declines caused by depressed customer demand. Typical preparations include establishing a risk management committee and periodically going through "what if" scenarios.
Which are 5 risk management strategies?
Risk management strategies include identifying risk, analyzing risk, creating a mitigation plan, executing the plan and continuously monitoring how changes in the external business environment influence the risks an organization faces.
What are the four major risk management strategies?
Risk management strategies include identifying risk, analyzing risk, creating and executing a mitigation plan and continuously monitoring risk.