Aligning Operations to Protect Value During COVID
At the start of the year, it would have been impossible to predict how the coronavirus pandemic would impact business. Shutdowns and lockdowns began in China in late 2019, and ever since, there have been a number of variables at play that continue to affect all points on the supply chain—from shifting levels of demand, to factory shutdowns and workforce shortages. Many businesses have experienced an immediate, steep decline in revenue, and there is still uncertainty around duration, depth of impact, and the timelines for recovery.
Reassess this new reality
To account for all this uncertainty, company leaders must make some immediate, long-term changes to their operating model to remain profitable and grow. Most companies and investors have spent the past several weeks focusing on improving liquidity, working with their banks to communicate risk, and adjusting staffing to sustain in the near term – but that isn’t enough.
Historical planning and cost allocation assumptions are no longer realistic, and very few PE investments are going to deliver strong returns without first implementing transformational changes. Company leaders and PE investors need to determine the biggest operational risks facing their business and move forward from there. In recognizing that uncertainty may very well be the new norm, businesses can best align their operations to the reality of the current market by considering the following steps:
Focus on your most profitable SKUs
To improve your liquidity position, determine how rationalizing your product lines or SKUs could generate EBITDA or cash in the short term. At a time when every sale matters, this may sound counterintuitive, but last month’s math may no longer be relevant. Underperforming SKUs can eat away at your EBITDA in times like these when cash is tight, so consider conducting a new real cost allocation to assess not just gross margin, but also the cost of capital and the allocation of scarce resources. This should involve:
- Determining which SKUs create value, and which destroy value
- Pausing or killing any SKUs destroying value
- Aligning scarce resources and sales incentives with the highest value SKUs
Rightsizing for resiliency
Many companies have started the process of reducing their roofline or shuttering production lines, but when it comes to rightsizing back office and customer-facing activities, efficiency is key. A flat cut across the board without any methodology is often costly and unnecessary. Similarly, valuing vertical integration at the expense of agility is potentially detrimental when it comes to ratcheting back up once we begin to recover. Instead, rightsizing should be a strategic process that necessitates:
- Assessing right levels of fixed vs. variable costs across the supply chain
- Projecting updated procurement, HR, IT, and finance transactional volume and staffing requirements
- Taking advantage of real-time intel from your salesforce to forecast outlook
- Returning to rightsizing projects that were previously delayed
Securing and de-risking the supply chain
While it may seem like suppliers would be bending over backwards to maintain business, checking in with key vendors on their health and capacity is essential in this uncertain time. This should involve looking upstream, beyond your immediate supplier. Most likely, your vendors are as worried about you as you are about your customers, so informing them of your business’ financial health will help when it comes to proactively negotiating terms. To best understand that state of their business, ask to see evidence of financial health and a contingency plan to ensure stabilized supply.
Once you have an understanding of the state of your suppliers’ businesses, develop safety net options through dual sourcing, especially if a vendor is struggling to meet the demands of your business. If you decide dual sourcing is necessary, it’s best to act fast– competitors and companies in adjacent industries will quickly consume capacity in countries with competitive labor markets.
Adjusting to demand variability with SIOP
The only certainty when it comes to demand in this current crisis is that it has become impossible to predict. Some products and resources in high demand prior to COVID-19 are now sitting in inventory gathering dust, while others that were in low demand now sit atop the sales list. Being able to align demand and supply will affect EBITDA margins and on-time delivery, but this requires more than just cutting production based on which SKUs are in demand. To ensure a more robust response that accounts for uncertainty, you should prioritize SIOP (Sales Inventory & Operations Planning) processes by:
- Controlling service levels via new production scheduling
- Refreshing communication routines between sales and ops
- Proactively managing pricing policies
As you scale back capacity, SIOP should ensure that factories are still being properly level-loaded, which will help conserve capital expenditures in the near-term. The alternative ends up being the more expensive option: overloading the factory will mean workers running overtime, and underloading the factory ensures you will not see the full potential of your labor costs. By allowing you to better forecast for demand, SIOP increases productivity, and lets your customers to see the true value your company is bringing them.
Refocusing for the future
In times of crisis, every business needs a specialized response plan—a one-size-fits-all solution could never sufficiently account for all the nuances that make a business unique. That’s why the first step to managing through these difficult times is doing the diligence work necessary to understand the needs of your company. From there, leaders can work to build out a comprehensive plan of action to help their business survive in short term, prosper in medium term, and thrive in long term.