CORPORATE GOVERNANCE The Directors’ Cut – Questions to ask in slowing times

Like it or not, the tide of business confidence has surged rapidly south this year. “The sense of dread about the coming year is more than just the back-to-work blues,” wrote Infometrics managing director Andrew Gawith in his Back from the beach client newsletter. “Measures of business and consumer confidence at the end of last year were at their lowest since the late 1980s or early 1990s. Economic growth has already slowed significantly since the start of last year, almost halving to 2.2 percent per annum by September 2005.”
Big issues for business this year, predicts Gawith, will include significant fall in the currency, sizeable question mark over the future of household spending, and squeeze on profits as poor productivity and tight labour markets hit home through rising cost pressure.
Having said all that, Gawith knows that negativity is highly contagious. “People have long been expecting the music to slow at some point. They are now frightened. They’ve had several good years and when everybody starts talking about the good times having stopped it’s pretty easy to join in.”
Business folk, he says, need to sit down and reassure themselves that the current business and economic conditions are nowhere near the same sort of conditions that existed back in the early ’90s or the late ’80s even though the confidence measures tell us that we should be as pessimistic as we were back then.
Why that disconnect? “It’s partly relative phenomenon,” says Gawith. “It’s quite hard to provide an absolute benchmark for economic surveys. If there have been fantastic times and then you become little pessimistic about the economy, people can become very pessimistic about their prospects even though they are still pretty good relative to any historical economic downturn in New Zealand.
“There’s no forecast out there that I can find that has the economy actually not growing in any full year over the next five years. So nobody’s forecasting definitive recession. Clearly some may have two quarters of negative growth behind the positive year-end numbers but very few have got year-end growth of below one percent. It’s like asking people ‘are you happy?’ Well, happy relative to what?”
So what conversations should directors now be having? And how should they be channelling their own and their management’s thinking?
First up, says Gawith, apply some perspective. Directors must help managers see the market, economic and business conditions as clearly as they can. Tease apart the current debate swirling around collapse in confidence and hard landing. “Part of the job of the board of directors is to ask if that is genuinely going to be true for their specific business. If not, their strategy will be little different from those of other organisations that simply read the newspapers and batten down the hatches.”
The reality check must avoid the twin temptations of following the herd and of being too cavalier with shareholders’ interests.
“Realities will vary hugely depending on which sector and which industry you’re in and how your company is placed,” advises Gawith. “Does the company have very strong market position? If so, it’s more likely to be able to retain sales or snatch them from competitors as they make the wrong moves and suffer. Or are you pretty small player? In which case you’re going to be at the end of the fo od chain and you may have to take some quite significant actions to protect your margins.”
Both management and board, says Gawith, must assess the literally hundreds of economic scenarios being projected by market observers and conclude which one they’re going to run with for their business plan. “While this may be primarily management decision, the board must be comfortable that the management team has taken the right view of the economy.
“Directors must be sufficiently know-ledgeable about the economy to be able to interpret it for their business so that if management says, for example, that it plans to slash the labour force and cut back capital spending they should be able to question if that is necessary. Perhaps directors think there’s going to short, relatively shallow slowdown and the organisation shouldn’t be over-reacting to business conversations.”
There is, admits Gawith, huge spectrum of debate. “But directors must eventually settle on the right scenario for their specific business.”
While acknowledging that good directors may well have their preferred sources and views, Gawith says he would “certainly be worried” if directors were to accept any one line of argument without looking at other information sources. “Directors must be soaking up lot of information to form these scenarios.”
Such scenarios will form the backdrop for raft of upcoming questions. Rapid economic growth over the past few years saw many organisations wrestle with difficulties finding the required labour, capital that was worked to capacity and inability to meet orders due to strong demand.
“We’re now shifting quite quickly to period in which demand won’t be sufficient to use all the capacity that they’ve got,” says Gawith. “Some of these organisations will have too much labour so what do they do with it? Do they lay it off – bearing in mind that it’s been incredibly difficult to get those people? Or do they hold on to the labour, hope that this cycle is fairly short and sweet and they can fully utilise it in year or so?
“There are big decisions for managers and directors to take in terms of what resources they should hold on to through this slower part of the cycle.”
Finally, directors and boards in the export and manufacturing sectors, in particular, will remain at the sharp end of decision-making processes that are predicted to grow more stressful over the next 12 months.
Given the squeeze that their businesses have been under for some time, Gawith predicts that both board and management of export companies should be asking themselves if their business can survive intact into the next year. “If not, what do they change in order to survive? Can they survive at these exchange rates, for example? Directors need to tell the management team that if the organisation is not going to be able to survive – if it’s going to make big losses this year and they’re not interested in losses – there are some major strategic decisions ahead.
“You’re not dealing with laying off few workers to get through the year because margins are bit tight and the profits may be down bit. In some cases in the export business, margins may be so slender that the companies are already bleeding cash and directors have to decide how long they let that continue. Are there any major strategic shifts that they can take to rectify that problem? Is there enough fat in the balance sheet to survive for another year bleeding like that?”
As Gawith says, it’s pretty easy to run business when the economy is booming. Now for the harder part.


Takeaways
• Think like Einstein. It’s all relative. Don’t forget that the current predictions of downturn come off the back of strong high.
• One size will not fit all. Directors must assess their individual organisation’s position in the changing economy. Organisations can operate in micro-markets. Adjust strategy accordingly.
• Boards must be prepared to make some big decisions around labour force issues and capital expenditure over the next 12 to 18 months. Double the dose if they’re in the manufacturing or export sectors.

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