Confronting the Prospect of a Global Recession

Even though companies have their hands full dealing with today’s uncertainties, they are well-advised to start thinking about how to prepare for a downturn that could compare to the 2008 financial crisis.

Outlook Remains Uncertain

The economic and social forces that could fuel a full-blown recession have been building over the last two years or so.

In 2020, demand for goods and services fell off a cliff as the Covid-19 crisis kept consumers at home. Countless businesses shrank or closed, unemployment rose, and U.S. GDP fell almost 30% in the second quarter of that year.

Governments the world over injected huge amounts of money into their economies, which helped to keep families afloat but also created cash surpluses that provided a platform for an unprecedented surge in demand.

The demand was particularly acute for products as people still hesitated to use services such as gyms, movie theatres, and restaurants. Over the following year other factors came into play, including labor shortages resulting from people quitting their jobs, choosing to stay home, and getting sick from Covid and isolating.

Furthermore, the crisis laid bare the inadequacies of the US freight logistics systems, leading to widespread bottlenecks. As a result, global supply chains were thrown out of synch, causing product shortages and steep price increases for transportation and storage capacity.

These disruptive forces are still at work today. We remain plagued by product shortages — a scarcity of baby formula is a current example — as well as labor constraints and Covid-related production problems in factories. Ominously, prices rose by 7% in December 2021, with the inflation rate for that year reaching a 40-year high. This news stoked fears of rising inflation and a possible hike in interest rates as central banks try to quell these inflationary pressures.

Will the Bullwhip Bite?

Another insidious force that could help tip the world’s leading economies into recession is the bullwhip effect.

Supply chain professionals are familiar with this much-studied phenomenon. In the context of a potential recession, it is being triggered by the extreme increase in demand that companies are now struggling to manage. In this environment, retailers place large orders with distributors, which prompts distributors to over-order to maintain their inventories and also in response to retailers’ forecasts of growing demand.

Manufacturers and their suppliers follow a similar pattern of behavior. The end result is that order sizes and inventories are amplified at each link in the chain, and are grossly inflated at the end of the chain. Uncertainty over the availability of products and delivery times is compounding this phenomenon today.

Eventually, demand will drop as the pandemic wave crests and the crisis subsides. People will go back to spending more on services and less on goods, and when that happens orders will also drop — precipitously. Companies will desperately try to offload bloated inventories. The impacts on companies become more severe as one progresses further upstream, and as we saw in the 2008 financial crisis, can feed a recession that causes widespread company failures and job losses.

I provide a more detailed account of these possible outcomes in my Sloan Management Review article: Prepare for the Bullwhip’s Sting.

Cold comfort — but comfort nonetheless

As I explain in my SMR article, there are measures companies can take now to mitigate the shock of a future recession. For example, they can identify critically important suppliers and closely monitor them, evaluate the financial health of essential partners, and explore possible ways to support vendors that could buckle under recessionary headwinds.

Also, it may be time to dust off the playbook for surviving a recession when it hits. Conserving cash and reducing inventory levels, rationalizing the supplier base, and prioritizing customers are all measures that can help companies weather the storm.

It is discouraging to consider that the light at the end of the tunnel — a cooling of today’s overheated demand — is actually an oncoming train. However, perhaps companies can draw some comfort from the fact that taking appropriate actions now can help them sidestep the train’s arrival.

Related: Supply Chain Resilience Core Capacities