Cutting through Disruption - Part 1: Financing

A LinkedIn blog by Falco Weidemeyer, EY Parthenon Global Turnaround and Restructuring Leader

The past three years have been marked considerations about the nature and pace of the multiple crises that companies are continually confronted with. For understandable reasons, CEOs and business leaders devoted significant time and focus processing the principles of this fast-paced, stacked disruption with two major consequences:

1.??????Companies get trapped in a reactive spiral, adapting to fast and fundamentally fluid situations at an increasing pace, forcing them to become more and more tactical, and creating a barrier to thinking strategically for the longer-term.

2.??????Time and focus is increasingly wasted on trying to know the exact shape and form of possible futures, thus procrastinating necessary and no-regret adaptations.

Taking these two as working hypotheses, this latest blog series deals with the following question: How do we cut through the disruptive noise, reveal the known knowns, and start to strategically align around those, instead of waiting for further clarity while losing time?

In this context, we will look at six key aspects of this strategic reset:

- Financing

- Talent

- Customers

- Organization

- Relevance

- Sustainability

This first blog deals with financing as a fundamental pillar of every possible future strategy. The context for financing has changed quite fundamentally, due to having to confront several crises. Policy interventions to mitigate crisis symptoms have been a source for attractive temporary financing and subsidies, and the market is still partially flooded with these funds. However, more recent policy moves to contain the unintended consequences of too much liquidity, in sharply raising interest rates in a fight against high inflation, have created an environment where a resulting credit squeeze (not crunch) is highly probable, including recessive tendencies resulting from that.

This has resulted in a challenging landscape where private equity (PE) firms have raised significant amounts of money that need to be invested in an obtuse market context and an environment leading to enhanced scrutiny for investment decisions, multiples declining and the M&A market transitioning through a slower phase. This (and other factors) have also caused turbulences in the banking sector, albeit seemingly well-contained so far.

Now, we may not know how all of this will exactly play out. We do not know where interest rate rises will end, while central banks are balancing monetary and bank stability. We do not know how the M&A markets will recover and to what extent – are only transformative transactions coming back, or also exit-motivated ones?

We have to assume that governments will continue with their interventionist reactions, to cure the earliest crisis symptoms, while tendentially neglecting the systematic need for adaptations. But we cannot not know this for sure.

So far, there is reason and evidence to believe that the contagious mechanisms for the current banking sector turbulence is different from those during the Global Financial Crisis and there is an element of hope in that. Long story short, there are open questions. But one thing is becoming more certain – the availability of external financing will decrease, and it will become more expensive.

Therefore, companies need to start adapting to this development by exploiting their own sources of financing:

Bringing down internal cost structures and making them as flexible as possible – Selling, General and Administrative Expenses (SG&A)-cost structures deserve a new and diligent look under changing circumstances. After a period in which money at practically no cost has fueled elevated costs, it is fair to assume that companies need to address the resulting slack. This is not an easy exercise, as the future availability of talent has to be considered. We cannot easily assume that people can just be re-hired when the economy picks up again. Also, critical skill profiles need to be considered, as companies need to remain fit for transformation, despite the reduced HR cost base. The potential for robotic process automation and outsourcing has to be embraced and exploited. Finally, the impact on the employer brand has to be kept in sight as well.

Managing working capital smartly – On one hand, greater inventory secures supply chains. On the other hand, money is getting more expensive. Suppliers need to be considered as strategic partners and be financially sustained, but payment terms need to be managed optimally. Cash needs can vary greatly across the portfolio of a firm, so smart steering and pooling is necessary.

Reducing the proprietary asset footprint and sharing utilization risk – Every owned plant needs a certain utilization, that can be cyclical. In a slowing economy, downtimes may have to be compensated, needing additional financing. Factories need to be modernized and maintained, and investments are necessary. A thorough strategic assessment of what needs to be owned or not, where critical know-how can only be protected in owned plants or where resources can be shared with partners, can help to reduce exposure. Geostrategic and Environmental, social and corporate governance (ESG) criteria also must be kept in mind.

Managing risk and return – Diversification may be good but can lead to complexity and suboptimal terms. Concentration may be easy to handle but can increase vulnerabilities. Having backup credit lines can bring peace of mind, but also generate cost. Investment decisions deserve greater scrutiny in a context of higher financing cost and greater volatility. Alternative sources of equity and credit can be interesting and also bring new perspectives to the table. Managing cash and financing needs innovatively is key.

In summary, it is not necessary to know exactly how all the trends will play out – knowing the direction should be enough to address the elements of strategic corporate leadership. However, their deployment is not as simple and straightforward as in the past. New criteria and contextual factors have to be respected as well. But the most important consideration in such an uncertain environment is to start acting instead of continually reacting.

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The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.