It has become a cliché at this point to say we are living in ‘unprecedented economic times’. In 2020, the Covid-19 pandemic plunged the global economy into a sharp, albeit short-lived, recession, with most countries seeing a dramatic plunge in GDP. While economies rebounded from the initial shock, recovery has been muted overall.
Global growth, which stood at 5.7% in 2021, is projected to slow to 2.9% this year. And, if warnings from the International Monetary Fund are anything to go by, that might not be the worst of it. Amid crippling energy shortages, record levels of inflation and rising living costs, many of the world’s leading economies could be on the brink of yet another recession.
In August 2022, the risk of a euro-area recession reached its highest level since November 2020, according to economists polled by Bloomberg. With inflation across the bloc averaging 8% this year, the European Central Bank (ECB) has responded by tightening monetary policy, hiking up interest rates for the first time in 11 years. In the UK, the situation is even starker. Here, inflation is expected to rise as high as 13%, and interest rates have now reached 3%. The Bank of England has warned that the UK economy will contract in Q4 2022, before dipping into recession for the whole of 2023.
Preparing for the worst
What that means for businesses remains to be seen – but it’s clear that Europe’s finance leaders are keeping an eye on the risks. In a survey of UK CFOs, conducted in June by Deloitte, respondents said it was more likely than not that we’d experience a recession within the next year. The vast majority (87%) said operating margins would be squeezed over that time, while 61% said the level of uncertainty facing their business was ‘high’ or ‘very high’.
Ian Stewart, chief economist at Deloitte, commented: “Finance leaders have edged towards more defensive balance sheet strategies, particularly cost control and building up cash.”
All the same, Stewart also remarked that CFOs are not quite in ‘batten down the hatches mode’, adding that risk appetite “is only slightly below average levels, and well above the lows seen in the financial crisis, at the time of the EU referendum and during the pandemic.”
In other words, the picture is mixed. While input costs have risen significantly, with credit seen as expensive, many CFOs have retained their appetite for investment. Strikingly, more than half (54%) expect revenues to rise over the next year. Charlie Steel, CFO of Babylon Health, suggests that some businesses will be better positioned to ride out a downturn than others.
“Financial markets have rapidly shifted away from growth and towards value investing,” he says. “So for those businesses that need to raise capital, that presents a significant challenge, because the cost of capital has increased massively. At the same time, though, there are a lot of other businesses that are much more recession-proof to start with.”
Steel adds that, while businesses have already had their resilience tested over the past few years, they should not assume that what worked in 2020 will work in 2023.
“What you saw during the pandemic was effectively a very short, very sharp reduction in demand,” he says. “The issues you’re seeing in the economy at the moment are mainly supply-side issues with things like inflation, increasing wages, global supply chain shocks, oil prices. So it’s completely different from the pandemic – in fact, the pandemic is not even a good data point to draw on.”
Facing the storm
As an AI-powered healthcare provider, Babylon Health sits at the intersection of two post-Covid growth industries: health and tech. The company has posted strong results in recent months, comparable to other tech startups in their ‘take-off’ years. Its Q2 revenues grew nearly fivefold year-on-year, following the signing of new US value-based care agreements, while revenues for 2022 are expected to top $1bn. Despite this momentum, Babylon has not been unaffected by the financial headwinds. The company, which went public last October, has already made a number of tough decisions in its bid to achieve profitability.
“We’re very cognisant of the fact that markets have moved and the discount rate has changed,” says Steel. “We’re making sure we’re building the business to respond to that.”
In July, Babylon said it planned to implement ‘revenue and cost efficiencies, in response to changing market conditions’. These cuts – which the company has not specified – will come into effect in Q3, and are set to generate savings of up to $100m a year. Bloomberg reports that they may include some job losses.
“We announced very recently that we’re doing a cost reduction exercise, which I think goes back to how we think about the financial flexibility of the business.”
24%
The percentage of CFOs who report credit as costly.
Deloitte
2.9%
How much European and Central Asian economies are projected to shrink by in 2022.
World Bank
“We announced very recently that we’re doing a cost reduction exercise, which I think goes back to how we think about the financial flexibility of the business,” says Steel. “Basically, we’re making the business a little bit leaner and making sure that we can respond to change extremely quickly.”
Babylon has also reportedly terminated contracts with two NHS trusts in the UK. Speaking to TechCrunch, Babylon’s Tim Rideout blamed NHS funding pressures and the rising costs of capital. He said the company was trying to be “ruthless at focusing on the things where we can make a real difference”.
Even so, Steel remarks that Babylon’s growth in top-line revenue is poised to continue, albeit probably at a slower rate than before. To an extent, he sees the current market conditions as an opportunity in disguise.
“All this healthcare technology that people were previously allocating capital to is now being cut by various businesses,” he says. “It means we can be the people still investing in this. We’ve seen before that, through recessions, a few players emerge as the very obvious and dominant winners. We very much expect to be one of those, while all the emerging competition is slightly more asleep at the wheel.”
Recession-proofing a business
Generally speaking, Steel thinks there are a couple of factors that might help finance leaders ride out a downturn. The first is having good cash reserves, while the second is flexibility.
“Having a big war chest of cash is always helpful, because fundamentally, that gives you optionality,” he explains. “The other thing is the ability to change your business model quickly in response to market conditions and consumer or investor requirements.”
Steel similarly thinks it’s important to be proactive about the strategies you put in place, as opposed to merely being defensive. While nobody can say for certain what the economy will be doing in 2023, the past few years have underscored that complacency is never a winning strategy.
“When you’re working in a really fast-growing environment, like we are, you need to be able to anticipate changes, rather than just sit back and hope for the best,” he suggests. “We’re very much thinking about this every single day, and that’s how we’re running the business.”
Clearly, no two CFOs are facing exactly the same circumstances, and their strategies will vary accordingly. However, there are a number of commonalities across industries. In a 2019 survey of US CFOs, finance leaders cited a range of actions they would take in the face of a downturn. These included reductions in discretionary spending, hiring freezes, delayed investments and debt changes. Deloitte, which conducted the survey, noted that CFOs might need to make more drastic moves in the event of a full-blown recession. Some businesses might need to reshape their entire operating models – for instance by reducing their reliance on outsourcing.
Deloitte also suggested that businesses should continue investing in new products and services. This was borne out in the more recent Deloitte survey, which found that 19% of CFOs wanted to increase their capital expenditure as a ‘strong priority’. Over the medium term, most CFOs expect to see a rise in digital technology spending.
Similarly, while many finance leaders are being forced to make job cuts, others are making tactical hires as a way to meet business demands. As recruitment professional Paul McDonald wrote in a recent Forbes article: “If you hold back on making critical hires, you could undermine your firm’s ability to be resilient and thrive at exactly the time you need all hands on deck.”
Of course, this may not be practical for every finance leader staring down the barrel of a recession. For any business, there are times to make big investments and then there are times to cut back. Steel remarks that having to double down and focus can actually be extremely powerful.
“It’s like how pruning a hedge can make the plant more healthy,” he says. “I think that that is one thing that businesses will really benefit from – having to be more disciplined about their use of capital. That will enable a great recovery, it just involves choices at this point in time.”
A downturn may not be any finance leader’s dream scenario. Even so, it can force change for the better, helping them forge more resilient businesses that are better placed to weather future storms.
1995
The last time the UK saw such a big interest rate hike.
Reuters
