Heading into 2023, several signals point to a global recession. These include the ongoing war in Ukraine; tightening financial conditions; and a synchronized economic slowdown in Europe, mainland China, numerous emerging markets, and the US.
The economy is cooling because of persistent inflation, rising borrowing costs, deteriorating private sector sentiment and rapidly slowing global economic activity. Continued cost pressures, weakening demand and elevated uncertainty are prompting some companies to make increasingly conservative talent and investment decisions.
In this environment, drivers of economic activity that were previously taken as a given will now warrant more attention from boards. To transform uncertainty into opportunity (via ey.com US), boards will need to focus on five central tenets to support their companies through economic uncertainty.
The supply-and-demand imbalance on the energy front, stemming from geopolitical tensions and climate change, is unlikely to be resolved soon. Increased volatility should be expected for energy, commodities and food price inflation.
While this may be a new experience for many US- and Canadian-based directors, others across Latin America undoubtedly have more relevant experience navigating inflation in their boardrooms. Regardless, boards should oversee how businesses are building pricing and supply strategies that are nimble enough to respond to more significant ebbs and flows in demand than in recent decades. They must also consider the role of cost management and productivity gains in companies’ inflation strategy.
While laying off excess labor has been a go-to for US companies for containing costs in times of economic slowdowns, today talent is not just more expensive, it is also perceived as more valuable. Business executives currently favor strategic hiring freezes, strategic layoffs, attrition and furloughs as cost-control measures rather than broad-based layoffs.
Boards will need to maintain a line of sight into the long-term talent agenda, as they oversee how productivity, training and efficiency gains can offset higher labor costs and keep an employee base engaged when rehiring is possible.
3. Cost of capital
The rapid and synchronized tightening of monetary policy globally has led to a surge in borrowing rates, a correction in equity prices, and significant foreign exchange movements. The rise in the cost of debt is driving a focus on optionality in meeting strategic goals, while the large fluctuations in equity valuations have created a wedge between buyers’ and sellers’ perceptions of the underlying value of an asset. Boards can partner with management to explore the business’s capital strategy plans.
4. Supply chain
The transition some companies made during the pandemic from just-in-time to “just-in-case” inventory management may not be sustainable, and some businesses may face a new strain as demand cools and inventory accumulates.
Geopolitical developments are also rapidly changing the business environment and redefining supply chain risks and opportunities, with companies exploring reshoring strategies as well. Boards can oversee how management is balancing supply chain risk and redundancy in an increasingly fragmented world.
5. Energy transition
The impact of energy supply and energy security concerns due to the war in Ukraine, along with other climate impacts, is disrupting economic activity in real time and bringing a sense of urgency to the energy transition. While inflationary pressures might delay some plans, boards can work with management to consider whether this is an opportunity to accelerate the transition.
Boards have a critical remit to provide guidance to management across these tenets by pressure-testing plans and assessing multiple options for achieving strategic goals under volatile and uncertain micro- and macroeconomic circumstances.
Directors are well positioned to ask about what scenarios have been considered (even highly unlikely ones) and the potential impacts to financial performance, growth and strategy. Regardless of what scenario plays out, management needs an appropriate strategy — and balance sheet — for any economic conditions that lie ahead, and boards can help them plan for that uncertainty.