Recession Planning

The degree to which a downturn will affect your business depends on how well you prepare and how fast and effectively you react to changing conditions.

Recession is a macroeconomic term often used to describe times of sales decreases over a broad range of industries accompanied by rising unemployment. At the time of this writing, it is unclear to what degree the U.S. economy is headed with respect to a recession. It is, however, undeniable that our industry experienced pandemic-fueled growth following the 2020 shutdown. Since the spring of 2022, most home furnishings retailers have experienced erratic retail traffic and sales, which could just be due to consumers shifting purchases from goods to services, such as travel.

These are all macro or large-scale effects on our industry that do not necessarily apply to individual retailers.

Prepare, React, Change

It’s important to keep in mind that should we experience a more substantial macroeconomic downturn it will not necessarily negatively impact every individual retailer.
The degree to which a downturn will affect your business depends on how you prepare and how fast and effectively you react to changing conditions. Here are eight useful strategies to consider that can help your business to weather a storm and possibly come out of it ahead of your competition.

“Watch the three most important contributors and detractors to cash: profitability (net income), inventory and customer deposits.”

1. Make sure to analyze your cash flow change.

   Review your cash flow at least monthly, from the beginning of each month to the end. Many retailers are seeing merchandise shipments arriving much faster than anticipated, resulting in increased inventory levels and decreased cash. At the same time, some report written sales declines. Delivered business for most remains strong. Depending on your customer deposit policy, deposits collected may decrease or increase your cash position. Watch deposit changes as closely as inventory changes.

   The formula you can use to analyze cash is:

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   Cash at start of period +/- net income - increases (+ decreases) in non-cash assets; + increases (- decreases) in liabilities; - shareholder draws (+ shareholder contributions) = ending cash

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   A goal should be to minimize cash swings caused by assets and liabilities. In a perfect world, profitability would be the ultimate contributor to wealth. However, in an imperfect world, watch the three most important contributors and detractors to cash: profitability (net income), inventory and customer deposits.

2. Watch trends in digital and in-store traffic.
   

   A business should not attempt to cut its way to profitably, especially if it results in not having enough good people to handle customers. Follow your digital traffic trends to get an idea of the volume of prospective customers who are searching for information about home furnishings products in your area. Track in-store traffic to provide a measure of the average number of people considering buying from you right now. Make sure that you have enough effective salespeople to handle your in-person traffic. For retailers that are not design-focused, that number ranges between 110-140 guests per month per sales associate. In most operations, the average sales associate sells $700,000+/year. So, if you are short two good people, for example, your business will sacrifice $1.5 million dollars in top-end volume and take a huge net income hit. If that is your situation, expense cutting may not be the right move. Increasing selling resources will be a better strategy.

“If you have seen three periods of sales, profitability and cash flow declines and have the right sales staffing in place, it may be time to take corrective expense actions.”

3. Continually examine expenses and the return those expenses produce.

   One way to do this is to separate expenses into three categories. Below are examples designated as expense categories A, B and C. Remember that there are no hard and fast rules regarding the items you place in each category. You must define how important each expense item is to you.

   Expense Category A: Necessary for continued operations. Examples:

   • Fair market rate rent
   • Utilities
   • Minimum number of operations people for delivered sales
   • Minimum number of salespeople for written sales
   • Software to process business – ERP / POS systems
   • Software to communicate with customers and prospects – CRM systems
   • Website
   • Non-excessive owner’s salary and benefits
   • Marketing with verified return on investment Expense Category B: Growth-minded investments. Examples:

   Expense Category B: Growth-minded investments. Examples:

   • Advertising with unclear return
   • Training, educational events, trade shows and associations
   • Business improvement software and services
   • Technology and processes to help people become more productive with their time
   • Employees and project managers above minimum levels to assist in growth projects

   Expense Category C: Discretionary, non-critical expenses. Examples:

   • Expenses purchased solely to reduce taxes with no value-added to the business
   • Excessive owner benefits
   • Non-productive employees in any department
   • Meals and Entertainment
   • Non-distribution vehicle expenses
   • Unnecessary travel expenses
   • Rents over current market rate
   • Overuse of utilities
   • Inventory carrying costs

“Stick to your minimum desired profitability targets —52% realized gross margin, 42% of sales in total operating expenses, and 10% net income minimum.”

4. Seek out and reduce waste in your organization.

   There are lots of moving parts in selling, ordering, receiving and delivering furniture. If you critically examine any one area, you will likely find ways to make your process better and reduce expenses. To help with this, use the acronym “TIMWOOD.” This model says that the primary causes of waste (unnecessary expense) to reduce are: T = Time, I = Inventory, M = Motion, W = Waiting, O = Overproduction, O = Overprocessing and D = Defects.

5. Stick to your minimum desired profitability targets.

   I call this the 52/42/10 model, which means that minimum targets are 52% realized gross margin, 42% of sales in total operating expenses, and 10% net income minimum. The best operations I consult with work to take emotion out of the equation and commit to minimum percentage of sales benchmarks.

6. Maximize margins, especially if sales are trending down.

   To some, this might be counterintuitive. They may think that sales are trending down, so reduced prices will reverse the trend, right? I have never seen this happen in the furniture business. Special events do increase traffic and sales, but the best events preserve your margin standards over the long run. Cutting prices too deep lowers break-even sales, so you’ll need to sell more despite lower traffic. Instead, make it easier for your business to achieve profit in slow periods.

   Maximize these five areas:

   • Best seller margin: Price at least five percentage points over desired financial margin level.
   • Special order margin: Pad in extra for custom orders due to the additional time and effort.
   • Protection margin: Ensure your ranges are such that they get you over 10% of the sale price. Some operations are 15% plus.
   • Delivery margin: Price to cover all related furniture and mattress delivery costs including wages, vehicle expenses, maintenance.
   • Service margin: Track and improve vendor chargeback (VCB) income, credits, service charges, less service costs.
   • Freight: Routinely review the cost of freight for all vendors. These are often hidden costs, so they need to be routinely audited.

7. What do you do if declines persist?

   If you have seen three periods of sales, profitability and cash flow declines and have the right sales staffing in place, it may be time to take corrective expense actions. This can also be thought of as “right-sizing” your business to a new volume level. Here are some ways to cut:

   • Cost of goods sold: This is the biggest cost on the P&L so make sure you are getting the best margins possible.

   • Category C Expenses (discretionary, non-critical): Review and cut unnecessary costs in this category. People who are not needed for continued operations or are not contributing to the future value of your organization should be released. Let go of salespeople who have the lowest revenue per guest and are taking traffic from high producers. However, do not stop interviewing and hiring sales employees. Good candidates may become great salespeople who can produce more volume with fewer customers. Cut unneeded expenses that are not growth-minded.

   • Category B Expenses (growth-minded): Do not completely cut. Consider trimming expenses to a lower service level and cost. Continually review these growth-minded expenses to improve ROI.

   • Category A Expenses (necessary for continued operations): Although these expenses are largely fixed, it is possible to right-size them. Rent, for example, can, on occasion, be re-negotiated or temporarily modified based on new market conditions if the landlord is willing to partner with your operation for the long term.

“Let go of salespeople who have the lowest revenue per guest and are taking traffic from high producers. However, do not stop interviewing and hiring sales employees.”

8. Do not overreact to daily events.

   Occasionally retailers make decisions that affect long-term growth based on a short-term occurrence. For example, deciding to cut out training or a growth initiative based on one weekend’s poor holiday sales. This might seem like a good way to preserve cash and increase profit immediately. But long-term, it might have negative consequences. It is important that when making cuts to preserve profits, do it with a scalpel rather than a machete. Act. Do not overreact.

Conclusion:

One wise retailer who participated in one of my performance groups was asked the following question at the height of the post-pandemic furniture boom: “Do you think consumers will stop buying because they came into the market sooner due to a focus on their homes?”

The answer was: “I have been in this business all my life, and I have never seen people stop buying furniture. Hold steady. There will be ups and downs, but it is our job to sell as much as we can in any period. Play the game!”