The “Great Reset” or a corporate solvency crisis?
In 2020 the World Economic Forum coined the term “The Great Reset” to describe the initiative to improve the state of the world following the global pandemic.
The slowdown of economic activity caused by COVID-19 and related emergency measures implemented to tackle the pandemic and ongoing lockdowns have led to severe strains for companies to meet their financial obligations. Many of the fixed costs and interest payments on debt remain due while the cash flow intended to meet these obligations has evaporated.
A New Beginning or a New Crisis?
Whilst many are looking forward to putting 2020 behind them, the end of 2020 may also mark the reduction of the COVID-19 temporary liquidity support or lifeline measures by governments across the globe, and with that comes the potential for a sharp rise in insolvencies in 2021. The narrative for 2021 will likely be a shift between a liquidity crisis to a solvency one.
So we pose the question: Are we looking at a new beginning as part of a ‘Great Reset’ or are we on the cusp of a corporate solvency crisis? Well, let’s explore some facts: Businesses have spent much of the past 12 months scrambling to adapt to extraordinary circumstances.
The World Economic Forum conducted a study to explore the top risks as a consequence of COVID-19; a prolonged global recession tops the list of most feared risks, closely followed by bankruptcy, industry consolidation, failure of industries to recover, and a disruption of supply chains.
Research by trade-credit-insurance and risk-management company Atradius estimated that global corporate insolvencies would increase by a whopping 26% in 2020, with all major regions expected to be vulnerable. With the recent spike in coronavirus cases and the ongoing stricter lockdowns globally, we can expect things to get worse before they get better.
Another report by Euler Hermes predicts a global corporate insolvency increase of 35% to 2019 levels. Figure 1: Changes in insolvencies by 2021 (2021 level compared to 2019 level in %).
The rise in corporate insolvencies & bankruptcies has so far been surprisingly modest, thanks in part to the extraordinarily responses from governments and central banks. However, it is likely this is the calm before the storm.
In the US, more than 200 corporations have joined the list of ‘zombie firms’ since the onset of the pandemic, according to a Bloomberg analysis. In fact, zombies now account for nearly a quarter of those firms. Even starker, they’ve added almost $1 trillion of debt to their balance sheets in the span, bringing total obligations to $1.98 trillion of debt.
The Importance of Adaptability and Agility
The narrative for businesses in 2020 was about adaptability. Businesses around the globe have been making adjustments in the way they sell their products and collect payment for them to maintain volumes and customer relationships. Where businesses did offer trade credit, many decided to increase the duration of payment terms they offered in a bid to increase flexibility and competitiveness and support customer liquidity issues.
In the Atradius report, it was observed that payment terms lengthened by an average of 12 days. A key feature of a supplier that customers value highly during times of crisis is financial flexibility. Companies with a healthy financial buffer have taken advantage of this by providing better payment terms to their high-value customers and even temporarily cancel fees if needed.
Unfortunately, another key theme that was observed was that overdue invoices and write-offs increased intensely, by two-thirds on pre-pandemic figures. This is a warning flag for disrupted cash flow and liquidity issues. Corporations are having credit risk profiles adjusted and as a result, will have fewer options to plug cash flow issues.
2020 was the year for businesses to learn how to adapt and become agile under extraordinary circumstances. I propose the narrative in 2021 will be to continue to build upon that agility, particularly in the commercial organization in the face of a solvency crisis.
Four Key Takeaways for 2021
Now that we have explored some of the facts, let’s look at four takeaways relating to commercial excellence.Now that we have explored some of the facts, let’s look at four takeaways relating to commercial excellence.
- Disrupted supply chains: The effects of the pandemic on supply chains were clear; lockdowns lead to disruptions and workforce reduction strongly impacted production levels. However, we must look now at a longer-term supply chain impact due to suppliers potentially becoming insolvent or even bankrupt due to the prolonged financial stresses during the pandemic. How will this impact the product offering, mix, or positioning? Product alternatives (from alternate pre-qualified suppliers), cross-sell or upsell initiatives may be necessary based on availability due to supply-side constraints.
- Product offering: Based on potential supply-side impacts (due to insolvencies) or perhaps internal issues due to in-house financial stresses it may be necessary to restructure or consolidate the product mix. Changes to the product mix will inevitably lead to price adjustment, re-alignment, and repositioning within the market.
- Market dynamics: Rapid response to these new market conditions was required and product, as well as service companies, were forced to implement immediate measures. Apart from cutting non-essential costs, a strong emphasis is put on minimizing the impact on sales volumes. Pricing, like customer relationships, is a long game – know who your core customers are and defend them especially now is not the time to lose your loyal customers to price slashing competitors. There is a saying that Disruption creates space for innovation and opportunity. As reported by Mckinsey, in the USA in Q3 2020 alone there were 1.5 million new business applications in the US, double the figure for 2019. Combine this with the growth of zombie companies struggling to stay afloat with ever-increasing debt sets up the potential for an entirely new market dynamic.
- Commercial organization: We should ask ourselves how potential supply & demand disruptions (as a result of insolvencies) will impact the commercial organization and ongoing commercial contracts & price agreements. Now it is more important than ever to evaluate the most valuable customers, segments & channels and prioritize serving and maintaining them. With the increase in late invoices and write-offs due to customer liquidity constraints in addition to reduced customer credit profiles, commercial terms will need to be monitored closely to align new risk tolerances.
In conclusion, the narrative in 2021 will likely be to continue to build upon the commercial agility in light of a potential corporate solvency crisis.