Profit Reduction and Commercial War

Within a few months, many companies, of different sizes and dedicated to various activities, will face a completely new situation in which the dangers will abound and opportunities will be scarce and where the search for profits, as the fundamental objective of any business could yield Your position in search of survival.

Indeed, at some point in the years 2020 or 2021, China must formally declare that its economy is entering a cycle of successive contractions of its domestic product. This cycle can be brief and violent, like a shock, or it can be long and smooth; it all depends on the actions carried out by the Asian government authorities; and also, it will leave the Chinese economy in a period of stagnation that should last at least a decade. On the other hand, the rest of the economies of the planet will go into recession one after one after the collapse of the Asian giant and then, in the same way, culminate in a long period of stagnation. Finally, a small group of countries would not be entering the global contractive wave but would fall at once in the period of stagnation.

The exception to the rule will be given by the United States, a nation that will not suffer, immediately, the effects of the Chinese collapse, but which, during the years 2022 or 2023, will begin to feel the consequences of the world recession and will notice the emergence of economic phenomena not seen before related to the pricing of products that will generate much discontent in the American population.

¿ How companies react to this global recession? How businesses have reacted in the past to the contractionary cycles ?. Before 1945, businessmen did not face recessions but simply, if the owners of the companies felt that the losses were projected over a very long period of time, then they decided to liquidate the business. After 1945, the typical strategy of the business sector to face recessions was to support the losses suffered during some quarters while government authorities are busy reactivating the economy.

The novelty present in the global recession that is approaching is that now the government authorities do not have effective economic policy instruments to combat the commercial war, on the other hand, today, to carry out the liquidation of a company can demand a significant amount of legal order requirements that makes this option an expensive alternative.

Within this sea of ​​uncertainty, each company should draw up an action plan designed "to suit", based on the following actions:

• determine if the company is able to withstand the consequences of the commercial war
• determine if the company has instruments to face the consequences of the commercial war.

These action plans should be based on absolutely objective arguments since the uncertainty situation favors confusion and misinformation. Indeed, it is expected that many media outlets dismiss the consequences of the commercial war, while the promoters of the US protectionist current are likely to sponsor the exacerbation of specific social movements, such as feminism, environmentalism or xenophobia; To distract public attention from the consequences of the commercial war, we can also anticipate that the government authorities of many nations will be very busy spreading calls for calm and proclaiming that they will protect their country's businesses from the effects of trade war when, in reality, this is impossible. If any company wishes to protect itself from the commercial war, it must base its actions based on objectivity and not on misinformation.

In the first place, entrepreneurs have to interpret the commercial war as a reduction in sales, reduction in production volumes, increases in unit costs and, therefore, reduction in profits, or, entry into the field of losses in The financial year. In the same way, it is important that they estimate with some degree of precision the moment in which the reduction in sales should begin to get to know the time available to design and execute a successful action plan. Finally, business managers should note that the expected reduction in sales will not occur in a single period, such as when a company faces an occasional shock, therefore, it is vital to determine the amount of periods with a level of success in which the company will see its sales decrease.
Go to: A Chinese recession is inevitable - don't think it won't affect you - Kenneth Rogoff - The Guardian
The instinctive reaction of the human being to a tragic situation is the denial of it. The negacionismo can take over a company, take it to the paralysis and demise. It is necessary that those who make the decisions in the company have all the information elements to conclude that the global recession is inevitable. Even in the case of a China-United States agreement there will be a global recession. The American protectionist discourse suggests that there is a commitment by the Trump Administration to reduce imports in a margin that would be between 30% and 50% at the end of the term.

This is how, before the imminent arrival of the effects that the commercial war will produce, each company must carry out the corresponding corporate planning and financial planning exercises that are necessary to build the plans that will allow it to face said eventuality.

The relevant parameters or milestones that provide the appropriate context for these planning exercises cannot reach identical values ​​for all companies. Obviously, there are elements and conditions that will give each company a greater or lesser degree of exposure or vulnerability to the effects that will be caused by the commercial war. However, we believe that it is necessary to establish a benchmark that allows us, indirectly, to quantify the level of risk that the company's operations have acquired.

We believe that the fundamental parameters that quantify, evenly, the impact of the commercial war on the daily operations of the company will be:

• percentage of reduction in net sales for a given period of time
• number of time periods in which the reduction in net sales occurs.

Of course, each company will have its own values ​​in the aforementioned fundamental parameters and, from them, you should obtain figures that will allow you to make sound decisions, as well as design and implement the corresponding action plans. However, there must be a reference point from which each company, in its planning exercise, introduces those elements that personalize it, reflecting its particular condition.

We believe that this benchmark or starting point should be the "worst case scenario" of expected behavior of net sales. This scenario should be considered valid and applicable to all companies that could be affected by the commercial war. So, we think that the "worst possible scenario" for a company is the successive contraction of sales for five years in the following sequence: 10%, 10%, 10%, 5% and 5%. Then, from this starting point, each company will introduce the corresponding adjustments, dictated by common sense, until reaching the "specific scenario" that corresponds to the company. These adjustments will aim to reduce or maintain the number of periods of contraction of net sales and reduce the percentage values ​​corresponding to each contract period.

So, it is the differentiation factors that allow the company to distance itself more and more from a planning scenario similar to the benchmark, that is, the "worst possible scenario." Some of these differentiation factors are:

• productive sector where the company is located: manufacturing, services, mining, etc.
• percentage of external sales with respect to total sales
• composition of the client portfolio
• composition of the group of suppliers, etc.

It lowered which premises we managed to build the "worst possible scenario" ?

• the Chinese recession will be the trigger for the next global recession
• the Chinese recession is inevitable
• the Trump Administration has the inescapable commitment to the US protectionist current to reduce imports in a range that ranges from 30% to 50%
• the Chinese government will make all the efforts that are required so that the contractive rate never exceeds 5% per year

In this way, we can assume that the Chinese economy will contract for three consecutive years at rates of 1%, 3% and 5% and then enter a period where growth rates will never exceed 0.5%.

However, the entrepreneur, when carrying out his planning exercise, cannot consider that his sales will contract in a measure proportional to the contraction of the Chinese economy; nor can it be assumed that the company will go through the same amount of contraction periods as the Chinese economy should show. The entrepreneur must start his analysis from the "worst possible scenario", which should consider that the global economy now has abundant collateral factors that will increase the damage caused by the Chinese economic contraction to the global economy.

Obviously, the planning exercise carried out by the entrepreneur must quantify the sensitivity of his clients to the commercial war at the time of carrying out the projection of the magnitude of future sales, as well as measure the impact that the commercial war could cause on its suppliers in order to rule out possible threats to the supply chain that could jeopardize the company's operations.

Global supply chain risk grows

There may be cases in which it is absolutely impossible to make an adequate projection in sales because the company is located within a productive sector where they are extremely volatile or is located in countries where there are superior contracting forces, including the commercial war. ; as is the case of companies located in Argentina or Great Britain. In this situation it is advisable to directly assume the "worst possible scenario" as the projected sales to be considered.

Return on Asset and on Sales Volatility, that we measured with the standard deviation of the percentage change in operating income, after the peak reached in 2014, has settled on more moderate values in the last two years and close to those recorded in 2012 and 2013

After having considerably realistic figures about the projected sales of the company, it is possible to determine how much annual production will be reduced and to what extent the average unit costs will increase, and then know the magnitude of the gains or losses that the company as a result of the commercial war.

Projected sales must include all discounts, price reductions, promotions and commercial strategy that the company deems to be carried out within the periods to be considered. On the other hand, the magnitude of the increase in average unit costs cannot be underestimated because it is an essential fact to reach the expected profit or loss. This information will be the fundamental input to design the corresponding plans and make the decisions that allow the company to survive the commercial war, hence the relevance in terms of data quality.

Indeed, the reduction in production will increase average unit costs by way of higher average unit fixed costs. Exporting companies usually have a considerable physical plant because export is a phenomenon that is more frequent in large companies; hence, we can determine that employers notice substantial increases in their average unit costs.

Non-North American exporting companies from all over the world will be affected, in one way or another, by the commercial war: reduction in profits or entry into the land of losses will be a constant within this group of companies. However, the corresponding government authorities of the countries where they come from should be implementing aid and incentives to them so that they do not close.

Can a company continue to operate normally after having suffered five consecutive years of losses ? Is the expectation formed in the directors of these companies about the possible transformation of many international markets from the competition format to the monopoly or oligopoly format ? How many managers will decide to close the company they represent when determining that the next few years can only achieve losses?