Depending on which economist, commentator or news channel you follow, the U.S. economy is either facing a slowdown and headed into recession or is healthy and poised for continued growth. While experts point to data supporting both views, and sometimes flip their take on the issue, one thing is certain—today’s geopolitical, social and economic environment is creating volatility in global markets and a challenging landscape for investors.
As corporate America heads into the 2020 budgeting and planning season, the possibility of a recession is on the minds of many executives, making this a prudent time to discuss steps that can be taken to help businesses navigate the next downturn.
Here are five specific actions that Holley Performance Products, a leading designer, manufacturer and marketer of high-performance automotive parts, took to optimize its operations and increase its staying power in the event of a downturn. The private equity firm I work for, Lincolnshire Management, owned Holley for five years and in 2018 sold the company to Sentinel Capital Partners, generating a strong return for investors.
1. Eliminate discounting and promotions
Following our investment in Holley, we worked with management to eliminate discounting practices that had been used in the past as a tool for incentivizing B2B customers to make purchases. Recurring promotions and discounts to these resellers had effectively been pulling sales forward from future periods and creating abnormal peaks and troughs in order patterns. Over time, this practice can contribute to large levels of excess inventory in the channel, as resellers purchase products based on incentives received rather than underlying demand from end consumers. In the event of a downturn, these large inventory balances exacerbate the downward pressure on the company’s order volumes, as resellers are able to work through large inventory levels rather than repurchasing product from the company. Eliminating these discounting practices and implementing pricing discipline helps bring reseller order patterns back in line with underlying consumer demand, which contributes to higher quality and more predictable sales, and mitigates the impact of a pullback in consumer spending.
2. Diversify sales channels
At the time of our initial investment in Holley, the company sold its products almost exclusively through B2B channels and depended on large reseller customers for an outsized share of annual revenues. In order to augment this dynamic and broaden the company’s distribution model, Lincolnshire worked with management to implement a Minimum Advertised Pricing (“MAP”) policy, which supported two important initiatives. First, MAP helped to level the playing field for the company’s smaller reseller customers, enabling them to compete more effectively against the large, national resellers. This had the effect of spreading sales out across the company’s customer base, helping to mitigate any concentration issues. Second, with MAP pricing in place, Holley was able to establish a direct to consumer sales channel (B2C), selling products primarily through the company’s website and phone lines. Importantly, B2C sales are not subject to destocking effects discussed in #1 above, and they provide valuable visibility into end consumer demand that is difficult to attain when a company only sells B2B. As a result, B2C sales provide management teams with valuable insight into market conditions that can be used to inform the decision making process in the event of a downturn.
3. Diversify and segment product portfolio
Holley generated nearly 50% of its revenue from one product category when Lincolnshire invested in the business. Through significant investment in new product development and two strategic acquisitions, Lincolnshire and management were able to blend this product category down to less than 20% of sales. These initiatives effectively rebalanced the Company’s revenue streams, creating a product portfolio that generated large chunks of revenue from five complementary product categories. This breadth and diversification helped to mitigate the impact of category specific fluctuations in sales and increased the Company’s total addressable market and share of customer spend. Likewise, within the individual product categories, Lincolnshire worked with management to implement a “good, better, best” product segmentation strategy, enabling the company to target and appeal to a wide array of customers across the spectrum from price conscious to premium buyers. This type of product line segmentation can mitigate the impact of a downturn on a company’s sales, as the availability of products at different price points provides consumers with affordable alternatives in the event of a pullback in discretionary spending.
4. Augment cost structure to increase profitability and operational flexibility
During Lincolnshire’s ownership period, we worked closely with management to effect several changes to Holley’s cost structure as a means of driving efficiencies and introducing more flexibility into the company’s operating model. Specifically, we were able to reduce the number of facilities the company operated, improving visibility and control while eliminating duplicative fixed costs. Additionally, we worked with management to implement an Advanced Planning System (“APS”) that significantly enhanced the accuracy of inventory and supply chain management. In the event of a downturn, a lean and variable cost structure with enhanced operational and financial visibility provides management with more levers to pull in response to changing business conditions.
5. Invest in R&D and new product development to fill pipeline and drive demand
Holley had significantly underinvested in research and development in the period leading up to the last recession and did not have any meaningful new products in its pipeline. Many of the company’s existing products were late in their respective lifecycles and were experiencing stagnant or decreasing sales—trends that were further exacerbated by the pullback in consumer spending at the time. Shortly after acquiring the business, Lincolnshire invested heavily in research and development and worked closely with management to maintain an active new product release calendar in order to stay top of mind and keep pace with changing technology and consumer preference. Keeping the company’s product portfolio fresh and exciting is critical, particularly during a downturn, as new products provide consumers with enhanced features and benefits which drive purchasing decisions and catalyze spend.
While there is tremendous uncertainty about the current macroeconomic environment, an overarching lesson we have learned in operational improvement at Lincolnshire is that there is no time like the present to take a fresh look at your business and implement changes to better position your company for sustainable, long term growth.
Will Whetzel is a principal at Lincolnshire Management, a private equity firm focused on control investments in growing middle market companies.