As of the fourth quarter of 2022, it appears that the U.S. economy is likely headed for a recession at some point in 2023. Since gross domestic product contracted in the first and second quarters of 2022, many economists argue that we have already had a brief recession and that 2023 will bring the dreaded “double dip” recession. It is estimated that GDP will grow just 0.2% in 2022 and will somewhat recover to a meager 1.2% in 2023.

An increasing number of public company CEOs are warning of the looming economic slowdown. In an interview with CNBC, David Solomon, the CEO of Goldman Sachs, said, “In the distribution of outcomes, there’s a good chance of a recession.” Jeff Bezos, Chairman of Amazon, recently tweeted, “Yep, the probabilities in this economy tell you to batten down the hatches.” The storm is coming and professional services firms need to prepare.

Professional services companies are highly-sensitive to macroeconomic sluggishness. There are a couple of reasons for this. First, clients tend to cut consulting roles before they cut employees. The cultural impact of eliminating consulting positions is negligible compared to that of employee layoffs. Second, as unemployment rises during a recession, it is easier for companies to find and hire employees with skills that were previously difficult to find or too costly. Thus, the need for consulting services tends to wane during a recession.

So, what does this mean for professional services companies? How should firm leaders be preparing for a pending recession in 2023? We’ll cover some important recession-proofing tactics below.

Lock in Long-Term Contracts

One of the best ways to weather the storm is to have long-term agreements with clients. When examining the 11 recessions since 1950, the average timeframe of a recession in the U.S. has been roughly 10 months. It can often take a year or two longer before consulting firms return to normalized growth. So, firms should expect no less than 12-24 months of challenging times once a recession hits.

Consulting firms that sign annual or multiyear agreements are best positioned to prosper – or at least hold steady – during a recession. When clients look to cut costs, they are more likely to terminate month-to-month consulting agreements than annual agreements. By the time an annual contract comes up for renewal, the client may already be experiencing a rebound and the contract could renew.

The time to negotiate a long-term contract is before a recession hits. Trying to get a long-term deal in place after a recession begins is nearly impossible. In order to entice a client to commit to a long-term relationship, there must be incentives for the client. The most common incentive is some reduction in fees in return for the longer commitment. While no firm likes to reduce its bill rates and gross margin, you will wish you had done so if the entire monthly revenue stream evaporates in six months.

Another incentive that can encourage a client to sign a long-term deal is offering to “lock in” specific project team members for the year. If the client commits to a year, they get your “A” players. Also, you can potentially offer some form of Service Level Agreement as a part of the long-term arrangement.

Focus on Non-Discretionary Service Lines

The best consulting services to sell during a downturn are those that the client can’t easily do without. Clients can delay discretionary projects without meaningfully impacting the business. If the new website doesn’t get built for a year or two, almost nobody will notice. But, non-discretionary spending is much harder to eliminate.

Good examples of non-discretionary service areas include:

• Regulatory – Professional services that are associated with a regulatory requirement generally hold up well during a recession. Companies usually can’t delay or cut spending that is associated with government regulation.
• Revenue Drivers – In the early stages of a recession, companies typically spend more on sales and marketing in order to counteract the trend of diminishing revenue. Professional services firms that focus on increasing sales for their clients often survive a recession with minimal damage.
• Cost Savers – Once a recession starts, companies will look to cut costs in any way possible. If a firm’s service offering allows customers to reduce their overall expenses, the firm will have an advantage. For example, if the client can leverage your managed service instead of having a team of fulltime employees, you could actually increase your revenue during a recession.

Forecast Religiously

In large part, managing a professional services company is about accurately predicting the future. A firm that can reliably predict its billable utilization for the forward six months will perform better than a similar firm that can only see two months into the future. All high-quality professional services firms are disciplined about forecasting hours, utilization, and revenue.

Many firms generate monthly forecasts during “normal” times, but the cadence should switch to weekly when there is economic uncertainty. When the economy starts to sputter, deals that were 90% probable yesterday might be dead today. Similarly, sold projects that are underway can get delayed or outright cancelled by clients. There is often little contractual recourse when such events occur.

Since the demand on the firm’s resources tends to be chaotic during a recession, it is important to regularly update the various forecasts. These forecasts will inform the recruiting and hiring motions of the firm. The last thing a professional services company wants to do is make a slew of hires in the face of weakening demand. That almost always results in layoffs a few months later.

Limit Hiring

When a recession appears imminent, question every single hiring decision. If employees normally carry an 80% billable utilization target, ask them to run at 85-90% for a few months. You are far better off pushing the team a little harder for a period of time than you are hiring when the pipeline is shaky.

With proper resource allocation and forecasting, you may find that while one practice in the firm needs to hire, another practice has too much bench time. Practice leaders should be in close coordination during these times and should swap resources whenever possible. Practice leaders need to be focused on the overall firm’s utilization forecast and not just on the forecast for their specific team.

Also, if the firm isn’t going to be hiring, it doesn’t need an army of internal recruiters. If the recruiters can be re-tasked on high-value initiatives, they should be. If they can’t, then unfortunately they likely need to be cut unless the firm has ample cash and is willing to absorb the impact to profitability.

Cut the Underperformers Now

Once any company reaches a certain scale (ie - a few dozen employees), there inevitably are employees that aren’t meeting the minimum performance bar for their given role. This is unfortunate, but almost always true. Cutting those underperforming people now will have minimal negative impact to the company culture. Arguably, it will improve the culture because high-performers don’t like to be slowed down by low-performers. But, waiting until a recession hits to cut those underperformers via a layoff will bring negative downstream consequences.

When companies cut headcount during a downturn, it dramatically increases the odds that high-impact employees will leave once the economy stabilizes. Any layoff tends to cause a spike in voluntary attrition down the road. You are better off cutting underperformers now to reduce the odds of needing to do layoffs later.

Eliminate Unnecessary Spending

When a recession is on the horizon, it is a good exercise to identify expenses that can be reduced or eliminated. The sooner you cut them, the better. Imagine that the firm’s revenue took a 20% hit tomorrow and it didn’t recover for the next 12 months. What could you cut?

All companies come up with ways to spend money during the boom times. The marketing team adds a couple of conferences to attend and also increases the pay-per-click budget. The engineering team subscribes to the gold plan of a toolset when the silver plan satisfied 90% of the needs. The sales executives fly all over the country and take client sponsors to steak dinners and professional sporting events. Most of that is excessive and can be cut.

Build Cash Reserves

Professional services firms generally do not enjoy high gross margins. This is due to the fact that the labor costs of the consultants are included in the Cost of Services Sold. The industry average in professional services is approximately a 37% gross margin. The problem with a low gross margin figure is that it doesn’t provide the firm with much buffer or flexibility. Once the operating expenses are subtracted, the firm might a have single digit net profit margin. When a firm has such razor-thin margins, any economic disruption can turn the income statement upside down – and quickly.

It is not uncommon for professional services firms to incur operating losses during a downturn. If a firm is not quick to cut overhead, the losses will mount. It is important to fortify the balance sheet before the recession arrives. This can be done in several ways, including:

• Prioritize Collections – The accounting team should be calling and emailing the Accounts Payable department of clients immediately when an invoice becomes past due. Additionally, the senior delivery leader who is responsible for a delinquent client should get involved right away. This is not a time to be shy.
• Draw Down Credit Lines Fully – If the business has one or more lines of credit, you should draw down those lines before the economy slows. The covenants of credit lines generally allow the bank to adjust the borrowing limit at its sole discretion. Once the bank sees significant outflows of cash across its customer base, it will almost certainly slash credit lines. It is better to pay interest on that borrowed cash for a year or two than end up in a liquidity crisis. Get the cash while you still can.
• Adjust Payment Terms for New Clients – It is difficult to reset payment terms for existing clients but you usually can negotiate faster payment with new clients. Instead of offering Net-30 to Net-60 terms, default all contracts to either “On Receipt” or Net-15. Do not allow small clients to negotiate long payment terms as they represent a much higher credit risk to the firm.

Become a Lower-Cost and Higher-Value Alternative

As companies look to cut costs during a recession, it is not uncommon for them to look to replace expensive vendors with more cost-effective vendors. For example, the I.T. Outsourcing industry has had its largest market gains immediately following periods of recession. Companies replace the high-priced consultants with firms that offer hybrid models that include offshore personnel and a lower overall cost of engagement.

Are there components of your service offering that can be delivered via personnel at a lower labor cost (and thus a lower bill rate to clients)? If so, you could potentially increase gross margin and drive improved sales conversion. Establishing an offshore delivery center can be a logistical challenge but partnering with an offshore firm might be a good initial step.

In Summary

Clouds are forming on the horizon for companies around the world. Professional services firms are particularly sensitive to macroeconomic fluctuations and need to be preparing for the storm now. It's time to batten down the hatches.