Mastering the next economic downturn

Economic downturns are cumbersome & almost impossible to predict. In fact, the running joke is that "experts" correctly anticipated seven of the last three macroeconomic events.

Geopolitics, economic cycles, and many other forces that can have substantial effects on the fortunes of your business are & will inherently remain uncertain. Higher volatility in our business environment has become the “new normal” for many. And while scenario analysis is a worthwhile exercise to rationally assess some of the uncertainties you are facing, there is no guarantee for getting it right.

So the question facing many business leaders about the resilience of their business performance given bleak economic outlooks shall be a very challenging one indeed. How best can we respond?

It turns out that in times of crisis and in times of economic slowdown, not everybody fares the same. Research into the performance of ~1000 publicly traded companies during the last major economic downturn shows that about 10 percent of those companies fared materially better than the rest. Those companies, here within referred to as “Resilients” showcased some noteworthy characteristics in how they weathered the storms: how they prepared for them, how they acted during tougher periods, and how they came out of them.

While I will share some more specific findings later on during the course of this article, I'll start with the core insight right here i.e, Resilients moved early, ahead of the downturn. They entered ahead, they dipped less, and they came out of it with guns blazing.

In short, your business context is and will remain always uncertain. However, if you get moving now, you can ride the waves of uncertainty instead of being overpowered by them.

Resilients did three things to create advantage over their rivals in performance:

1. Resilients created flexibility—a safety buffer. They did this by cleaning up their balance sheets before the trough, which helped them be more acquisitive afterward. In particular, resilients were deleveraging during 2007: they reduced their debt by more than $1 for every dollar of total capital on their balance sheet, while peers added more than $3 of debt. They accomplished this partly by divesting underperforming businesses 10 percent faster than their peers. The upshot was that resilients entered the trough with more financial flexibility. At the first sign of economic recovery, the resilients shifted to M&A, using their superior cash levels to acquire assets that their peers were dumping in order to survive. Overall, the resilients were about 10 percent more acquisitive early in the recovery. They accelerated when the economy was stuck in low gear.
2. Resilients cut costs ahead of the curve. There is little evidence to suggest that the resilients were better at timing the market. However, it is quite clear that they prepared earlier, moved faster, and cut deeper when recessionary signs were emerging. One such warning came in the summer of 2007, when the global financial markets briefly seized up before settling back down. By the first quarter of 2008, the resilients already had cut operating costs by 1 percent compared with the year before, even as their peers’ year-on-year costs were growing by a similar amount. The resilients maintained and expanded their cost lead as the recession moved toward its trough, improving their operating edge in seven out of the eight quarters during 2008 and 2009. In doing so, the resilients appear to have focused primarily on operational effectiveness, reducing their cost of goods sold, while maintaining selling, general, and administrative costs roughly in line with sales.
3. Resilients played offense by reinvesting selectively for commercial growth. Coming out of the last recession, Resilients went on offense early, while many of their peers focused on survival and waited for the cycle to clear. In general, Resilients used a few common tactics to boost commercial growth.

They invested substantially in R&D instead of dialing back. They pointed sales teams to top priorities among accounts and prospects, as determined by the account’s all-in profitability and potential lifetime value. They realigned distribution by rebalancing the mix of current and new locations, or next-generation formats. They also maintained marketing while competitors cut back. And they focused on improving the customer experience, making it more simple and personalized through investments in digital capabilities.

Practical steps to take now

Every company enters a recession from a different starting point, so the right plan hinges first on knowing where the company stands in both its strategic and financial positions. Although specific actions will vary by industry, all companies sort into one of four basic positions that will determine the shape of the cost program and additional strategies to pursue. These range from investing for leadership based on a superior strategic and financial position, to readying a weak business unit for sale.

To raise the odds of success, management teams can map out a series of offensive moves that aim to create a stronger business through the downturn and beyond:

1. Start with the end in mind. What do you want the company to look like at the end of the downturn and three years after? A future-back approach that defines the desired end state helps you know exactly where to invest—the customer segments to target, the value proposition and the digital technologies supporting the business. A clear plan lays out specifically how the business will outperform competitors through and beyond the downturn.
2. Stress test the P&L and balance sheet. Model the 2019–2022 P&L, cash flow and balance sheet through turbulent scenarios, including negative market growth, lower prices and higher unit economics, for your company and against your competitors.
3. Identify M&A targets early. Map out a proactive M&A plan that includes add-on acquisitions, divesting noncore assets, and potentially big moves with large-scale peers. That way, you can pull the trigger when the time is right, as opposed to reacting—and missing the opportunity.
4. Manage costs, now. A smart cost program starts early and focuses on sustained changes, instead of cutting muscle or trimming across the board. 

All this will require a leadership team that is itself agile and resilient, able to make effective decisions quickly in an atmosphere of uncertainty and stress. Many superstars imploded under pressure during the last recession, and most of their equivalents today have not been tested in the cauldron of a serious downturn. Resilient executives will likely display a more comfortable relationship with uncertainty that allows them to spot opportunities and threats and rise to the occasion with equanimity. Now is also the time to develop a plan spelling out who will be involved, and how often, in making and communicating key decisions, ideally empowering those employees closest to the work. Particular attention should be focused on a process to ensure that "big bet" strategic decisions—those like divestments and acquisitions—are the outcome of a healthy and well-informed debate rather than made on the fly.

Underlying the priorities we’ve been describing is a bias toward action—an urgency that reminds us of an old adage: “Every morning in Africa, a gazelle wakes up. It knows it must run faster than the fastest lion or it will be killed. Every morning a lion wakes up. It knows it must outrun the slowest gazelle or it will starve to death. It doesn’t matter whether you are a lion or a gazelle: when the sun comes up, you’d better be running.”

If we really are concerned about the resilience of our business, we better start moving before the sun comes out.