Recession 2020 has arrived. What now?

The economic downturn caused by the Great Lockdown will lead to a global recession. While many businesses will not survive, what can we learn from businesses who survived past recessions?

According to famed sci-fi writer Arthur C. Clarke, 'Don’t Panic' from Douglas Adams’ Hitchhiker’s Guide to the Galaxy novel series, was perhaps the best advice that could be given to humanity. Recessions are inevitable. They come about roughly once every decade, often caused by financial collapses (2008), shifts in market expectations (2000) or economic events (1973 / 1979). This time it has been caused by government policy in response to a global pandemic. Regardless of its causes, recessions lead to business failures due to a lack of demand and, quite often, the market requires a good few years to recover.

A 2010 HBR study considered the business performance of 4 700 listed companies during recessions spanning from 1980 to 2002 and found that 17% did not survive the recession. Of the survivors, 80% took longer than three years to regain their pre-recession performance in terms of revenue growth and profitability. A more recent study by Bain & Company found similar results for the Great Recession of 2008. We are thus in for a rough ride.

Yet, these same studies found a relatively small group of companies (around 10%) that were not only resilient during recessions, but managed to thrive. Some key examples include the rise of Amazon after the tech bubble in 2000 and the significant strides made by Samsung to rival Apple post-2008. In South Africa, we can look to Naspers and its transformation from being a print company to a global internet giant since 2000. The key here is that companies should not sit idly by: They can and must respond to the recession to mitigate its impact and ensure survival.

Should we ‘pivot’?

The figure above anecdotally represents how business strategy is developed. The strategic intent of the business represents it vision, mission and values. It attempts to define what a business is, beyond merely what it does. The strategic intent informs the objectives that it aims to achieve at the corporate level (10 years), business level (2-5 years) and operational level (1 year). These objectives then inform the specific strategic initiatives undertaken across these three levels. It is thus crucial to note that the strategic initiatives ensure that objectives are met and these objectives allow the business to reach its strategic intent.

A lot has been written of the need for businesses to ‘pivot’ and re-imagine during this time. But it is unlikely that a shift in the strategic intent of a company is required. If a recession requires you to re-think your entire business and its purpose, then you were possibly already in trouble. Naturally, there are a few businesses that may have to fundamentally reconsider things, such as WeWork and the shared workspace industry, but it is more likely that the current recession will require new or adjusted objectives and strategic initiatives.

Taking the initiative(s)

There are perhaps two natural positions to take during a recession: The first is to become pathologically focused on cost cutting in order to avoid business failure. The second is to view the market as ‘ripe for the picking’ and go on an aggressive expansion drive. Both may be effective, as we will discuss, but empirical evidence has found that a careful balance between the two positions holds a greater probability for success.

How to find this balance will depend on your current competitive position (market share, customer loyalty, revenue growth, R&D pipeline, product portfolio) and financial position (revenue/ assets, profitability, operating leverage, financial leverage). The figure below presents these factors across two axes, and defines four strategic focus areas: Swing for the fences; Look to the bench; Attack, but defend your line; and Strong offense.

Swing for the fences

Perhaps the most natural reaction to a recession is to cut costs. After all, the most important business prerogative is to not run out of funds, something which becomes increasingly likely during an economic downturn. This is usually done to allow for profits (cash) and to improve the financial position of levered companies.

From the figure, it is seen that if a company holds a weak financial position (low profits and high debt levels, as an example) it has little choice but to focus on reducing its expenses and lowering its exposure to debt. If a company also does not hold a strong competitive position its only focus will be on cost cutting. These companies are referred to as being ‘prevention-focused’ by the HBR study, as they attempt to prevent the downside of decisions.

Some examples would be to cut operating costs (including staff), eliminate discretionary expenses, rationalise product lines and divest assets to free up funds and reduce debt. Companies would also focus on working capital management to free up cash from operations. A focus on reduced costs will also mean that funds for marketing, R&D and strategic investments (capex) will be limited.

Strong offense

A recession invariably also means that investors can take advantage of the bear market as asset prices plummet. Companies thus have the opportunity to acquire competitors, customers, products or services, strategic assets and employees (all at a discount).

From the figure, it is seen that if a company holds a strong competitive and financial position (high market share and stable cash flows with little debt, as an example) it has the ability to use excess funds to make strategic investments. Cost cutting may also be implemented, and the excess funds can be used to make investments. These companies are referred to as being ‘promotion-focused’ by the HBR study, as they attempt to capitalise on the upside of decisions and invest for the future benefit of the organisation.

The risk of becoming pathological

The points raised above do not discount the value of either cost cutting or making strategic investments. However, an exclusive focus on either measure could hold unintended and unforeseen consequences for a business. This is supported by reports from HBR, McKinsey and Bain, that found a careful balance between these two positions holds a greater probability for success during and after a recession.

• Cutting costs

A pure focus on cost cutting means that short-term payoffs are considered over long-term impact, which could mean that the business will fail after the recession or take longer to recover. For example, there is no long-term benefit to cutting costs that will be re-instated after the recession as this will simply mean that the company will be at risk when the next downturn arrives. Viewing investment opportunities in terms of cost also means that value-adding activities may be foregone. And, finally, cutting jobs and closing divisions may lower staff morale.

• Investing for growth

On the other hand, a too-optimistic approach may create a culture of ignoring the present, which may be risky. Thus, future business performance is considered over the current reality of cash shortages, supplier payment periods, customer profitability, etc. The idea is that as long as more funds are channelled to marketing, R&D and investments made to grow revenue, profits will follow once the market turns. Naturally, business fundamentals are still required and closer scrutiny should be applied to these decisions; not only in terms of when the market will recover, but also if all of the current investments will indeed be of value after the recession. A common repercussion of this approach is a bloated expense budget that requires drastic intervention once this is identified.

Finding a balance

What is required is moderation: A focus on cost cutting to survive the recession and to out-compete the competitors as well as a focus on investment for growth.

• Cutting costs

The key during cost cutting is to first determine the core business of the company and the key activities that are required to be effective. All other costs then become ‘secondary’ and can form part of the initial aggressive cost-cutting initiative. It is best to not start with staff costs, but rather conduct a full supply chain analysis to define areas for optimisation and efficiencies. The focus here should be first on lower-level operations and processes and the reduction of duplication and complexity.

It is important to always keep the recovery in mind during this process. There is, for example, no use in cutting a retail location during the recession if it will be required to re-open it after the recession. The same applies to employees, assets, business units and products. Do not prioritise short-term over long-term.

Digital adoption can assist here to reduce costs. For example, the automation of certain processes can reduce costs and lead to long-term efficiencies.

• Strengthen the balance sheet

The key here is to ensure that the balance sheet of the business has the required flexibility to move beyond the recession and cope with the next one. This requires liquidity and solvency that is perhaps more conservative than what was used before. A good way would be to divest in non-core assets to reduce debt levels. Restructuring debt to take advantage of the current low interest rates will also reduce non-operating expenses and free up cash.

For capital-intensive industries, looking at collaboration opportunities (such as JVs) may hold benefit over conventional ownership structures.

A major focus would also be to ensure that working capital is used optimally. The key here is to do a supplier and customer analysis to determine further credit policies and ensure that you do not lose valuable customers and suppliers during the recession, only to have to try and win them back post-recession.

Digital adoption can assist here with real-time visibility of financials and accounts. This will assist in making better-informed decisions.

• Invest for growth

This will again require the company to define its core business (current and desired) and develop an appropriate investment strategy to reach its objectives. Here the key would be to develop a potential M&A pipeline (target identification) and to conduct adequate due diligence to ensure that investment value is unlocked once the recession is over.

It is important to not wait for a full market recovery before initiating these activities, as values will rebound and competitors may also make moves at acquisitions. There will thus have to be a focus on developing expanded footprints (and rationalising old), new products (and rationalising old) and a continued investment in marketing and R&D.

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