There is no doubt – for most of us the outbreak of the Corona Virus is more of a financial crisis than a health crisis. We all have the utmost respect for how our government is dealing with the situation and agree with the prioritization of lives over livelihoods. The problem for business owners are that we have to deal with the reality of the financial impact of the crisis for long after the pandemic has been controlled. A global crisis like the Corona Virus outbreak is a high-pressure exercise in change management. We fortunately have the opportunity to look at past financial crisis situations in order to learn the best way to respond to the current one.
It is very understandable to be concerned for the survival of your business and to take drastic action to protect it, but just reflect for a moment on the following statistic during the last financial crisis:
According to a Harvard Business Review study, firms that cut costs faster and deeper than rivals did not necessarily flourish. These firms have the lowest probability—21%—of pulling ahead of the competition when times get better after a crisis. Businesses that boldly invest more than their rivals during a recession don’t always fare well either. They enjoy only a 26% chance of becoming leaders after a downturn. And companies that were growth leaders coming into a recession often can’t retain their momentum; about 85% are toppled during bad times.
Another crucial statistic is that 2 out of 5 companies that experience a crisis like this will fail within 5 years after the event without a continuity plan.
In their 2010 HBR article “Roaring Out of Recession,” Ranjay Gulati, Nitin Nohria, and Franz Wohlgezogen found that during the recessions of 1980, 1990, and 2000, 17% of the 4,700 public companies they studied fared particularly badly: They went bankrupt, went private, or were acquired.
Among the companies that stagnated in the aftermath of the Great Recession, “few made contingency plans or thought through alternative scenarios,” according to the Bain report. Business continuity planning in a nutshell refers to the process of creating a prevention and recovery system for any potential threat to your business. The idea is to be able to respond quickly to any disaster so that your employees and assets are protected.
There are two major mistakes that companies make in times of crisis:
1. Being Too Defensive
Many company leaders default into crisis mode when a crisis hit and focus too heavily on just surviving the storm. Polices are immediately adapted to reduce costs, eliminate frills, stop all discretionary expenditure privileges and reduce staff numbers. These companies also immediately stop spending money to develop new business or buying value-generating assets.
This strategy resembles the approach Sony took during the 2000 downturn, when over a two-year period the Japanese giant cut its workforce by 11%, its R&D expenditures by 12%, and its capital expenditures by 23%. The cuts helped Sony increase its profit margin from 8% in 1999 to 12% in 2002, but growth in its sales tumbled from an average of 11% in the three years before the recession to 1% thereafter. In fact, Sony has struggled since then to regain momentum.
When companies start thinking like this it becomes a culture where everything is done to minimize loss, which stops innovation in its tracks. This cost cutting also does not always translate into improved efficiencies – they just try and do the same amount of work with fewer resources. The loss in morale and product quality is not worth the saving.
Defensive companies adopt two tactics – reduce the number of employees and improve operational efficiency.
2. Being too Aggressive
For some business leaders a crisis presents an opportunity to pursue opportunities aggressively while other competitors might be neglecting customers to deal with internal issues. They also invest in long-term projects and pursue the acquisition of people and assets. The idea is to gain a maximum benefit once the crisis blows over.
At the height of the 2000 recession, Hewlett-Packard drew up an ambitious change agenda even though sales and profits were falling. HP embarked on a massive restructuring program, made the largest acquisition in its history by buying Compaq for $25 billion, and increased R&D expenditures by 9%. It also spent $200 million on a corporate branding campaign and $1 billion on expanding the availability of information technology in developing countries. These initiatives strained the organization and spread top management’s attention too thin. When the recession ended, the company found it tough to match the profitability levels of IBM and Dell.
These companies struggle to grasp the severity of the crisis over time and ignore early warning signs. The end result is that these companies are blind-sided when the financial results continue to decline.
They also struggle to make the required cost cuts when the negative results persist and end doing too little too late.
Offensive companies adopt two tactics – develop new markets and invest in new assets.
In the Harvard study, only a small number of companies (about 9%) flourished after the crisis. These companies were able to perform better on key financial parameters and managed to outperform rivals in their industry by at least 10% in terms of sales and profits growth.
So what did the companies who thrived in the study do differently?
The Best of Both
The best you can do for your business during this time is to find a balance between the two extremes. Cost cutting is necessary to survive the crisis, but investment is equally essential to spur growth. The companies that performed the best after crisis situations universally applied the following tactics:
Improve operational efficiency with minimal changes in employees.
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Cut employees only if necessary and reduce the number of employees affected if it is unavoidable. Once employees understand that management is committed not to cut jobs, they become a big part of the solution to reduce costs in a creative way. The research is very clear on the increased productivity of staff who are not worrying about their job security. By also spending significantly more time examining their business model, these companies are able to reduce expenses in a manner that remain in effect after the crisis is over and thus make them more competitive. Look at alternative options, such as hour reductions, furloughs, and performance pay.
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After the stock market crash in 2000, Honeywell laid off nearly 20% of its workforce and then struggled to recover in the downturn that followed. So when the Great Recession hit, in 2008, the company took a different approach, as Sandra J. Sucher and Shalene Gupta describe in their 2018 HBR article, “Layoffs That Don’t Break Your Company.” “Honeywell furloughed employees for one to five weeks, providing unpaid or partially compensated leaves,” Sucher and Gupta wrote. That saved an estimated 20,000 jobs. Honeywell emerged from the Great Recession in better shape than it did the 2000 recession in terms of sales, net income, and cash flow, despite the fact that the 2008 downturn was much more severe.
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Rebecca Henderson (of Harvard Business School) likes to remind her students, “Rule one is: Don’t crash the company.” Do not run out of money. Drastically improving operational efficiency is the fastest way to reduce your burden on cashflow.
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During the 2000 recession, Staples closed down some underperforming facilities but increased its workforce by 10% during the recession, mainly to support the high-end product categories and services it introduced. At the same time, the company contained its operating costs and came out of the recession stronger, bigger, and more profitable than it had been in 1999. Its sales doubled, from $7.1 billion in 1997 to $14.6 billion in 2003. On average, Staples was about 30% more profitable than its top competitors in the three years after that recession.
Invest in both new markets and new assets.
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Crisis times present opportunities to buy property and equipment at lower prices. This makes it possible for them to scale more cheaply when post-crisis demand picks up. Investing in new markets is also very important as customer needs change dramatically during crisis times. Much of this investment can be funded by the savings provided by the operational efficiencies that have been created.
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Downturns encourage the adoption of new technologies – Technology can make your business more transparent, more flexible, and more efficient. According to Katy George, a senior partner at McKinsey, the first reason to prioritize digital transformation during a downturn is that improved analytics can help management better understand the business. Companies should prioritize “self-funding” transformation projects that pay off quickly, George says, such as automating tasks or adopting data-driven decision making. IT investments make companies more agile and therefore better able to handle the uncertainty and rapid change that come with a recession.
A great example of a company that nailed this balancing act is Target during the 2000 recession. The company drastically increased marketing and sales efforts as well as capital expenditure. They expanded their stores, expanded into new merchandise segments and significantly grew their online sales. At the same time they constantly endeavoured to reduce costs and improve efficiency. The results from implementing this strategy speaks for itself: Sales grew by 40% and profit by 50% over the course of the recession.
Structured for success
A company’s performance during and after a recession depends not just on the decisions it makes but also on who makes them. In a 2017 study, Raffaella Sadun (of Harvard Business School), Philippe Aghion (of Collège de France), Nicholas Bloom and Brian Lucking (of Stanford), and John Van Reenen (of MIT) examined how organizational structure affects a company’s ability to navigate downturns. They found that decentralized firms may be better positioned to weather big economic shocks. Because decentralized firms delegated decision making further down the hierarchy, they were better able to adapt to changing conditions.
Adopting a more agile structure can be incredibly helpful during crisis times. You might not have been structured correctly prior to this crisis, but you can certainly make some changes now to be able to weather future storms better.
Conclusion
It is not easy to plan for the next crisis and be ready for when it comes, but we can adopt certain tactics and structure changes to ensure that we fare a little better the next time around. What is important is to understand the elements that make up the whole and how they fit together at different times to create a company that can thrive under any circumstance. This is the secret sauce to success when facing a global crisis like the one we do now. Our hope is that you have a little more insight into each of the tactics that have proven to work in difficult times. Use them well.
Resources
https://hbr.org/2010/03/roaring-out-of-recession
https://hbr.org/2019/05/how-to-survive-a-recession-and-thrive-afterward
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