Economic Downturns and Resilient Part-I

LESSON LEARNT FROM PAST ECONOMIC DOWNTURNS AND RESILIENT

Economic downturns are incredible to foresee and sure as the sunrise. Build resilience now, because when the sun comes up, you had better be moving. Since the economic cycle is subject to change from time to time. It is inevitable truth proved by empirical information. A joke is still popular that “experts” correctly anticipated seven out of the last three macroeconomic events. Despite the above cyclic economic turn, it is better to not waste time predicting the next downturn. Inopportunely, it is not likely that the hit rate will be any better next time around. Geopolitics, economic cycles, and many other forces that can have immense significant effects on the fortunes of the business, and industry are innately not predictable precisely. 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 we are facing, there is no surety for bouncing back. It is quite natural to be concerned about the economic outlook, and if we find challenging questions from the board about the resilience of business performance, we must form a strategy. It turns out that in times of crisis and in times of economic slowdown, its impact on everybody does not face alike. While examination of above thousands of publicly traded companies, It is revealed that during the last downturn, about 10 percent of those companies fared materially better than the rest due to their “resilient” nature. Even though our business context is and will remain uncertain. If we are prepared to overcome the waves of uncertainty instead of being swayed by those waves.

 There are some noteworthy characteristics in how resilient weathered the storms, their preparation, their action, and their strategies during tougher periods, and how they bounced back. Resilient moved early, ahead of the downturn. They entered ahead, they dipped less, and they came out of it with guns blazing. Simply, our business context is and will remain uncertain. But if we get moving now, we can ride the waves of uncertainty instead of being crushed by them. The corporate performance follows a power curve. A small number of companies capture the lion’s share of global economic profit, while the vast majority return just slightly above their cost of capital. Moving up the power curve requires big moves: dynamic resource reallocation, disciplined M&A, and dramatic productivity improvement. Those findings held across economic cycles. This analysis in the technology, media, and telecommunications sectors proved the above. In the thriving years before 2007, the resilient underdelivered slightly on TRS. However, they opened a slight TRS lead relative to their sector peers during the downturn and extended this lead through the recession. By 2017, the cumulative TRS lead of the typical resilient had grown to more than 150 percentage points over the non-resilient. This lead was tough to reverse nearly 70 percent of the resilient remained top-quintile performers in their sector, with just a small fraction of the non-resilient joining them.

When the economy started heading south, what distinguished the resilient was earnings, not revenue. Barring a few sectors that were exceptions, resilient lost nearly as much revenue as industry peers during the early stages of the slowdown. However, by the time the downturn reached its trough in 2009, the earnings, measured as earnings before interest, taxes, depreciation, and amortization (EBITDA), of resilient had risen by 10 percent, while industry peers had lost nearly 15 percent

Resilient did three things to create this earnings advantage:

1.   Resilient created flexibility which offered a safety buffer. They did this by cleaning up their balance sheets before the trough, which helped them be more acquisitive afterward. Resilient 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 proficient this partly by divesting underperforming businesses 10 percent faster than their peers. The upshot was that resilient entered the trough with more financial flexibility. At the first sign of economic recovery, the resilient shifted to M&A, using their superior cash levels to acquire assets that their peers were dumping to survive. Overall, the resilient were about 10 percent more acquisitive early in the recovery. They accelerated when the economy was stuck in low gear.

2.   Resilient slash costs ahead of the curve. But no evidence to indicate that the resilient were better at timing the market. However, it is 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 resilient 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 resilient maintained and expanded its cost lead as the recession moved toward its trough, improving its operating edge in seven out of the eight quarters during 2008 and 2009. Therefore, the resilient appears 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.

Resilient in sectors focused on growth, even if it meant incurring costs. There were three sectors in the last recession that behaved very differently to the rules above, primarily because they saw a little impact on their revenues and only slightly slower growth as an industry. Oil and gas were in the middle of a commodity supercycle in the early part of the recession, with prices reaching as high as $120 per barrel. Meanwhile, demand for healthcare and pharmaceuticals proved relatively inelastic. For these growth sectors, the impact was quite different. Their resilience outperforms significantly on revenue while taking on higher costs. Invaluable as the lessons of history are, we also must be cognizant of changes in the external environment. Consider first costs: reducing them, faster and deeper, in the way that the resilient did during 2008–09, is likely to be difficult. That is partly because competition in global markets, and the relentless pressure of activist shareholders, have left businesses with less fat to trim than in previous cycles. Although, when drive comes to thrust, it starts seeming more feasible to realize challenging savings—these days, across-the-board cost cuts can create more problems than they solve. For starters, there is the risk of undercutting digitization efforts by underinvesting in mission-critical talent. There are also the wider social costs of layoffs, which companies are starting to feel in the form of backlash from communities, customers, politicians, and workers.

 Accelerating digitization has widened the gap in capabilities and performance between digital leaders and laggards a gap that is likely to grow during any downturn. Digital and analytics-driven productivity signs of progress may be an important alternative to conventional cost cuts or cross-border labor-cost arbitrage. The major manufacturing businesses across a range of sectors over the past two years indicate that for many companies, cost-reduction opportunities using “traditional” levers amount to only about 2 percent of costs, whereas those applying digital and analytics tools can reduce costs by a further 5 percent. These environmental differences don’t mean you should forget about costs in the next recession; the ability of the resilient to drive earnings growth despite top-line challenges was a critical differentiator. But it does point toward a resilience rule book emphasizing more balanced performance interventions, as well as faster decision-making enabled by a resilience “nerve center” and a well-prepared organization.

 Composed performance involvements

 Getting past the limitations of traditional performance approaches oriented around headcount and cost will require fresh thinking about boosting productivity. A large electrical-equipment manufacturer, for example, found that adopting robotic-arc welding led to a 30 percent decrease in manufacturing costs, a 50 percent improvement in production time, higher quality, and better process control. Production costs fell to levels like those in China, and the manufacturer decided against further offshoring, expanding manufacturing in the United States instead. This example shows that the economic logic of advanced technologies and automation cuts in multiple directions, with robots creating and saving some jobs even as they replace others. Working through this distinction, and interacting with relevant stakeholders, will be an important part of leaders’ roles moving forward.

 Despite the resilient’ earnings edge reinvigorated primarily on cost savings, they were also better at locking in post-cycle growth, partly using emerging tools that enabled them to better serve higher-value customer segments. A specialized cargo airline, for instance, developed a new system for categorizing customers in its micro-markets based on demand, flight availability, and capacity per flight. It then rewarded customers that contributed most to its tough-to-fill routes and negotiated prices with large customers based on their route-by-route volume. This increased the carrier’s share of wallet as high as 20 percent with key customers. These performance interventions need to be well-adjusted with creating flexibility—either operational or financial. Financial flexibility is achieved partly by unlocking the balance sheet, or by divesting noncore assets early before the fire sales start. Operational flexibility may be created through variable contracts and more diverse supply sources and platforms that share components across product lines and parts, among other levers. Toyota has been on such a journey, investing billions to ensure its factories can shift seamlessly between different body styles and power trains.

Strident digital correction

As advanced technologies and analytics create performance opportunities, they are reshaping competitive dynamics in far-reaching ways. This digital divide, combined with the tendency for downturns to drive a sustained block in performance, could mean a long-lasting bifurcation among digital “haves” and digital “have-nots.” The digital haves will connect better with loyal customers; provide a frictionless, private customer experience; serve them at a lower cost; absorb price hits, and avoid expensive IT upgrades at a susceptible time. Digital have-nots, on the other hand, may feel a need to limit, making catch-up elusive, even when economic conditions improve.

Future resilient will likely have a clear view of which critical processes should be digitized to drive near-term value and which initiatives are critical to remaining competitive. An auto insurer, for example, might safeguard an initiative aimed at using analytics and machine learning to create claims estimates without sending an inspector to look at a damaged car, because of its transformational potential. It might also stay the course with the development of a new pricing system that has significant near-term potential. On the other hand, a process-redesign effort whose full potential will be difficult and time-consuming to capture because of regulatory and reporting differences across geographies might get moved off the priority list.

Most advanced technology efforts require engaging people in multiple parts of the organization—analytics experts, customer-experience specialists, operators skilled at robotic process automation, lean-operations gurus, and the like. Breaking down organizational silos to participate all these people often requires special attention. The challenge during a downturn is that near-term cost pressures and traditional organizational reporting lines sometimes yield efforts to “lean things out” function by function, with each executive or manager told to “make cuts in what’s in our control.” This approach becomes outmoded fast in the horizontal, cross-functional world of digital innovation and execution. Instead, companies should get important digital work done through agile operating units, deployed flexibly against value-creation opportunities.

The resilience nerve center

A resilience nerve center aims to do three things well: monitor a small number of material risks and use stress tests to orient the company, early, toward downturn-related economic impacts, decide how the organization will manage these impacts faster, and execute by organizing teams into agile, cross-functional units that drive toward clear results, create forums for faster executive decision making, and monitor the results through value-based initiative tracking. The art of effective resilience monitoring starts with an acknowledgment that any effort to identify an economic scenario precisely will inevitably miss something that turns out to be important while creating an ear-piercing disharmony of risks that leaves leaders overwhelmed and unable to act. It is far better, in our experience, to agree on a small number of representative major threats and for each to define a clear leading indicator, as well as triggers for escalating the threat to decision makers. Thinking this through ahead of time is great preparation for tackling unexpected threats when they emerge.

 Globalization in transition: The future of trade and value chains

 The next step is to incorporate these material threats into a map, like the one devised by an oil and gas company we know, that focuses on the potential timing, sequencing, magnitude (confirmed by stress-test modeling of financial impact under different scenarios), and second-order effects associated with various hazards. This map becomes the basis for big strategic moves. If a particular idea will not help neutralize one of the issues spelled out in the threat map, it may not be bold enough to make the company resilient.

All this work ends up being a theoretical exercise unless it leads to quick decisions and then action—which in our experience starts with forming cross-functional, highly autonomous teams with well-defined objectives. Preparing your organization, your leaders—and yourself

The fast-moving teams that support nerve-center activities, and are intertwined with many digitizations and operational-improvement efforts may sound a lot like agile squads. That’s no accident because more and more organizations are embracing agile approaches.

Leaders should certainly use resilience planning to build on those initiatives but as part of a much wider effort to simplify the organization and prepare for uncertainty. A full-scale reorganization is tough to pull off anytime, particularly so in the throes of a major downturn, so a decluttering of activities may help. This is best done in the flow of ongoing strategy dialogue about portfolio priorities, particularly divestiture and acquisition opportunities whose urgency could rise with swings in the macroeconomy. The decluttering can be dramatic, approaching a zero-based “clean sheet” approach, or something more incremental. Resilient executives will likely display a more comfortable relationship with the uncertainty that allows them to spot opportunities and threats and rise to the occasion with equanimity.

Simultaneously, we can identify, using an analytical approach, the skills, and people needed to carry the business through turbulence. Most companies shed people during a recession, but resilient players are just as conscious of investing in the skills needed to win in the recovery. Know your key roles. Then look at how your top talent is arrayed against them and what we need to do about any mismatches (which might include, for example, retaining or acquiring digital skills, or rethinking the outsourcing of IT talent). All this will require a leadership team that is 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 the 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 described is a bias toward action, an urgency that reminds us of a quote: “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 are concerned about the resilience of our business, are we already moving?

Conclusion

We have tried to explain how past economic downtrend was overcome. In Part - II, we try to explain, the present downward trend. We will explain this time, how to regain resilience at this hour in our Part-III.