Battle Plans for a Downturn
In the best of times, business resembles a cruel contact sport. In the worst, it becomes a deadly battlefield for companies unprepared for the strategic decisions a major economic downturn requires. Should you dig defensive trenches to protect your revenues and profit margins while freezing all investment programs? Or, do you go on offense, aggressively pursuing opportunities afforded by competitor weakness?
THE WORLD HAS ENTERED a significant recession, perhaps the largest since the 1930s. Industries worldwide continue to convulse from sharp declines in demand. In Germany, for example, orders for machinery, metal products and cars dropped by more than 30 percent last December. These declines, coupled with severe financing restrictions, have already injured companies in many industries. As a result, governments around the world have scrambled to save the financial system, led by the United States, which stepped in with roughly $8 trillion in bailouts, stimuli and other guarantees—an investment worth nearly half the entire U.S. economy.
As chief executives examine their options on this fresh battlefield, past recessions can provide some guidance. In 2001, ground zero for the "dotcom" industry and for semiconductors in particular, two companies, NVIDIA and Microchip Technology, thrived in the face of a dramatic drop in overall computer chip sales. In retail, while thousands of stores closed across the United States in 2001, JCPenney and Kohl's not only outperformed their competitors but also discovered newfound growth. Likewise, Gillette chose the middle of the 1990 recession to launch its innovative Sensor shaving cartridge, which is one of the company's most successful new product introductions to date. Colgate-Palmolive has a penchant for going on offense during and immediately after recessions, including its highly successful 1991 acquisition of the producer of Murphy's Oil Soap.
Recessionary periods often act as fertile incubators for newborn companies with innovative new technologies and business models, in part because they clear room in markets by culling weaker participants. Microsoft, Apple, FedEx and Southwest Airlines all emerged in the recession-plagued 1970s and flourished during the 1980 to 1982 downturn.
We are convinced that similar opportunities exist today for companies to outperform and even grow during this downturn.
Creating Value in Hard Times
The different strategies companies adopt during recessions can lead to vastly different results in value creation. Our analysis shows organizations that have followed deep cost-cutting strategies through current and past downturns have lost value relative to their industry sectors (see figure 1). On the other hand, players capable of going on the offensive in difficult times while holding their core investment strategies steady typically outperform their peers in share value. Of course, firms forced to make deep cuts in the crisis have made mistakes in the past —the act of cutting costs does not destroy value, but instead is the antidote to earlier, market-perceived missteps. Likewise, financially healthy firms now benefit from prior good management decisions and can thus capture opportunities exposed by their widening performance compared to weaker competitors.
Executives need to act now to preserve cash and plan new strategies. In these unusual times, business as usual no longer applies.
With so much value at stake, how can organizations identify the full range of options at their disposal? How do they capture available value despite the current cataclysmic economic conditions?
One of the first casualties of this economic "war" has been the widely held belief that growth is a given, a natural consequence of sound business practices. Managers who think they can rely on classic growth strategies, such as offsetting declining demand in mature markets by participating in developing economies, should think again, as their businesses face urgent new growing pains. Companies worldwide have entered an era where the top line no longer takes care of itself, forcing managers to stabilize revenues and seek additional growth opportunities. Some immediate actions to avoid short-term revenue declines: adapting quickly to the new competitive reality, avoiding extensive market-side risk exposure and stabilizing sales wherever possible.
While every company should address these immediate tactical issues (and many already have), business leaders must also determine their best strategic course through the economic downturn. They need to identify new medium- to long-term opportunities as markets return to life.
Plotting Your Battlefield Position
Pursuing the dual goals of avoiding short-term revenue declines and capturing new medium-term opportunities requires consideration of two factors that determine the new competitive arena: market power and financial power (see figure 2). A company's relative market power results from a number of factors, including its presence in attractive segments, its customer access, the attractiveness of its product and its sales power. Recessions change this equation in several ways, as customers shift buying behaviors, competitors slash prices and buyers almost instantaneously gain additional leverage over sellers. Financial power measures a company's access to cash and cost of capital, which the downturn has altered as well. Managers who a year ago viewed financing as a cheap and ready commodity now prize it as a scarce and crucial element of success.
Together, these two factors form the competitive battlefield across which companies plot their strategic decisions. Firms with high market and financial power in the recession, such as discounters Wal-Mart and ALDI, occupy a safe haven as more customers seek bargains. Purveyors of luxury goods of all types—in contrast to recent crises—have seen their market power diminish in the recession, as have companies that rely heavily on financing. In a clear example of the latter, the global auto industry has experienced a "triple whammy" of sorts, as consumer financing, dealer inventory floor plans and automaker access to capital have all dried up, causing several major players to enter the danger zone (see Caution: Rough Road Ahead).
Companies with strong cash positions but less market power might exploit the recession and "buy" a better market position by pricing aggressively for strategic customers and permanently driving weak players out of the market, while highly leveraged, middle-of-the-pack companies must contend with a significant cash squeeze. Furthermore, the field is dynamic: In a truly onerous market downturn, the danger zone could fill half the matrix.
The Art of Business Warfare
Severe economic downturns can quickly overstress company income statements and balance sheets, causing declining revenues and margins, productivity problems and cash shortages. This downturn certainly has its own unique DNA, with credit contractions, bank failures, a rapid decrease in housing values and low consumer confidence testing nearly every aspect of business. While such extreme levels of uncertainty can paralyze a management team, executives need to act now to preserve cash and plan new strategies. In these unusual times, business as usual no longer applies.
Every aspect of a business will be tested during a downturn, and the right strategy will differ depending on the issues. In some cases, an aggressive pursuit of revenues and strategic investments may be the right choice. For example, a company with countercyclical revenue streams can offset a downturn in one product category with success in another. An innovative company that can maintain volumes and pricing power is in a good position, as is a firm with a variable cost structure and the ability to protect gross and operating margins. Likewise, a sound level of capital and a lean asset position can provide the flexibility to go on the offensive. Companies that in flush times developed these traits can continue their existing growth strategies without interruption, or use their strong competitive positions to acquire weaker competitors at a discount.
In contrast, companies with revenues and margins threatened by recession must form a strong defensive line, including liquidating non core assets and reassessing their cost structures.
From our experience with Fortune 500 companies, we know these factors often emerge before an economic downturn even begins. What if Microsoft had succeeded in buying Yahoo! in February 2008 for $45 billion, a premium of 62 percent at the time? By the end of the year, Yahoo's stock had fallen 50 percent and Microsoft had the cash and an even better position to go on the offensive. On the other hand, what if Royal Bank of Scotland's $96 billion purchase of ABN AMRO in 2007 had not gone through? That total is now larger than the combined market capitalization of Citibank, Morgan Stanley, Bear Stearns and Barclays, and in November 2008, British taxpayers bailed out Royal Bank of Scotland and now own 70 percent of the company.
Decisions such as these, whether by skill, luck or timing, can determine the choice between offense and defense. Company leaders may either plan skillfully for uncertainties or sit back and watch complacently while events unfold before them.
Choosing the Right Offense
Not every company should attempt to assume an offensive posture. However, for strong, financially stable firms, a downturn of this magnitude can present enormous opportunities to consolidate fragmented industries and take up superior positions for the inevitable return of market stability. Such companies typically know their strengths: They enjoy strong cash flow, unencumbered access to capital, predictable core markets and stable revenue growth. Additionally, they run real-time, anticipatory business-performance-monitoring processes and maintain flexible, highly skilled strategic planning functions.
In choosing the right offensive strategy, there are many possible options (see figure 3). You can leverage your financial power to boost market power (or vice versa), enter new markets, acquire weaker competitors, pursue the best talent, improve sales-force effectiveness or invest in innovation. We have numerous examples of successful attackers across industries. For example, NVIDIA, the semiconductor company, identified new market demand, pioneering a groundbreaking six-month product-development cycle. This move helped secure competitive advantage by allowing the company to maintain pricing power on its products despite the recession. Meanwhile, NVIDIA's archrival, ATI Technologies, struggled to fund research and development effectively enough to compete with NVIDIA's sustained and consistent release of new products. NVIDIA increased sales by 160 percent from 2001 to 2003 and maintained gross margins of more than 30 percent, while ATI's sales dropped sharply. As a result of its strong position, NVIDIA acquired weaker competitors in a move to consolidate the industry and prepare for postrecessionary growth.
In retail, Kohl's booming success during the 2001 downturn provides a compelling example of a strong offense based on its innovative business model. Before the recession, Kohl's unique merchandising philosophy—focus on a low cost structure, lean staffing levels and sophisticated management-information systems—propelled growth that outpaced the retail industry as a whole. When the downturn began, Kohl's was in a position of strength. While Ames and Kmart were declaring bankruptcy, Kohl's step-by-step expansion included organic growth and a series of acquisitions. The company emerged from the downturn with 50 percent more selling space and new access to major markets.
One more example: Centrica, owner of British Gas, announced it was acquiring a significant interest in Venture Production, an exploration company focused on acquiring, operating and revitalizing North Sea oil and gas fields with proven but untapped potential. Venture reportedly owns Britain's largest gas reserves not already tied to a major utility.
Preparing a Solid Defense
Stories of successful growth during a downturn can sound seductive, but offense is not for everyone. Sometimes the best strategy to protect your business involves building up your defenses—protecting revenues and margins and preserving the balance sheet.
This downturn certainly has its own unique DNA, with credit contractions, bank failures, a rapid decrease in housing values and low consumer confidence testing nearly every aspect of business.
Companies can steer revenues and market-associated risks by reducing sales pressure in unattractive, rapidly shrinking segments and reallocating sales efforts and resources to more stable segments. Segment-specific pricing and adjustments of terms and conditions may also be beneficial.
Additionally, balance sheets can be protected by restructuring assets, managing working capital and optimizing capital expenditures, which may require a full review of the assumptions behind each capital expenditure project and any related deviations resulting from the current credit crunch and market downturn.
It is likely that newly expensive capital could tip the net present values of some projects into losing territory.
Our analysis indicates that such moves, when well-executed, can present an opportunity to clean house in the short term and prepare the company for potentially significant growth down the road. For example, Micron Technology experienced a severe negative impact during the dotcom recession as the management team faced a 97 percent decline in annual gross profits. In such a situation, protection makes more sense than acquisition—something Micron learned when it tried to buy South Korea's Hynix Semiconductor for $3 billion in stock, which Hynix's board rejected, saying the terms offered by Micron were too cheap.
Successful defense strategies typically share two traits: aggressiveness and speed.
Move aggressively. Companies need to target all corporate costs aggressively, especially given the uncertainty the current recession presents. Look beyond the low-hanging fruit to develop an all-encompassing turnaround strategy. Instead of simply targeting headcount and divesting assets to improve income statements, attack cost structures forcefully enough to outpace revenue declines. Success depends on a clear understanding of strategic versus nonstrategic costs.
In the 2001 downturn, for example, Omnicom Group and Interpublic Group were both leaders in the advertising business, with revenues of $6.2 billion and $5.7 billion, respectively. Omnicom, in a stronger position due to a countercyclical portfolio of businesses, continued several key strategic investments focused on improving its bench strength—an important strategic asset for an advertising firm. At the same time, it aggressively reduced all nonstrategic costs related to office and real estate expenses. Omnicom not only grew its countercyclical business during the downturn, but also created a longer-term competitive advantage by eliminating unnecessary non-strategic costs and holding true to its core brand and service positioning.
Interpublic, on the other hand, held a weaker position as it attempted to integrate a large acquisition and struggled to grow revenues. Its strategy centered on a $650 million restructuring initiative to reduce headcount, terminate real estate leases and sell all noncore assets. But the overall plan wasn't sufficiently aggressive to outpace the agency's decline in revenues due to the downturn. Standard & Poor's placed Interpublic on its credit watch list, citing vulnerable revenues and faulting management for not cutting expenses faster.
Be speedy. Wasted time can adversely affect a company's short- and long-term plans. The speed with which companies respond determines if and when they emerge from the downturn. Indeed, a reluctance to deal swiftly with cost-structure problems in large part caused Broadcom's struggles during and after the 2001 to 2002 recession. One of the high-flying semiconductor companies of the Internet boom, Broadcom held a commanding 90 percent share of the cable modem semiconductor market that saw a 200 percent increase in revenue during the two years before the recession.
When the recession hit in early 2001, it exposed Broadcom's balance-sheet flaws. Inflated valuations for Broadcom acquisitions led to significant asset-impairment charges. Although revenues remained stable, operating expenses continued to rise over the next six months, and the company's position plummeted. Serious restructuring did not begin until November 2002, by which time the company had suffered through seven quarters of losses.
How Scenario Planning Delivers Insights
In the current recession, which ranks as one of the deepest in a generation, today's cash-rich consolidator could become tomorrow's bailout prospect if it lacks a well-developed strategy. Our experience suggests that scenario planning can help companies see beyond the common pitfalls around status quo, sunk costs and forecasting, allowing decision-makers to generate new insights, manage complexity and communicate more effectively during these extraordinary times.
A structured scenario-building process can guide decision-making, helping managers develop a long-range view of the future that also provides new insights into the current situation. Figure 4 illustrates this with three basic future scenarios: pessimistic, baseline and optimistic as they relate to globalization, demographics and consumption patterns. Many leadership teams are using scenario planning to get ahead of the curve by shaping costs and operating models to fit what might happen in terms of ongoing economic contraction. For example, a building services company is now transforming its operations to deal with a possible 3 percent reduction in already-tight margins across its order book. If the worst happens, the organization is ready to weather the storm. If it doesn't, and margins prove more resilient to ongoing pressures than anticipated, the company has created headroom to emerge from the downturn ready to invest and build its business.
By introducing "wildcards"—potentially disruptive high-impact, low-probability events that move rapidly and exist beyond the control of any single institution, group or individual—managers can add dynamic muscle and sinew to the scenario-building process. Once established, these wildcards enable the company to manage risk based on the impact and probability of the scenarios.
Agility and Vision
In the current crisis, company executives must make short-term decisions with agility and medium- and long-term decisions with strategic vision. Do you counterattack, taking advantage of a decimated competitive landscape to win the high ground, retreat behind castle walls to wait for better days, or position your company somewhere between these two extremes? Whatever the choice, the insights and ideas expressed here can help companies emerge victorious on their respective competitive battlefields.
Consulting Authors
Graeme Deans is an A.T. Kearney alumnus formerly based in the Toronto office.
Anne Deering is a partner in the London office.
Martin Handschuh is a partner in the Stuttgart office.
Martin Walker is senior director of A.T. Kearney's Global Business Policy Council, based in Washington, D.C..
The authors would like to thank their colleagues Julie Dekleermaeker and Vivek Arya for their contributions to this article.
For more information, contact the authors.
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