How to Think Strategically in a Recession

How to Think Strategically in a Recession - Strategy for the Recession
12/10/2001
What would your company do if demand suddenly fell off? Or if a global recession hit? In this article from the Harvard Management Update, Bain & Company consultants Chris Zook and Darrell Rigby take on every manager's worst-case scenario. Now is the time to build strategic contingency planning into your company's culture, they stress. And don't forget the importance of loyalty and of protecting your core assets.
by Chris Zook and Darrell Rigby

Even before the September terrorist attacks in the U.S., business executives were paddling furiously to traverse the economic doldrums. Now it is almost certain that the crossing will be longer and harder. How can your company make it through the difficult times ahead? The following practices will help ease your passage.
Build strategic contingency planning into your culture
The contingency measures that World Trade Center tenants adopted after the landmark's 1993 bombing are widely credited with saving lives and businesses in the wake of the most recent disaster. The impending downturn, however, calls for more: you'll need entire strategies crafted to address your worst-case scenarios.
What if your risk profile shifts dramatically? Act now to spread that potential risk or buy it down. U.S. insurers rethought risk-sharing in the wake of 1992's Hurricane Andrew, which caused a then-record $16.8 billion in losses. Primary insurers (think Allstate) began to share risk more broadly among themselves and sell off more to reinsurers (think Lloyds of London), which provide surplus coverage for major losses. The reinsurers upgraded their computer models to predict payouts and avoid overextending themselves. As a result, the insurance industry expects to fare better today even though the damages from the September attacks may be double those of Hurricane Andrew. How about your industry? How could your risk profile change, and what should you do today to prepare?
The speed of the economy's decline from its high point eighteen months ago will soon underscore the importance of relative cost position.
—Chris Zook and Darrell Rigby
What if demand suddenly falls off? Could you quickly find allies who could help you consolidate the industry and save jobs? Arrow Electronics (Melville, N.Y.), a distributor of electronic components and computer products, faced just such a dilemma when computer sales flattened in 1985. Arrow, the industry's scrappy No. 2 player, was able to acquire the No. 3 player. This swift move catapulted Arrow to the No. 1 position, which it still holds. Chairman Stephen Kaufman says his company's outward focus has enabled it to react more quickly than its competitors. Companies today should take a cue from Arrow, reviewing their competitive landscape and thinking through merger scenarios.
If you think you may experience a drop in regional demand, map out alternative markets that could absorb your additional supply. Many Asian consumer-products suppliers had to shutter or trim production when the region's economy went south in 1997. But firms like Emerson quickly shifted product to export markets and kept Asian plants running. By locking in talent and capacity, Emerson was able to gain market share when local markets rebounded.
What if global events disrupt your supply chain? Compare General Motors' plight in the days after September 11th to Dell's. GM had to close down factories in Ontario due to parts delays at the Canadian border. Dell, which has built one of the world's best supply chain networks, chartered an airliner to fly parts from Taiwan to its Texas factory, ran factories day and night, and converted three 18-wheel trucks into mobile technology and support facilities in order to supply 24,000 computers to New York City and Washington, D.C. Which position would your company find itself in, and where should you strengthen your supply chain network to avoid your worst case?
What if prices drop precipitously? The high-cost producer sets the price during boom times, and most competitors make money. In difficult times, the low-cost producer sets the price, thereby controlling the level of competitors' profit margins. Intel has cut prices on its microprocessors by 35%. Dell halved its prices and still makes money—not so for some of its competitors. The speed of the economy's decline from its high point eighteen months ago will soon underscore the importance of relative cost position. Firms must scrutinize their purchasing costs and cycle times relative to their competitors, detect the inefficient processes, and fix them.
What if a global recession hits? The variance of GDP growth rates across countries is at its lowest point in thirty years; never in recent history have economies been so closely in step with each other. This increases the odds of a synchronized global recession, which means that companies will have nowhere to turn to shift supply. In such an extreme scenario, do you have the cash reserves to help consolidate your industry and save jobs? Have you evaluated which competitors you should acquire based on your core businesses? Or, if you have a weaker financial position, have you identified where you can cut costs without cutting out the heart of your business? Where are you making your profits and generating the best R&D to renew product lines? Where do you hold the most competitive cost position? Gillette recently concluded that it could improve its chances for profitable growth by selling off its stationery and some consumer-appliances businesses and focusing on shaving products and batteries.
In North America, scenario planning rated 17th out of the 25 techniques included in Bain's most recent management tools survey. Only 30% of the 245 senior executives who responded said they used it in 2000, which is a third less than in 1994. But scenario planning is a critical step toward a comprehensive contingency strategy; now is a good time to reconsider its use.
Strengthen the bonds of loyalty
To help customers get back on their feet after the terrorist attacks, hundreds of companies, from rental-car agencies to mortgage lenders, offered price breaks, even though it meant taking a financial loss. Many firms set up counseling sessions and gave employees time off to support others. The lesson here, as the economy heads toward recession: now is the time to prove that you deserve your stakeholders' loyalty and trust.
Pay special attention to your employees. Financial services powerhouse Morgan Stanley had 2,700 employees based on 22 floors of World Trade Center 2, almost all of whom made it out. Within an hour of the attacks, CEO Philip Purcell put in motion a plan to help survivors and all employees' families through the trauma. He brought in counselors. He set up a hotline out of Morgan Stanley's Discover Card unit, based in Chicago, to locate and assist employees, converting some 1,000 customer service reps into lifelines and listening ears. Once the crisis passes, such extraordinary measures won't be necessary, but as the downturn becomes more severe, employees will feel added stress. Your efforts to support them will reap benefits for the company—friends in a foxhole often become friends for life.
Be a good vendor. Get close to customers; unless you're looking to exit a particular business, now is not the time for running short-term profit optimization models. Dell lowered prices on many of the servers, laptops, and desktop computers it sold in the first week following the attacks. You can bet its customers won't forget. Granted, not every business is a loyalty business—commodities sellers, for example, don't rely heavily on customer loyalty. But for strong customer-facing businesses, our research has shown that a 5% increase in customer loyalty can lead to 40% to 90% increases in the lifetime value of a customer across a variety of industries—from automotive services to advertising. The rental-car company Enterprise, which has had loyalty in its business model for some time, is now the largest in North America, having surpassed Hertz and Avis. Its profit margins allow Enterprise to pay managers substantially more than its competitors. The lesson: Loyalty is not just the way out of a recession; it's the way back to better-than-normal prosperity.
Protect your core assets
Downturns often make cuts to personnel unavoidable. But just as the human body diverts blood to vital organs during physical trauma, so should companies protect their core businesses and critical functions. The temptation, however, is to give more attention to the most troubled businesses and take the core for granted. Case in point: the resources New York City—based Loral devoted to its troubled Globalstar initiative at a time when the core satellite business was slowing down and losing market position. This loss of focus hurt the core business. Loral went from one of the great growth companies of the 1980s and 1990s to a company in trouble: In the last 12 months, its stock price has dropped by 95%.
Reinforcing your core assets helps recession-proof your company. Weak businesses have proven much more volatile than strong ones. Our research found that over the course of a business cycle, the profitability of weak businesses or companies—as measured by margins or return on capital—can be two to three times less than that of strong businesses in the same industry. For instance, over the past 10 years, Advanced Micro Devices (Sunnyvale, Calif.) has had losses of as much as 20%, whereas industry leader Intel's profit margins have ranged from 16% to 22%.
In a recession, employees need to know that their actions matter. Explain to them in detail how their efforts can help protect your core assets. You may also need to ratchet down targets and extend time horizons. Realistic targets will help the people who power your core get back on track without feeling like they're failing. But it's surprising how overly optimistic companies can be: a recent analysis we conducted of long-term company targets for revenues and profits revealed that, in spite of the slowdown, nearly 80% of companies are targeting long-term performance levels that only 15% of companies have managed to achieve in the last decade.
Don't set up stakeholders for disappointment. Clear-eyed expectations and strategic contingency planning will reassure them that your company can be counted on in a recession.
Reprinted with permission from "How to Think Strategically in a Recession," Harvard Management Update, Vol. 6, No. 11, November 2001.
Chris Zook is director of Bain & Company's worldwide strategy practice and author, with James Allen, of Profit from the Core: Growing Strategy in an Era of Turbulence (HBSP, 2001).
Other HBS Working Knowledge stories featuring Chris Zook:
The Core of Strategy
Darrell Rigby is a director at Bain & Company and author of the study "Winning in Turbulence: Strategies for Success in Tumultuous Times" (Amazon eDocs).
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