Managing Your Business in a Recession
By Geoff Colvin, Senior Editor, Fortune Magazine
There's no script for running a company in this historic downturn. So what the heck do you do? Here are ten ways to weather the storm.
RESET PRIORITIES TO FACE THE NEW REALITY
Easy to say, hard to do. When a company's view of the world changes, everything changes, and the shift can be traumatic. In good times the top priorities may be expanding into new markets, hiring enough people, and growing earnings 15%. Suddenly changing direction may seem drastic, but it must be done. Jamie Dimon, CEO of J.P. Morgan Chase, one of the nation's few remaining strong major banks, recently told a group at the Harvard Business School, with regard to the recession, "I am shocked at the number of people who are watching that train coming down the track, and they're still worrying about their strategic plan for 2009. We canceled all that stuff - all of it - meetings, travel, you name it, to focus on the fact that we're in the middle of a real crisis."
Whole Foods Market CEO John Mackey says, "We have to manage the business differently." Economic growth used to be a tail wind that the company built into its business plans. Now, says Mackey, "one of the leadership challenges I have is that that assumption is no longer true." The new era "requires a different mindset - we have to be more frugal, to think about every expense, every capital investment - because we won't be bailed out by growth."
KEEP INVESTING IN THE CORE
Recessions end, and much of the art of recession management involves remembering that fact. When this lousy stretch is over, will your business be more competitive or less? The most successful companies never stop funding their most critical competencies - product innovation, customer service, or anything else.
Kohl's, the big retailer, actually spent more on marketing this past holiday season than it did last year. Intuit's Smith says, "We're not going to cut innovation. This company for 25 years has been fueled by new-product innovation. We're protecting the innovation pipeline so we come out of this strong." For virtually all companies, a critical part of the core is the continual development of employees. Yet it's remarkable how many businesses cut training and development in a downturn. The best never do.
COMMUNICATE LIKE CRAZY, BALANCE REALISM WITH OPTIMISM
The instinct of most executives is to hunker down in uncertain times, keeping quiet until they believe they have some answers. That's the opposite of what's needed. In a recession all of a company's constituencies are nervous: Employees are worried that they'll be fired, suppliers that they won't be paid, customers that quality will decline or prices rise, investors that the stock will tank, communities that operations will close down. Your silence just makes them worry more.
Good managers respond by communicating even more than usual. They find that they needn't have all the answers, but they do need to say what they're thinking and be honest about conditions. Julia Stewart, CEO of DineEquity, parent of the Applebee's and IHOP restaurant chains, says, "It's important to assure your employees by making clear your vision, making sure they know that you care, and making sure that you're direct and honest. They just want the truth."
Even when the news isn't good - which it usually isn't - effective leaders find ways to keep hope alive. Home Depot chief Frank Blake cites an observation by Colin Powell: "Optimism is a force multiplier." Conditions are especially brutal for Home Depot, and last year Blake closed 15 U.S. stores and cancelled 50 on the drawing board. But he reminds everyone that the company is around for the long haul and intends to stay strong. John Hammergren, CEO of the giant pharmaceutical distributor McKesson, has been holding employee town halls, where his goal is "to give confidence that we're in a great industry, and McKesson is in a leadership position." Every good company has upbeat facts, even in a recession, and they need to be repeated.
YOUR CUSTOMERS FACE NEW PROBLEMS, SO GIVE THEM NEW SOLUTIONS
The best performers deeply understand their customers' businesses and can respond in sophisticated ways. For example, McKinsey reports that when the economy was booming, a client company that sells plastic resins developed a fast-curing resin for customers that wanted maximum productivity from their injection-molding machines. But when the economy turned down and clients no longer needed as much output from their machines, the company developed a less expensive, slower-curing resin. Customers are happy because their costs have fallen, and since the new product is cheaper to make, the company maintains its profit margins even when selling at a lower price.
In any industry the general principle is helping customers make the most of what they've got. McKesson's customers include big retailers that are under pressure to cut costs as consumers grow stingier. For those retailers, negotiating significant cost reductions from suppliers of generic drugs is tough, so McKesson offers them this proposition: Just buy all your generics from us and redeploy your purchasing team to projects where it can achieve bigger savings. Both parties win.
No matter what business you're in, you can redefine value for the customer. When the economy was strong, CKE Restaurants, parent of the Hardee's and Carl's Jr. chains, developed a winning strategy based on massive burgers at premium prices. Reacting to the recession by suddenly selling skinny burgers cheap would destroy the company's market position, so it's responding in other ways. "We can't add meat to a burger anymore," says CKE marketing chief Brad Haley, since the cost is too high. "We have to be more creative. Carl's Jr. is promoting a guacamole bacon cheeseburger. Avocados are a less expensive topping."
DON'T RUSH TO CUT PRICES
Yes, everyone would like to pay less, especially in a recession, but the dangers of price chopping are greater than you may realize. McKinsey research finds that in a typical S&P 1500 company, a price cut of 5% would have to generate increased sales volume of 19% in order to pay for itself - and that almost never happens. The implication is that while holding prices steady may cause sales to decline somewhat, that course may nonetheless be wiser.
It all depends on the pricing dynamics in your business, which may be changing rapidly in this recession. For example, gasoline at $4 a gallon caused many U.S. consumers to cut back drastically on discretionary purchases; since gas today is below $2, some consumers may have more available income - but may also be more worried about their jobs. Now is the time to study price sensitivity in your markets much more closely than before.
FOCUS ON CAPITAL - HOW YOU'RE GETTING IT AND WHERE YOU'RE USING IT
In good times, and especially in a period of low interest rates, it's easy to get lax about capital and to forget the most fundamental rule of business: that you must earn a return on capital that exceeds your capital's cost. That error really hurts now that capital markets have become tight. The unprecedented seize-up of the commercial paper market in September and October forced many companies to rethink all their sources of capital. Dunkin' Brands, which had previously turned to the largest national financial institutions for capital to help franchisees finance new stores, is now finding that healthy regional banks are also a good source.
Companies that are managed explicitly for capital efficiency are stronger now than they would be otherwise. Dan Ustian, CEO of truckmaker Navistar, no longer invests the $350 million to $400 million needed to develop a new engine; instead he buys from others and says he spends $30 million to $40 million optimizing "controls, software, and air-fuel management" to make the engines work best in his trucks. "It's our capital ethos," he says. "We don't need to make another investment." Similarly, knowing that inventory represents warehouses full of capital, Deere avoided the inventory pileups that afflict many manufacturers in a downturn and that have especially hurt the Detroit automakers.
REEVALUATE PEOPLE AND STEAL SOME GOOD ONES
Just as most investment managers look like geniuses in a bull market, most employees can look like excellent performers in a booming economy. Now is when you identify the impostors. Working hard at that task is important, because if you need to lay people off, as you well may, it's critical that you choose wisely.
A subtler danger: If salaries or bonuses need to get whacked, you may be tempted to reduce them equally across the board in an effort to show that we're all in this together. But think of the message that practice sends to your best performers, who will feel they're being punished rather than rewarded for their great work. Mel Stark of the Hay Group consulting firm points out that in his survey of the World's Most Admired Companies as ranked by Fortune, the best ones take extra pains to reassure their "most driven and focused employees," the ones it is most important to keep. Instead of spreading the pain, reward your best workers well, even in a recession. Then scout for competitors that are sharing the misery equally and steal their best performers.
REEXAMINE COMPENSATION - WHAT IS IT OFFERING INCENTIVES FOR?
A widespread criticism of the Wall Street firms that stumbled or fell in the financial crisis is that their pay programs encouraged too much risk; executives had much to gain if their high-risk bets paid off and little to lose if they didn't. In fact, Washington's $700 billion rescue package specifically requires that incentive compensation at the affected firms must not "encourage unnecessary and excessive risks that threaten the value of the financial institution."
While you're making sure that pay arrangements at your company don't encourage too much (or too little) risk, think more broadly about what they encourage. At Deere, for example, incentives are based on economic profit, a measure that includes capital costs, and bonuses earned in any given year are paid out over four years; if performance falters, part of the bonuses can be canceled. The system encourages long-term thinking and seeing the recession as part of a larger cycle.
THINK TWICE ABOUT OFF-SHORING
A time of greater cost pressures may seem an odd moment to ask whether offshoring still makes sense, but in fact the economics have changed drastically. The labor-cost advantage of manufacturing in China or Malaysia has shrunk as wages in those countries have jumped, and now that U.S. unemployment is increasing, the wage gap in some industries may shrink further. The price of oil, while down from its peak, is still much higher than five years ago and unlikely to fall much more, in the view of many analysts, so transportation costs may also cut into offshoring's edge.
Combine all the factors and now may be a smart time to bring manufacturing back, or at least closer, to the U.S. McKinsey found, for example, that a midrange computer server could be made for much less in Asia than in the U.S. in 2003, but by last year the cost advantage had reversed, so that making the machine was actually cheaper in America.
Manufacturing costs aren't the only factor in an offshoring decision. Taxes, tariffs, speed, and transition costs can make a big difference. But at a time when costs count more than ever, don't assume that offshoring is still your best option.
BE SMART ABOUT MERGERS AND ACQUISITIONS
It seems obvious that a recession is a great time to buy assets cheap. The wonder is that so few companies do it. Merger activity tends to peak when markets are at their height, while most companies see a recession as a time to hoard resources until things improve. Companies are twice as likely to acquire businesses in their major segments during an upturn as they are during a downturn, the opposite of what makes sense.
Of course if you're strapped, you can't follow Warren Buffett's dictum to be greedy when others are fearful. But if you're financially strong, this is your moment. McKesson's Hammergren says, "This is a great opportunity to pick up small companies and their talent," for which he is scouting avidly.
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