How to Win a Recession: A Research Roundup
Walter Frick, Deputy Editor of HBR.org, collects studies and draws conclusions on what separates companies that survive through recessions and those that fail.
A Wide Range of Recession Performance
Mr. Frick cites a 2010 HBR article, Roaring Out of Recession by Gulati et al., to show the stark difference between companies that handle recessions well and those that don’t:
“[D]uring 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. But just as striking, 9% of the companies didn’t simply recover in the three years after a recession—they flourished, outperforming competitors by at least 10% in sales and profits growth.”
The Difference Maker
Mr. Frick declares that the difference maker between success and failure is management-flexibility and preparation for the recession. This is because recessions “are a high pressure-exercise in change management.”
More specifically, the necessary disciplines of preparation and flexibility are needed for four recession survival tactics:
1. Deleveraging before a downturn
2. Decentralize Decision-making
3. Preserve Human Capital
4. Make Technological Improvements
1. Deleveraging before a downturn
This recession-survival tactic is necessary for the obvious reason that the macroeconomic conditions of a recession mean lower revenues and diminished ability to raise capital to finance (or re-finance) operations. A miscalculation could mean that companies in a midst of a recession are unable to meet their debts payments and are forced into bankruptcy.
Thus, companies should ensure that debt levels are sustainable even in catastrophic macroeconomic conditions and should time capital raises to strengthen recession-survival capacity.
More specifically, the author invokes some McKinsey wisdom to recommend shedding weak assets as a way to strengthen balance sheets so that core operations are not drained by weak, highly-leveraged assets that will not perform well in recessions.
2. Decentralizing Decision Making
This recession-survival tactic is based on a wide-ranging 2017 study by Sadun et al., that indicates that organizational (decision-making) structure is critical to surviving downturns.
Specifically, the study examined manufacturers with different levels of centralization of decision-making authority. The study found that those companies that vested local plant managers with greater decision making authority “to make investments, introduce new products, make sales and marketing decisions and hire employees” were able be “more aggressive in adjusting their product offerings in response to changes in demand.”
Overall, the study concluded that “decentralization was associated with relatively better performance for firms or establishments facing the toughest environments during the crisis.” (Note however, that “the benefits of decentralization faded as economic conditions improved.”)
The cause for this better performance through recessions was that “decentralized firms may be better positioned to weather macro shocks ‘because the value of local information increases.’”
Ultimately, while firms need to make centralized decisions to coordinate strategic changes, during a recession, a firm should allow local managers the autonomy to try different ways to adapt to local conditions and to interact with local customers, suppliers, and employees in order to survive through the recession.
3. Preserving Human Capital
This recession-survival tactic is based on the finding from the Gulati et al. study that “companies that emerged from the crisis in the strongest shape relied less on layoffs to cut costs,” as layoffs result in lost hiring and training investments (that will need to be re-done once demand picks back up) and also damage morale and thus productivity.
Instead companies that rely on hour reductions, furloughs, and performance pay will preserve valuable human capital and be better able to expand once macroeconomic conditions improve.
However, note that companies should exercise discretion when choosing which employees are affected by hour reductions and furloughs. Since “across-the-board pay cuts or hiring freezes that fail to consider employee productivity can backfire, damaging morale, and driving away the most productive employees,” companies should instead use performance criteria and/or performance pay to make company-saving, employee-cost-reducing decisions in recessions.
4. Make Technological Improvements
This recession-survival tactic is based on a 2018 paper by Hershbein et al. that finds that successful companies use downturns to hire for and invest in IT. This partly could be due to the fact that during a recession employee attention and company resources can be devoted to technological and operational changes / improvements as opposed to maximizing production and sales (which are less necessary and possible during a recession).
Mr. Frick cites interviews with McKinsey partner, Katy George, to declare that making technological investments ahead of or during a downturn enhances recession-survival for the follow reasons:
1. Improved IT-based analytics can help management understand how the recession is understanding the business and where there is potential for operational improvements;
2. Digital technology can help cut costs and create “more flexibility around product changes, volume changes, etc. as well as around movement of your supply chain around the world.”