What should be the winning strategy during economic slowdown?

Winning strategy in Economic slowdown

In this blog, we shall discuss on what should be the winning strategy for companies to survive in economic slowdown. We shall limit the scope of this article to Technology sector.
Any economic downturn should hold substantial opportunities for companies operating in Technology sector.If companies manage to build an action plan and execute it successfully, then it puts them on path to emerge resilient during the economic downturn.

Unprecedented growth in Technology sector

  • Over the past decade, the tech sector has seen an unprecedented growth.Seven of the ten largest companies globally by market capitalization were dominated by tech companies.
  • Incumbents like Apple, Disney and Verizon are joined by the new group of digital companies like Alibaba, Facebook, Netflix, Amazon and Google who have been able to successfully disrupt the industry by its innovative business models.
  • The successes of these companies are largely due to growing appetite for technology products/services from business and consumers.
  • This growth has finally hit a roadblock as the current global economic growth is uncertain and gloomy. Business investments in the US, UK and Germany – Three large global economies contracted in second quarter of 2019.
  • Although it is difficult to predict the next downturn and its damaging consequences, there are enough signals to show that we are inching closer towards the next slowdown.

How the economic slowdown will impact Technology sector?

  • It is impossible to predict the impact of economic downturn on individual companies in the tech sector, but one thing is certain; the resilient companies will outperform the rest of the sector by a huge margin.
  • The resilient companies do more than cost cutting.They outperform their competitors by investing in several key strategic initiatives, some of which are no-regret moves.
  • Some of these initiatives include improving the productivity and amount of their Sales and Marketing investments, increase their investments in core growth engines and remaining active in M&A/Divestitures.
  • A slowdown will give an opportunity for all companies to set itself up for long term trajectory growth.Successful companies go for an overkill during the downturn to strengthen their long term strategic positions.
  • Hence investors who were using their huge cash reserves to drive returns to shareholders by resorting to share buybacks and dividends payments should look for making strategic investments to drive the next leg of growth.
  • Tech sector needs to start planning earlier and then take actions as companies cannot wait till the onset of the downturn to take actions.Executing strategic initiatives takes time as it requires buy-in from executive leadership, board and shareholders.Hence it is important that these strategic plans are long term and not yield to short term impulses.

Lessons from previous economic slowdown

  • One of the biggest lessons observed that mattered greatly was how resilient companies operated heading into and during the downturn matters.
  • Studies show that only 20% of the companies had success and accelerated their performance relative to its peers.These companies consolidated and further strengthened their growth after coming out of the slowdown which led to their market leadership position in the years following the downturn.
  • Tech sector had traditionally outperformed other sectors during downturns and hence give them significant tailwind compared to other industries.

Four factors that contributed to their success is:

Strategy 1 during economic slowdown – Improving productivity and increasing Sales/Marketing investments

  • Successful resilient companies improved their sales productivity and at the same time also increase their investments in sales during the downturn.
  • For instance, Salesforce increased its productivity in Sales/marketing investments to 34% of its revenues from 31% during 2008 recession.

Strategy 2 during economic slowdown – Continue investments in R&D

  • Successful resilient companies increase their R&D investments during recession.
  • For instance during 2008 recession, Salesforce increased its R&D budget as % of revenues from 9% to 11% to upgrade its existing products and expand to new offerings.

Strategy 3 during economic slowdown – Create capacity by reducing leverage

  • Successful resilient companies deleveraged and reduced their outstanding debts when moving towards recession.This created additional room for them to invest in strategic initiatives.
  • Non resilient companies had Debt to EBITDA ratio of up to 2.5 times more than resilient companies going into recession and this ratio increased to 9 times during the recession.

Strategy 4 during economic slowdown – Active in Mergers, Acquisitions and Divestitures

  • Resilient companies divested their non core offerings during the recession to unlock capital which could be invested for high growth initiatives.
  • Resilient companies increased their M&A activity during the recession as the economic climate helped them to get companies at a fair market value.
  • For instance, Disney acquired Marvel Studios – Famous for producing Avenger movie series for only $4 billion.The total box office collections from the Avenger series is $18 billion.

How to plan for the next economic slowdown?

  • The market environment has changed significantly now when compared to the last recession.Tech sector is growing significantly lower than when it was heading towards recession last time.
  • Trade and geopolitical risks like US China Trade war are creating significant uncertainty for global supply chains.
  • Leading disruptors like FAANG companies have been successful in achieving scale where as new age disruptors – Uber and Airbnb have raised a huge amount of capital.
  • Financial factors have also altered the situation.More companies have high debt resulting in higher Debt/EBITDA ratio where at the same time interest coverage ratios – EBITDA to Interest expense have deteriorated. The proliferation of subscription models have increased variability risk in revenue which can increase vulnerability particularly during the slowdown.Shareholder activism is at all time high as activist control how boards should deploy large amounts of its cash reserves.
  • Cost cutting measures as a mechanism to improve productivity is no longer sufficient.Productivity gains require investments in digital, automation and analytics which would be difficult to obtain during downturn.

How successful companies build and execute their Action plans?

  • Traditionally more companies operate to focus on day to day tasks of increasing revenues and shareholders returns rather than preparing for slowdowns.Hence leaders must have an action plan that results in sustained stable growth regardless of market conditions.
  • This action plan needs to have leadership commitment and support.The plan needs to be grounded on how the recession will impact not only the company but its competitors, customers and suppliers.For instance tech companies needs to understand which customers are going to continue spending and which are going to pull back.As companies move towards adjacent businesses, they need to understand the competitive landscape and the actions taken by the new and existing players to weather the slowdown.
  • The plan must include an assessment of the company strengths and weaknesses in Operational, Organizational and Strategic front and a financial plan that incorporates scenarios based on these inputs.

Resilient action plans will be different for each company and should be built based on whether the organization is a disruptor or incumbent.

Disruptors during economic slowdown

  • Companies that are disruptive and well capitalized will go for offensive to establish a sustainable competitive advantage.They would be aggressive in M&A as well as invest in organic investments in Sales/marketing. Disruptors with clean balance sheets should buy strategic assets as they will be available at attractive valuations.
  • These companies will focus on reallocating resources to high priority initiatives in order to boost its slowing topline growth.
  • These include critical revenue drivers like encouraging renewals and expand company footprint through superior customer experience.Margins drivers like Value added pricing, using Machine learning and AI to drive R&D productivity along with implementing Agile and Devops throughout the organization.
  • Disruptors spend higher amount on operations but also ensure these investments provide superior returns.

Incumbents during economic slowdown

  • Incumbents need to plan on how to position themselves during the downturn.For companies operating in matured and legacy markets, downturn will cause drop in revenues, hence incumbents need to plan for that possibility.
  • Incumbents M&A strategy needs to finalize where to acquire and divest.This needs to be done after company evaluates its business portfolio to validate if it is still the best owner for each asset and if it can create most value.If company has decided to divest, then it needs to do quickly given the relatively higher value for these assets now.For M&A, acquisitions needs to be evaluated to confirm if they can add shareholders value.
  • For organic growth, incumbents needs to decide where to cut and to invest.Investments in Digital and Analytics is required to compete against Digital natives.Any R&D investments needs to aligned towards high growth products even though they are not yet major revenue sources.The productivity needs to be improved by optimising processes like adopting agile, Devops and lean aided by Machine learning and AI.
  • The sales and marketing costs can be optimised by driving improvements across the customer life cycle in sales, pricing, renewals while at the same time improving revenues.

Conclusion

  • Economic slowdown generate significant opportunities for tech sector.Every recession has given rise to next generation leaders in tech sector.
  • Resilient companies build their action plans before downturn starts and align their plans across shareholders, executive team and board without delay.


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