Analysis of Q1 2020 earnings calls by the Federal Reserve found that 42% of the 600 calls reviewed discussed cuts to investment compared to 25% in 2008. Though wisdom advises never to invest based on past performance as an indicator of future results, businesses have more post-recession management wisdom at their disposal today than 10 years ago. We know that cutbacks and reducing investment during a recession are not the optimal strategy for growth post-recession.
An analysis, published in the Harvard Business Review, of companies that not only survived but thrived after the past three global recessions (1980–82, 1990–91, 2000–02) uncovered a key factor to outperforming competitors:
balancing cost-cutting measures with investing in the future during the economic downturn.
Sounds simple, right? Sure. You know how to reduce operating costs here and reinvest it in tech or in equipment there. In a recession caused by an epidemic, the future is blurred by several factors outside of management’s control and the stakes are high—40% of companies studied by Gulati, Nohria, and Wohlgezogen in the aforementioned Harvard Business Review article never returned to pre-recession profits.
Our fractional CFOs partner with SMEs to provide the financial visibility needed to make smarter decisions that bolster your business’s sustainable competitive advantage during and after a two-quarter fall in GDP (also known as a recession). Knowing where your business financials stand is only part of the growth equation.
Research shows that a balanced approach to cuts and spending during a recession is a winning one. A critical question for management with the goal of growth post-recession is how to balance viability with a competitive advantage?
Have a Clear and Compelling ‘Why’ for Both Cuts and Spending
Make these hard economic times easier for your employees, investors, and customers. When the cuts start and other areas receive the green light to spend be sure to have a clear and compelling reason why both are necessary.
Why You Need to Cut Costs
Your employees know that defensive moves like restricting travel, reducing staff, and decreasing (or outsourcing) non-revenue generating activities are a part of doing business but leaders who are able to effectively communicate why reductions in spending are good for the company and, ultimately, good for employees shows that you respect their contributions and bolsters team spirit. Tell employees why because working with purpose garners results.
“Don’t make work another source of worry,” advised David Royce, Founder and Chairman of Aptive Environmental. Royce shared his top five lessons learned from the Great Recession of 2008 with Business Insider.
Keeping morale high among employees, investing in your people power, and hiring new talent are three of Royce’s five main insights. While others were laying off talent, Royce was picking up the cream of the crop for Aptive Environmental. The company’s then-president of sales instituted a daily 20-minute sales training that the company continued long after the recession ended and the company’s robust revenues reflected this investment.
Remember to communicate your plans consistently to investors during prolonged downturns. Mergers and acquisitions increase during economic downturns. Keeping your investor outlook positive will result in a short-run boost in confidence and long-run financial benefits.
Customers also need to know why your product costs more or why the quality changed. Neither one of those things is preferred, by the way. After the Great Recession, Netflix learned the hard way just how critical clear communication with subscribers was to their bottom line. In 2011, they tried to spin-off the DVD business and usher in streaming-only plans but customers weren’t ready and, more importantly, they weren’t happy about the switch.
The announcement about the DVD spinoff Qwikster (that was never to be) was a video posted to YouTube that caused enough chatter to overshadow then CEO Reed Hastings’ blog message posted in September 2011:
“I owe everyone an explanation. It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming, and the price changes…”
In July 2011, Netflix’s share price topped out at $304 and by October 25 shares were trading 37% lower. The message was too little, too late.
Why the Best Defense is a Comprehensive Offense
A careful look by Harvard Professor Gulati et al. into how 9% of companies emerged more profitable (10% or more than industry average) revealed that leaders who made cuts to the company’s core competencies did so selectively.
Staff reductions were not made across the board but within groups where efficiencies were possible. Moreover, when these same outperforming leaders invested they did so more comprehensively by spending on R&D, marketing, and capital expansion with a sustainable competitive advantage in mind.
Recession F.O.M.O. Can Lead to Aggressive Spending
The Fear Of Missing Out on advantageous circumstances like weakened competition, lower interest rates, and softened prices on capital expenditures is real. In troubled economic times, smart growth does not sacrifice your company’s sustained competitive advantage.
The cost of doing business during double-digit growth bears a corresponding (higher) price tag. During the Great Recession, Panera Bread grew to 1,421 franchise locations (from 191) by acting on a softening real estate market and sluggish demand for construction.
“The best time to grow is in a recession,” Panera Bread executive chairman and founder Ronald Shaich said about the company’s 26% increase in share price a year after the 2008 financial crisis, “The worst time to grow is in the boom days.”
Revenue growth is a huge driver of post-recession performance
Cost cutting for cash flow during recessions only goes so far. True momentum is achieved through revenue growth.
The BCG Henderson Institute’s 2009 survey found that companies that combined strategies of reducing costs with bringing on talent or adding capacity realized a higher return on investment (50% of total shareholder return) than from cutting costs alone.
Beware of Positive Group Thin
Sometimes a positive outlook can blind management to realities.
Our Harvard researchers of the last three recessions found that ‘a culture of optimism’ can crowd out more level-headed, realistic views on reductions in consumer spending, changes in consumer preferences, and getting out ahead of a market’s readiness to adopt your company’s innovation.
By taking a more balanced approach to cost-cutting and investment in the future of your business that strengthens your core competencies and competitive advantage companies can position themselves for growth after the recession ends.
Balancing this two-sided coin is the challenge, even for so-called ‘recession-proof’ companies like Netflix.
Learn from Netflix Growth During Recession
During the 2008 Great Recession, Netflix signed the integrated media and entertainment giant Starz to add thousands of well-known titles to its expanding streaming service during a time when disposable income for entertainment was tight. Choice is paramount to Netflix’s dominance in the field of streaming content. Incidentally, Starz did not renew its contract in 2012 over tiered pricing that required subscribers to pay more for Starz content but Netflix was already headed in another direction.
Netflix has experienced incredible growth during both the 2008 financial crisis and the current coronavirus pandemic. It is not surprising that home entertainment demand goes through the roof when you’ve lost your 401K or are staying home.
Netflix doubled its global subscribers in Q1 2020 during the global pandemic. Nearly 16 million new subscribers signed up (beating the projected 7 million) to watch original content like “Murder, Mayhem, and Madness” (that Netflix reported had 64 million viewers). The company is conservative in its projection for Q2 acquisitions as countries tiptoe into reopening restaurants, tourist attractions, and other entertainment venues that the public is yearning to experience during the summer months.
To remain competitive, Netflix is investing heavily in producing its own original content. It faces stiff competition from Walt Disney and Amazon in the streaming business. Until Netflix’s multimillion-dollar investment in producing original, runaway popular movies and TV series becomes profitable, the company is still reliant on costly licensed content.
Analysts are watching Netflix closely for a transition from its current model that is heavily reliant on new subscribers to offset expensive licensing deals ($100 million to stream Friends) and provide a cash flow that will uphold its share price.
Netflix’s core competencies—brand strength, global platform, and capacity for content creation—remain difficult to beat and provide that winning value proposition for subscribers (167 million globally in 2019). We will all have to wait and see if co-CEOs Ted Sarandos and Reed Hastings will be able to balance reducing costs like marketing spend while it pursues content creation.
Managing costs with spending is a bit like having one foot on the gas while the other foot is pumping the breaks. tempCFO fractional CFOs are adept at navigating market twists and turns.
Strategic growth requires the right balance of cuts and spending. At tempCFO we can help you keep your eyes on growth post-recession. Get in touch today.