Written By : Johns J. Mangattu & Mrinalini Venugopal for Epiphany - S.P. Jain Competition, 2008
The current Global Financial Crisis, unlike the previous adversities which were caused by external shocks, is due to the pecuniary system itself. The subprime crisis is the root cause of the current financial crisis that engulfed first the financial industry and then the entire economy. It has led to the bankruptcies, write-offs, foreclosures and global credit crunch. In fact all the economies of the world are facing crisis to deal with this meltdown. The meltdown has led to shock waves across the world. In the long run the solutions to the crisis should include refurbishing the financial structure by deploying a grand package of initiative to limit risks and restrain the formation of such bubbles. The bailouts which are required in the short term should be focused at the low-income victims of the crisis. Companies now are tackling this issue by focusing on cost cutting and increasing the number of job layoffs. This meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. The slowdown in emerging market economies is largely due to the reduction in trade finance, decreasing capital inflows, refinancing short-term debt has becomes more difficult and the decrease in investor confidence. Now we should focus on improving our financial framework by including more reliable unbiased financial information and simplified yet stringent legal contracts and regulations.
What does it take to survive severe economic turbulence? Let’s take a look at the survivors of the great depression of 1930s. To begin, not all was gloom and doom during the Great Depression. It was a time when those who knew what they were doing made great economic strides and the very nature of the depression itself was an economic boon for them. It was a time when several companies benefited from great strategies while their rivals were short sighted. A good example of that would be Proctor and Gamble. P&G has made progress in every major recession and that is no accident. When their competitors were swinging the budget axe, P&G actually increased their spending. While the Depression caused problems for many, P&G came out of it unscathed.
D.G. Yuengling & Son, at 179 years, remains America’s oldest beer maker. During the depression they were not interested in shutting down or selling out their family managed brewery. The company adopted the strategy of diversifying by opening and operating a dairy farm and manufactured ice cream. They also invested in Broadway shows and a number of dance halls, including New York's famous Roseland Ballroom. This way their business stayed afloat.
Martin Guitars is the oldest surviving guitar maker in the world was founded in 1833. During the depression the company was contemplating on providing bulk order discounts as there is always a tendency to change policies during crisis. But they did not change their pricing strategy and did not offer bulk discounts. They were selling them at the same price as they did to independent companies. They stuck by their principles of being fair and equitable while maintaining strong relationships with dealers. They also acknowledge this to their ability to make high quality guitars, offering life time warranties to the original owners, reinvesting their profit back into the company and not leveraging or expanding through acquisitions.
The Impact on India
Even though the subprime crisis started in the USA, it has affected countries all around the world. This is mostly because the world is inter-connected and companies are going global. So a downfall of one major economy has a cascading effect on all economies.
The Growth Strategies for Indian Companies
Analyze the Company’s Vulnerabilities:
In the current challenging economic environment every company needs to assess its vulnerabilities at all levels - the industry, the company and at the SBU level. It has to quantify the impact on its business. First it has to run simulations for each of these scenarios that generate financial outcomes on the basis of major variables, including sales volume, prices, and variable costs. Next, quantify how the balance sheet will be affected under the different scenarios to find the extent to which the cash flows and cost of capital affect the company.
Evaluate Rivals’ Weaknesses:
It’s critical to not only understand the company’s strengths and weaknesses but also its position relative to those of its competitors. They will have different financial positions, cost structures, sourcing strategies, product mixes, customer focuses, and so on. To emerge from the downturn in a lead position, the company must calibrate the actions it plans to take in light of the actions that its competitors will most likely take. For example, assess potential acquisitions with a focus on vulnerable customer groups of weaker competitors.
Reduce The Company’s Exposure:
Once the company and its competitors’ are compared and the possible impact on the business is derived, it is important to find and follow a path that would minimize the ill effects of the depression.
Manage the Current Investments and its Financing:
The company has to ensure that there is adequate cash flow and access to capital. Though a lack of liquidity can create immediate problems, it is equally important to make smart investment decisions. There should be an effective cash management system to monitor and maximize the cash position. The Company has to not only work towards reducing or postponing spending but also aggressively manage customer credit risk. They have to reduce the credit period and should also segregate its customers based on either credit ratings or by its own analysis of the customers’ credit worthiness. The company will have to control credit sales by either restricting it to low-risk customers or to the ones more strategically important. They need to aggressively manage their working capital and reducing working capital to a certain extent can also free up cash. This can be used for day-to-day operations, meeting current liabilities as and when they fall due and for reducing the risk of refinancing. It is all about reducing the Company’s financial risk and enhancing the risk profile in the eyes of investors.
Control the Costs:
After ensuring that the company has a firm financial foothold, it needs to protect its business. Begin with aggressive moves to reduce costs and increase efficiency. During such crisis usually the company’s actions are tentative and conservative but the company needs to implement the actions swiftly to take advantage of the turbulent economic environment. Downturns provide the opportunity to reduce material costs as suppliers are now really competitive and also reduce the supply chain costs. Falling shipping costs or a weakening of the rupee can either help the business or adversely affect the firm depending on its industry.
Follow the Customers:
Downturns provide the opportunity to strengthen relationships with customers thereby improving customer loyalty. Identify ways to generate additional revenue from current business. Make changes in the sales force incentives and utilization by reallocating marketing spending to boost immediate revenue generation rather than long term brand building. For this, the company has to rethink the product mix and the pricing strategies in response to shifting customer needs. During recession, consumers opt for lower priced alternatives or to buy goods that are on discounts. But a careful segmentation may reveal the products that customers are still willing to pay full price. Innovative pricing strategies must be adopted by the companies to increase revenue. Changes in the pricing basis would allow a customer to hire equipments for shorter durations, or on subscription basis or by unbundling services and having different prices for different elements. Offering consumers new and creative customer financing packages could influence them to buy goods. It was during the Great Depression, that GE developed its innovative strategy of financing customers’ refrigerator purchases.
Discounts can be Dangerous
During tough economic times, companies often rush to reduce prices on their products and services as people can’t afford to spend as much, so charging less to keep them buying. But discounting has its perils. Discounting is effective when done wisely and strategically. It can get consumers excited about a product, encourage them to buy more, and help in the short-term.
Consider Abercrombie & Fitch, which lowered prices by roughly 15% during the 2000–2002 down turn. When the dust cleared, the company realized that it had sacrificed much of its brand’s cachet and lost significant market share. A&F didn’t recover until 2004 – and then only after returning to higher prices. In August 2008, having learned its lesson, the company announced that it was considering another price increase, despite a decline in second-quarter profits. But it is safe to discount something that doesn’t affect the core brand. It is similar to what GM did in 2001 by discounting its financing rather than its cars.
Use Downtime to Enhance Skills
A downturn presents the perfect downtime to enhance the skills people really need to excel. Employees at all levels can be sent for training to improve their team-building, collaboration, process ownership, and other skills – which pays off when economic normalcy returns. For example, in response to the economic downturn of 2000–2002, Alliance Business Academy, an institution in Bangalore, started conducting annual team-building exercises at a top Indian software company. Working with two of the company’s 200 teams a year, ABA focused the training on endeavors such as completing joint tasks, clarifying group values, and improving team processes. Since the program started, trained teams have been 50% more productive, on average, than untrained teams. Such professional development pays off most with employees whose team skills are poor but whose impressive individual performance precludes letting them go.
Divest Noncore Businesses
The company needs to get rid of things that have outlived their usefulness. The company needs to divest its noncore businesses, by selling off peripheral or poorly performing operations. It’s better for the companies not to wait for better times, in the hope of getting a price that matches those of recent years, when the economy was buoyant and credit was plentiful. Those conditions aren’t likely to return anytime soon, and if the business isn’t critical to its activities and increases its vulnerability to the downturn, divest it immediately.
Optimize the Marketing Mix
The Indian companies need to take advantage of the new and more cost-effective methods of interaction, where possible. Many of the successful companies today are looking across cost effective channels like Web, phone, SMS, direct mail etc.
Invest for the Future
The costs of investments are lower now, as competition for resources slackens. Today, the companies should invest more on product development and technology so that it can reap the profits once the recession is past. For example, Apple Computer, Inc. wasn’t in a particularly good shape as it headed into the 2001–2003 recession. For one thing, revenue fell 33% in 2001 over the previous year. Nonetheless, Apple increased its R&D expenditures by 13% in 2001 – to roughly 8% of sales from less than 5% in 2000 – and maintained that level in the following two years. The result: Apple introduced the iTunes music store and soft ware in 2003 and the iPod Mini and the iPod Photo in 2004, setting off a period of rapid growth for the company.
Invest in People
A downturn is also a good time to invest in people – for example, to upgrade the quality of the company’s management teams. Companies also have an opportunity to pick up good people who have been shown the door by their present employers, and get them at low cost. Competition for top people will be less fierce, availability higher, and the cost correspondingly lower.
Involving All Levels of Management Figure out the Future
When the economic situation is complex, and the stakes are high, it’s best to involve as many intellects as possible to find a solution. The solutions can be found in the most unexpected places.
Pursue M&A by Keeping an Eye on Strategic Fit
Exploit the competitors’ vulnerabilities to redefine the industry through consolidation. History shows that the best deals are made in downturns. Smaller companies with strategic fit, which are having attractive valuations, can be good opportunities to invest for the future and they may even welcome advances as they lack financial cushion. The bid for Constellation Energy by Warren Buffet owned MidAmerican Energy Holdings is an example for a potential strategically fit M&A during recession. A strategy that successful companies adopt is to move while others are distracted.
The Path Ahead
India corporate have to rethink all assumptions on liquidity, prioritize supply chain risks, revisit 3 years business plans and reassess all capex projects not already underway. They also have to renegotiate all vendor contracts so as to not get surprised by sharp fall in finished goods prices. Review commodity or index-driven pricing on contracts. Make sure treasury/sales/procurement departments work closely to ensure alignment of working capital and cash management. Revisit payment terms in the light of new credit environment. Assess supplier base for criticality and solvency. The focus should be on conserving cash. Companies need to be more dynamic and flexible to strategic planning – envision multiple scenarios and outcomes retain flexibility for changing course and build in options. The length of this crisis depends on the extent and results of coordinated actions taken globally. With some certainty, we can say that India would remain cushioned from global turmoil, to some extent, on the back of its consumption lead growth and, thus, would recover faster than the other bigger global economies.
References
- Pankaj Ghemawat, “Strategy and the Business Landscape”, Second Edition, Pearson Education, 2009
- Robert J. Shiller, “The Subprime Solution: How Today’s Global Financial Crisis Happened, And What To Do About It”, Princeton University Press, 2008
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- Ian C. MacMillan and Larry Selden, “Change with Your Customers and Win Big”, Harvard Business Review (December 2008) : 23 – 24
- Jeffrey M. Stibel and Peter Delgrosso, “Discounts Can Be Dangerous”, Harvard Business Review ( August 2008)
- BV Krishnamurthy, “Use Downtime To Enhance Skills” , Harvard Business Review ( December 2008) : 29 – 30
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