How to survive a recession and an election, and prosper afterward
Recessions—defined as two consecutive quarters of negative economic growth—can be caused by three things, or by some combination of the three. First, the cause may be an economic shock, such as a spike in oil prices. Or the trigger may be financial panics, like the one that preceded the Great Recession, or finally, rapid changes in economic expectations.
In 2018, South Africa experienced its first technical recession since the global financial crisis. This was at a time when the global GDP grew at 3.7% and developing economies’ GDP grew at 4.7%, according to the International Monetary Fund’s report on annual real GDP growth. The technical recession was announced following negative GDP growth in quarter one (at -2.6% and -0.4%) and in the second quarter of 2018. Fortunately, SA recovered quickly from the recession with positive third quarter GDP growth of 2.2%.
Although elections are political and not financial events, the lead-up to and the outcome of the national elections in May have significant economic impacts. Investors are feeling discouraged by the uncertainty of the outcome of the elections, and ratings agencies are keeping a close eye on SA. Issues range from the raging controversy about the land expropriation bill to effective financial budgeting on the part of the national treasury.
Most firms suffer during a recession, primarily because demand and revenue fall while uncertainty about the future increases. But research shows that there are ways to mitigate the damage.
In their 2010 HBR article “Roaring Out of Recession,” Ranjay Gulati, Nitin Nohria, and Franz Wohlgezogen found that during 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 is the fact that 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. A more recent analysis by Bain using data from the Great Recession reinforced that finding. In Bain’s analysis the top 10% of companies saw their earnings climb steadily throughout the recession and continue to rise afterward. A third study, by McKinsey, found similar results.
The difference maker was preparation. Among the companies that stagnated in the aftermath of the Great Recession, “few made contingency plans or thought through alternative scenarios,” according to the Bain report.
Risk-taking is at the core of judgement and since the world is relatively uncertain, it is difficult to judge what the probabilities of a growing economy or a recession ahead really are. But the right way to deal with that unknowing, is to build in a cushion to protect yourself against the possibility of an event occurring. People are often taking more risk than they understand, which makes it necessary for companies to bring in an independent pair of eyes to look at the ‘dark scenario.’
Research from Grant Thornton, seen by the Financial Times, found that during the last recession only 30% of companies saw danger coming and were able to tap into their risk management procedures to mitigate the impact of the recession.
During the boom period of optimization when house prices were high and the economy healthy, firms were not building enough of a cushion against something going wrong. They were not even building much awareness that things might go wrong. They viewed a recession as so improbable, so outside their memory or experience that they saw no reason to spend the resources it takes to build up a cushion. They had no recent memory of panics; it was just so improbable….
Recession re- thinking
Today we have that memory and we need to raise resources to cover losses. Companies with high levels of debt are especially vulnerable during a recession. The more debt you have, the more cash you need to make your interest and principal payments. When a recession hits and less cash is coming in the door, you are at risk of defaulting. To keep up with payments, companies with more debt are forced to cut costs more aggressively, often through layoffs. These deep cuts can impair their productivity and ability to fund new investments.
In Tim Geithners book, Stress Test, he says “we need to instil into the process of decision-making culture a sense of humility and caution about the uncertain future.” We need to establish a sense of caution, so even if there is a low probability of a downturn we need to prepare for the event.
Basically you must picture what could go wrong and work out measures of how you can protect yourself against that.
It’s the most important thing to do when there seems to be the least reason for doing it. Geithner says that when you think recessions will be mild and unlikely, this is the most important time to set aside the returns from optimism and build yourself a better margin of safety.
Layoffs to cut costs
In their January 2019 Engineering News article “South Africa’s largest labour union plans nationwide strike over mass layoffs,” Reuters highlighted South Africa’s large-scale layoffs at ailing state-owned firms. As for private companies, Eskom announced plans to shed around 7 000 staff over the next five years. Loss-making state broadcaster SABC plans to lay off around 1 000 permanent employees.
Numerous mining firms also plan massive layoffs. Impala Platinum plans to reduce its workforce by a third, Sibanye-Stillwater expects to cut 12,600 jobs over three years, and Gold Fields will shed more than 1 000 jobs. Lender Standard Bank aims to cut 526 information technology (IT) jobs.
Some layoffs are inevitable in a downturn because they are strategies that cut costs and lean instead on operational improvements. However, layoffs aren’t just harmful to workers; they’re costly for companies, too. Hiring and training are expensive when companies have to rehire as the economy picks back up. Layoffs can also hurt morale, dampening productivity at a time when companies can ill afford it.
Sandra J. Sucher and Shalene Gupta, in their 2018 HBR article, “Layoffs That Don’t Break Your Company” describe just what the title implies. Honeywell suggested solutions that, depending on local labor regulations, saved an estimated 20,000 jobs. They suggest that companies should consider strategies like hour reductions and furloughs. Furloughs may include leave of absence or short-time work, which allows companies to have discretion over which workers are affected. Performance pay, or compensation based on some measure of productivity or business outcome, is another way to control labour costs without hurting productivity. These all take a longer term approach to productivity.
Companies most likely to outperform their competitors after a recession
In the article “Roaring Out of Recession,” mentioned above, the researchers found that the CEOs of pragmatic companies recognize three key facts: that cost cutting is necessary to survive a recession, that investment is equally essential to spur growth, and that they must manage both at the same time if their companies are to emerge as post-recession leaders.
They cut costs mainly by improving operational efficiency rather than by slashing the number of employees relative to peers. However, their offensive moves are comprehensive. They develop new business opportunities by making significantly greater investments in R&D and marketing than their rivals do, and they invest in assets such as plants and machinery.
According to Katy George, a senior partner at McKinsey, the first reason to prioritize digital transformation ahead of or during a downturn is that improved analytics can help management better understand the business and how the recession is affecting it. They can also see where there’s potential for operational improvement. Progressive companies stay closely connected to customer needs—a powerful filter through which to make investment decisions – and digital technology makes this possible.
Secondly, digital technology can help cut costs. Companies should prioritize “self-funding” transformation projects that pay off quickly, George says, such as automating tasks or adopting data-driven decision making.
Thirdly, IT investments make companies more agile and therefore better able to handle the uncertainty and rapid change that come with a recession. Digital technologies “create much more flexibility around product changes and volume changes, as well as around movement of your supply chain around the world.”
Companies that adopt these approaches in combat, often initiate solutions which become the foundations for their successes after the downturn and provide them with the momentum to reach new levels of success. Stay committed to improving your business and you can emerge a stronger company and a more experienced entrepreneur.