I’m often asked about how firms respond to recessionary pressures, and what role strategy plays in such an environment. While I couldn’t possibly comment on the specific responses of each and every firm, there are some general comments that can be made about firm strategy during economic slowdowns.

We often think of firm strategy (whether at the business level or corporate level) as a forward-looking, planned set of actions and behaviors. Now if we’ve anticipated the slowdown, then presumably we’ve already prepared and planned our strategy appropriately. If so, there should be very little change to our strategy in a recessionary environment because we’ve predicted it, and adjusted our strategy to it well in advance.

Too bad things in the real world aren’t so simple. Economists can’t even agree that we’re in a recession, let alone whether one will eventually occur (I’m going to go out on a limb here and say that we’re currently in one). If economists who focus on these things can’t agree on whether or not we’re in a recession, how can we have planned for something that as little as 6 months ago we could not even have foreseen? That’s a good question. So for all those firms that didn’t expect the slowdown/recession, what impact might it have?

It’s important to recognize that during recessions, some industries are hit harder than others. Moreover, some firms feel it more. For firms in the healthcare industry, recessions often have less of an impact, especially because people don’t stop getting sick when the economy sours. However, even within healthcare, there are expenditures which are more discretionary (e.g., it would be nice to have that corrective eye surgery) versus non-discretionary (e.g., I need the open heart surgery because if I don’t, I might die). Therefore, we might expect firms that specialize in corrective eye surgery to be impacted more than firms that specialize in open heart surgery.

But the issue of industry/firm heterogeneity aside, strategy during a recession can become about delaying and postponing activities while continuing to exploit current operations, especially for firms that are fundamentally sound. For example, a firm may have devised, and planned, a strategy for growth through acquisition. However, once a recession takes shape, they realize that credit may be unavailable to pursue their strategy. Although equity prices usually drop during a recession, making target firms cheaper in nominal terms, the aquirer may not be able to finance any purchase because there might not be anyone willing to underwrite it (or at least underwrite it at an attractive rate). What happens in such a case? Well, you put your plans on hold in the near term. Does this fundamentally change your strategy? Not really, you might just have to delay its execution. In the meantime, the firm focuses inward – turning its attention to managing its current operations (or portfolio of businesses) efficiently and slowing its rate of growth (reducing the rate of investment/expansion in current businesses and reducing the rate of new hires).

In some cases however, especially for those firms that have less sound balance sheets (e.g., too much debt), strategy becomes more about holding on for dear life just to weather the storm. For example, during economic slowdowns, demand for a firm’s goods often wanes in the near-term. For some, an unexpected negative shock of this sort can come as a big surprise. For these firms, forget postponing acquisitions or growth activities. They’ve got more important things to worry about, like remaining solvent. Paying their bills becomes priority number one. Firms in this situation may not have the financial flexibility to withstand a recessionary shock, and might be forced into multiple rounds of layoffs to eliminate costs as quickly as possible, in the hope that costs will decrease faster than the revenues – all in an effort to remain current on their obligations. Interestingly though, for these firms, so many divisions, business lines, and people (talented human resources) are lost during the process that even if the firm is able to survive in some form, it comes out in a much weaker position than it went in – having to re-plan, and re-build its strategy again from the ground up.

As I have pointed out in the past (see The Future of Corporate Performance), unfortunately there are currently many more firms in the latter situation (financially unsound as judging by the historically high percentage of bond issues with non-investment grade ratings – 48% in 2007) than the former. This should usher in a difficult period of above-average default economy-wide, …and a period of strategy on the fly for many firms. I am left only to hope that a good deal of firms have accurately predicted, and prepared for, the slowdown…

This entry was posted on Tuesday, January 29th, 2008 at 12:37 pm and is filed under Business Strategy, Corporate Strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.