Apparently more than just the lines in the sports book, …at least so says the CEO of MGM Mirage (see Casino CEO Encourages Newspapers to Change).

You see, according to Terry Lanni, the CEO of MGM Mirage Casinos, newspapers stand to learn a fair amount about change from Las Vegas.

The chief executive of the world’s second-largest casino company told newspaper editors Monday that he wished them the best in embracing change in the journalism industry, and said Las Vegas casinos have required reinvention to remain profitable.

MGM Mirage Inc. chief executive Terry Lanni…offer[ed] insights on responding to change and connect[ed] journalism’s current challenges with the transformation of Las Vegas — from a gambling-only town to a resort destination with many other amenities.

That’s what happens when an innovation (in this case, the internet) poses a fundamental challenge to your entire business model. Your options are to stick to your knitting and risk going the way of the dodo, or to change, and maybe still meet the same fate.

The problem with change in the face of such a crisis is that it is extremely costly for management to undertake, and even if they do, there’s no guarantee of success. Changing to a new business model or diversifying into new businesses is not only costly, but often stretches the firm beyond its capabilities. It’s really a double-edged sword.

But this dilemma is not unique to the casino industry or the newspaper industry. It is universal, part of a normal pattern of industry evolution. Every so often, industries experience upheaval. This is referred to as a punctuated equilibrium model of innovation (industry evolution) in the management literature. Industries experience long periods in which technologies do not change all that much, and competition is relatively stable. Then some radical innovation appears (either coming from within the industry itself, or from a complementary industry - such as the internet in this case) that upsets the apple cart.

In the aggregate, this is generally a good thing for economies. It is called progress. But at the micro level, for individual firms, industry upheavals of this sort can cause a lot of pain.

Lanni recognizes that and expressed it eloquently in his comments:

“Suffering through the turmoil of change is never easy. But as (then) U.S. Army chief of staff Gen. Eric Shinseki said, ‘If you don’t like change, you’re going to like irrelevance even less,’”

Now it might have been a bit of a stretch for Lanni to compare the type of change currently being experienced by the newspaper industry to that experienced by casinos in Vegas (in my opinion the latter experienced a much less radical challenge to its business model/value proposition). But I have to admit, it was nice of Terry to let what happened in Vegas get out of Vegas for once.

Back in March I expressed concern about Tata’s deal for Jagaur/Rover (see Buyers Remorse).

I think that this deal is destined to fail.

…For Tata, while bold, the deal just doesn’t make much sense. Aside from several luxury brands, an increased global presence, and some notoriety, I’m not sure what Tata gains. For example:

1. Where’s the synergy? Can Tata and Jaguar/LR share components, design, production, dealerships, or management? On its face, the synergies are just not there. But perhaps the investment was made for learning purposes, with Tata hoping to use Jaguar/LR capabilities to improve the quality and/or image of their existing automobiles. Possibly.
2. Can Tata rationalize Jaguar/LR’s production to make them more profitable? Actually, they cannot. They made pledges not to cut staff or close plants. And it’s unlikely that they would be able to reduce costs substantially by sourcing parts and supplies from India.
3. Can Tata right a ship that larger, more experienced, more formidable competitors had been unable to? In Jaguar and Land Rover, Tata is inheriting pieces of the old British Leyland Motors (Jaguar, Rover, Austin, Morris, etc.) that all tolled experienced (and continues to experience) more than 40 years of uncompetitiveness and underperformance. Quite simply, they are inheriting a lot of baggage (see Riding the Elephant for more background on British Leyland). It will be difficult for Tata to overcome this tremendous inertia.

Some analysts have argued that Jaguar and Land Rover were purchased on the cheap (at $2.3B minus $600M that Ford is throwing in to offset pension liabilities), and at the right time - when both Jaguar and Land Rover have a stable of new models about to hit the market (e.g., the Jaguar XF and the Land Rover LRX). These analysts point out that if these new models hit it big, it will make Tata’s acquisition look like a steal. However, this assumes that Tata can revive flagging sales at Jaguar and Land Rover in the middle of a downturn. Likewise, it assumes that Tata, by simply owning the brands, will not dilute their image. Finally, it assumes that the Jaguar and/or Land Rover brands can be revived after years of neglect and consumer dissatisfaction, and that consumers will once again be interested in buying relatively expensive, gas-guzzling cars and SUV’s (especially in the case of LR).

For all these reasons, I remain skeptical.

A recent article in The Economist echoes some of these concerns, but expresses some hope (see Now it’s Personal).

In the first quarter of this year JLR [Jaguar Land Rover] rang up profits of $421m.

But life has since become much harder for makers of large, powerful cars. In America, where petrol at $4 per gallon means big sport-utility vehicles have suddenly fallen from favour, Land Rover’s sales fell by 31% in the year to July.

So far, booming demand in Russia (up by 106%) and China (up by 151%) have more or less plugged the gap. Land Rover’s overall sales are only 2.7% lower year-on-year than in 2007. But JLR’s new boss, David Smith, acknowledges that the second half of the year will be much tougher. Land Rover’s production is being scaled back by 25-40%, depending on the vehicle model.

MY COMMENT: And it looks like things will be even tougher with global demand (even in places like China and Russia) slowing quite a bit.

A further worry for JLR is tightening environmental rules in most of its big markets. In Europe carmakers with fleets averaging more than 130 grams of CO2 per kilometre (g/km) are likely to face financial penalties by 2012. JLR is particularly exposed. Its best CO2 performer is the diesel Jaguar X-Type, which emits 154 g/km. Its worst is the Range Rover Sport which, in supercharged V8 form, chucks out 374 g/km.

MY COMMENT: JLR has a long way to go on emissions. It is not clear to me that Rover (given its portfolio of offerings) is anywhere near competitive.

One of the nice things about this article, however, is that it begins to detail JLR’s strategic plan for the next several years.

Mr Smith claims that JLR has a new nimbleness which allows it to exploit its smaller size. Strategy is set by a board consisting only of Mr Smith, Mr Tata and Ravi Kant, the head of Tata’s automotive business. Tata is committed to supporting the business plan until 2011, but the intention is that JLR should operate as a more or less independent, self-funding entity.

MY COMMENT: I’m not sure operating as an independent, self-funding entity should be Tata’s purpose with this acquisition. The best use of JLR is not to treat it as if it were a portfolio holding of Tata’s, but for Tata to exploit synergies with JLR - either reducing overall cost structure by sharing operations, parts, components, etc. AND/OR by using JLR as a means to learn - to help Tata develop up-market vehicles and learn about selling/manufacturing cars in developed markets.

Mr Smith’s strategy consists of three main elements. The first is improving customer service. Jaguar is already rated highly in America by J.D. Power, a consumer-research firm, but Land Rover “is not there yet” says Mr Smith.

The second is to recognise that, although JLR cannot compete across the board with the likes of BMW, Mercedes and Audi, it can be the best in its chosen segments. Land Rover, he says, has “benchmark products” in all its segments, and the XF, rated by several car magazines as superior to equivalent German cars, has shown what Jaguar can do. A new small Land Rover, based on the LRX concept-car displayed at car shows this year, seems certain to get the go-ahead, and Jaguar’s big saloon, the XJ, will be replaced next year with something sportier and more modern-looking. Mr Smith sees both Jaguar and Land Rover going even further upmarket, pushing into territory occupied by the cheaper Bentleys and Aston Martins.

MY COMMENT: This will be difficult for JLR to accomplish. One of the reasons JLR has a tough time competing effectively with the likes of BMW, Audi, and Mercedes is precisely because they don’t offer “across the board” models. They specialize in up-market saloons and SUV’s. BMW, Audi, and to a lesser extent Mercedes have a distinct advantage over JLR in their ability to spread development costs across models by using a single platform across multiple offerings (cars and SUV’s). This makes it difficult for LR to compete on cost with the likes of BMW, Audi, and Mercedes. Moreover, does JLR really believe it is in a league with Bentley and Aston Martin??

The third element is to reduce emissions. Jaguar is already a leader in lightweight aluminium construction and Mr Smith expects a 25% improvement in fuel efficiency over the next few years just by refining existing engines. But JLR is also investing $1.5 billion in new hybrids which will come on stream from 2012. Land Rover’s “e-terrain” technology, a diesel-electric hybrid powertrain with an electric rear-axle drive system, should give future Land Rovers even greater off-road ability while cutting emissions by 30%.

MY COMMENT: That is not enough. JLR does not currently manufacture one car that meets the European environmental standards that take effect in 2012.

And if all that were not enough, on top of all the strategic issues that JLR faces, for Tata there is the added difficulty of managing/coordinating operations across borders and cultures - i.e., an Indian firm managing a largely British operation. In cross-border deals, corporate culture needs to be integrated in a context complicated by differences in national culture. That is no easy task.

For JLR and Tata’s sake, I hope JLR survives to see 2012. But even if it does, there is no guarantee that it will turn into a profitable investment.

So I remain unswayed. I still think this is a bad deal for Tata.

Last night I read an article about the difficulty students are having borrowing money to fund their education (see No Funds to Lend to 40,000 Students). This is not a new story. Bernanke testified on the topic back in February (see Bernanke on Student Loans). There have even been ongoing conversations on the topic at my institution for the better part of eight months now. But this is the first I’ve heard of the crunch putting students at immediate risk for the upcoming semester (which starts in as little as 5 weeks).

According to the Boston Globe article:

The Massachusetts Educational Financing Authority yesterday said it will not be able to provide student loans this fall for the first time in its 26-year history, leaving more than 40,000 families without an important source of tuition funds just weeks before college classes begin.

“As a result of our problems and the continued dislocation of the capital markets, we have been unable to raise funds for the coming academic year,” said Thomas M. Graf, the authority’s executive director.

Across the country, more than 50 lenders have stopped making federal or private student loans this year, largely because of the turmoil in the nation’s credit markets that began with the subprime mortgage crisis last summer.

This news saddens me. I am saddened that the financial crisis has had such extensive a reach that financial institutions are not able to fund one of our nation’s most valuable investments - education. I am also saddened that otherwise qualified students, who might not be able to afford the substantial costs of tuition on their own, may be forced to accept uncompetitive loans at very high rates, or in the extreme, forced to sit out of school until the economy improves.

I have one proposal.

Since many universities have amassed fantastic endowments (see Wikipedia on Endowments), now might be the time for them to tap those endowments to make loans on a temporary basis (until conditions improve) to their own students. Now there are obviously large disparities across universities in their endowments; however, I suspect that many universities are in a position to support such programs. After all, it would not represent a pure expense for the school (in the form of a non-repayable grant), but rather, an investment with a potentially healthy return.

My wife and I had dinner over the weekend with some close friends who were visiting from Washington DC. One of our friends just so happens to be Chief of Staff for a U.S. Congressman. He was interested in my views of the financial crisis, and the conversation quickly turned to the recent SEC-imposed ban of naked short-selling on a host of financial institutions (see SEC Restricts Shorting 19 Financial Stocks for background).

My friend and I agree on many issues. This was not one.

It is his view (and by extension, that of his boss) that short-sellers (UPDATE FOR CLARITY: He meant short-sellers in general, naked or otherwise) are to blame for much of the ills that have befallen U.S. banking stocks. He believes that by talking their books, hedge fund managers have effectively caused runs on banks. Moreover, he suggested that rumors passed from fund managers to CNBC, then reported on CNBC as fact (even if only as “alleged” fact), exacerbate the problem.

C’mon now, are you kidding me???

As much respect as I have for this friend, who is quite intelligent, I think he’s misguided on this issue. Blaming short-sellers for the failure of banks is as ludicrous as blaming Charles Schumer for the failure of IndyMac.

It is not the short-sellers that have caused the problems, but the banks themselves for lending irresponsibly thereby impairing their own balance sheets. Short-sellers are simply calling it as they see it, making logical deductions from the information at their disposal.

Now this does not mean that there are not instances of fraud, and I agree that fraud and attempts at outright manipulation should be prosecuted to the fullest extent of the law. However, to make a well-reasoned case for why certain banks are not healthy (even if consistent with your underlying trading position) is not fraud. Concerns about the health of banks not only should be raised - they deserve to be raised. The public ought to know what professionals truly believe about a company, for good and for bad. And for whatever it’s worth, the short-sellers often have it right (see Nasty, Brutish and Short).

Short-sellers provide a vital service to the functioning of our capital markets. Restricting their behavior is not only myopic, but also raises questions about the legality of those restrictions, and the “fairness” of the system (see Naked Fear for a nice summary of key issues).

And the point about how information relayed by CNBC can lead to a run - again, who’s joking whom? By the time information is disseminated by CNBC, it’s old news.

If you truly want to know about the health of a bank, there are two places to look - its balance sheet (if you’re so inclined to pore over such minutiae) and/or the credit default swap market (as bond traders are fairly keen at evaluating the health of corporations).

For what it’s worth, the credit default swap market has recently been sounding the alarm over Washington Mutual (see WaMu: Liquidity Options Running Low, Credit Default Swaps on WaMu, Uninsured Depositors at WaMu Begging for Trouble, or Death Spiral Financing at WaMu), among others.

To my knowledge, there has been no run on WaMu yet reported by CNBC. But if WaMu were to fail, I would not be surprised.

And that would have nothing to do with this post.

I’ve never been fond of the distinction that folks make between Main Street and Wall Street, as if there were some actual divide between the “real” economy and the “financial” economy. My hunch is that the correlation between the performance of our financial institutions and the performance of our economy is fairly strong (and positive). And if anything, that correlation is becoming stronger as we move toward an increasingly service-based economy (with more than 80% of our economy now devoted to services).

Nevertheless, if there were ever a company that speaks to the general health of our economy, it is American Express. Amex is a consumer and business finance company, and scrutinizing the behavior of its customers can provide insight into the direction of the broader economy. So where the adage once was, “As General Motors goes, so goes our economy”, my guess is that could be changed to, “As American Express goes, so goes our economy.” After all, consumer spending accounts for something like 70% of GDP.

It is for this reason that I was troubled by the earnings presented by American Express (see American Express Falls), and also by subsequent comments made in the conference call.

Don’t get me wrong. I am not troubled by what Kenneth Chenault said. Just the opposite. I applaud him for being honest about current conditions. Rather, I was troubled by the content, and what it likely means for the U.S. economy.

As reported by Bloomberg:

American Express Co., the biggest U.S. credit card company by purchases, fell the most in New York trading since the Sept. 11, 2001, terrorist attacks after earnings missed analysts’ estimates and the lender withdrew its 2008 forecast.

Chief Executive Officer Kenneth Chenault said yesterday in a conference call that the business climate was “much weaker” than earlier this year and American Express was hurt in the second quarter by rising U.S. unemployment and falling house prices.

Moreover, as reported by Calculated Risk from Amex’s conference call (see here and here):

“Fallout from a weaker U.S. economy accelerated during June with consumer confidence dropping, unemployment rates moving sharply higher and home prices declining at the fastest rate in decades,” said Kenneth I. Chenault, chairman and chief executive officer. “Consumer spending slowed during the latter part of the quarter and credit indicators deteriorated beyond our expectations.“

“In light of the weakening economy, we are no longer tracking to our prior forecast of 4-6 percent earnings per share growth. That outlook was based on business and economic conditions in line with, or moderately worse than, January 2008. The environment has weakened significantly since then, particularly during the month of June.”

“Over the past month or so, we have seen clear signs that the US economy is weakening. Unemployment rates, as we know, took the largest jump in over 20 years. Home prices declined at the fastest rate in decades, and consumer confidence is at one of its all-time low points. Card member spending particularly among consumers slowed sharply during the latter part of the quarter. Credit indicators as we signaled a few weeks ago deteriorated beyond our expectations, and by almost any measure the US economy and business environment are much weaker than the assumptions we first spoke to you about back in January and the conditions that existed in early June. Now this fallout was evident across all consumer segments, even our longer-term super prime card members.”

“Affluent customers in some situations are cutting back on discretionary spending…we’re seeing a slowdown in spend across the board…The severe decline in home prices and the marked rise in oil prices have had a fundamental impact on consumer budgets and behavior. Not just as it relates to mortgages and home-related spending, but also across the full spectrum of the consumer economy…we now believe the economic weakness in the US will likely worsen throughout the remainder of the year…” (emphases added by Calculated Risk)

Given this information, my expectations are that the chances for a second-half rebound are extremely remote, irrespective of what happens to oil prices (see Mish’s excellent posts on Deflation here and here). Moreover, I now expect conditions similar to those experienced by Amex to spillover to a broader swath of corporations, …not limited to housing, finance, and consumer discretionary.

For me then, this news speaks to the breadth of impact that we should expect from this recession - on both Main Street and Wall Street. My call therefore is still for long-and-deep versus short-and-shallow.

I don’t know how many of you have been following the Miller Coors story, but the Justice Department gave its blessing to the joint venture combining the U.S. operations of SABMiller and Molson Coors (see Justice Department Clears SABMiller-Molson Deal). The venture will be called Miller Coors.

The approval was not entirely unexpected. Although I am not an expert in antitrust issues, the consensus was that this deal would not vastly alter the competitive landscape. However, I will point out that Miller Coors and Anheuser Busch will now collectively control about 80% of the U.S. beer market (sounds fairly concentrated to me).

Antitrust issues notwithstanding, now the hard work begins - combining the two firms. For those of you who have followed my blog, you know where I stand on this deal (see Now Introducing Miller Coors, JV??? and Miller Coors JV for background).

I basically suggested that I thought the deal should have been structured as an acquisition rather than a joint venture, and that the joint venture structure would strain the union. Back in November I wrote:

In my opinion, a joint venture between SAB and Molson Coors in which each shares equally in the decision rights will run into many conflicts…Sharing power across firms in a joint venture can lead to conflicts over the appropriate way to go about running the new business, can result in delays in achieving synergies, can lead to greater staff defections, and can result in greater than necessary managerial costs. All this ultimately stands to hurt the performance of the new venture, and these kinds of deals can quickly devolve into an ugly power struggle between senior managers from two companies that don’t understand each other’s culture.

Because the potential for synergies, the opportunity for pricing power, and the ability to create a more formidable competitor vis-a-vis Anheuser-Busch are all so great between Miller and Coors, centralized ownership (with one firm and one set of managers calling the shots) would be a more effective way to achieve those benefits. I therefore have this uneasy feeling that “management problems” will plague this joint venture in the months and years to come.

So congratulations Miller Coors, …and good luck!

So now that I’ve had the time to decompress and think carefully about my experience at the 2nd Sumantra Ghoshal Conference on Managerially Relevant Research (see Off to London for background), I’m more convinced that my time was well spent.

It was nice to be part of a conference with the explicit intention of bringing academics and practitioners together to discuss research papers, and the role of academic research in the everyday lives of managers. The conference was attended by academics from various of the top business schools in both Europe and the U.S. Moreover, there was ample managerial representation from firms such as Accenture, Hoffman-LaRoche, McKinsey, Saatchi & Saatchi, RBC, and the Financial Times (to name a few).

Some highlights from the conference included:

• The organizers of the conference administered a survey before the conference began and presented some interesting data on the most important issues managers and scholars believe are facing businesses moving forward (credit concerns aside). What I found most interesting is that managers generally agreed about the most critical issues facing their businesses. They identified the following strategic issues as crucial: How to attract and retain talent; How to build and leverage knowledge; How to Identify the next area of growth for the corporation; How to align the organization toward common goals; and, How to draw up an appropriate mission statement. The academics, by contrast, were all over the map. We didn’t agree on much of anything. About the most you could take away from the data for the academics is that all of us in attendance have very different research interests. Some of us thought that “Building and leveraging knowledge” was important, some thought that “Identifying the next area of growth for the corporation” was important, some thought that “governance” was important. But for the most part, there was little agreement among us.
• There was general agreement among most of us that academics influence practice in a multitude of ways, and that influencing practice is not always about getting our research directly in front of the eyeballs of managers. In fact, if anything, this is probably a small part of how we influence managers. We obviously have the greatest impact through our teaching, at the undergraduate, MBA, and executive levels. We also influence managers through consultants (who borrow and implement our ideas), and on occasion, by consulting directly with firms. Scholars also influence practice through our impact on policy - by proffering informed opinions to politicians or testifying on business practice. In this sense then, we help shape the game and inform the agenda - helping decide which issues are important and which are not.
• One of the McKinsey representatives suggested that she (and other management consultants) routinely scan and read academic research to extract the latest ideas, concepts, and tools to apply on client engagements. Interestingly, one research paper presented at the conference suggested that those ideas, concepts, and tools are often applied inappropriately, and sometimes without effect. However, the research also suggested that although sometimes applied incorrectly, they get people within the organization to openly communicate about strategic issues, thereby generating some value, if not exactly that originally intended.
• With respect to our research, there was considerable debate on the type of research we ought to be doing - whether research that directly addresses specific management problems, or research that we ourselves consider important, irrespective of whether it’s managerial relevance is immediately obvious. One view expressed (with which I must say I agree) was that we must not lose site of the fact that as business school faculty, we are a part of an applied, vocational program with a mandate to train business leaders. We therefore cannot lose sight of, or become completely detached from, our audience when conducting our own research, for taken to an extreme, research that is disconnected with the interests of our constituents will ultimately repay us with lower enrollments.

All in all, I got a lot out of the conference. It was fun to spend a few days interacting with a bunch of really smart folks (both academics and managers) discussing some really interesting issues.

The 2nd Sumantra Ghoshal Conference on Managerially Relevant Research officially wrapped-up last night. A very worthwhile endeavor again this year! I’ll provide more detail in a follow-up post later in the week, but I just wanted to pass along what I thought was the best quote of the conference. Mark Spelman, the head of Global Strategy at Accenture, had the following nugget of insight to pass along:

The most problematic relationship for the Chief Strategist is the one with the CFO

What a great line. It makes complete sense to me. According to Spelman, the strategist often does not have control, or decision-making authority, over the deployment of any actual resources. Rather, it’s the CFO that holds the purse strings. In this sense then, the Chief Strategist can only influence decisions. So the best strategists are not only keen, intelligent types, but those who can make an influential case that leads others in the organization to take actions consistent with his or her recommendations.

…some food for thought.

More to come as soon as I’ve finished collecting my thoughts.

In June of 2007 I blogged about Tesco (the British supermarket, and the world’s third largest retail firm) and its entry into the U.S. (see Tesco’s American Foray for background). At the time, I expressed some serious reservations. I suggested that Tesco would have difficulty in the U.S. market for several reasons:

1. Tesco would have trouble convincing customers to come to stores that offer more convenience simply because they are smaller. I suggested that American consumers actually prefer the variety that larger supermarkets have to offer.
2. Tesco would likely end up in a classic “stuck in the middle” trap because they were targeting the middle-market (not the mass consumers and not the upscale consumers). As a result, they would have trouble appealing to the top portion of the middle market that prefers to shop at the upscale chains, and the bottom portion of the middle market that prefers to shop at the downscale, mass market outlets. In trying to broadly appeal to the middle market, they therefore wouldn’t satisfy any niche adequately. For this reason, I argued that Tesco would find itself squeezed on both sides by the likes of competitors such as Whole Foods and Wal-Mart.
3. Tesco would face difficulty precisely because they were foreign. Foreign firms face difficulty because they often don’t speak the language, don’t know the culture, lack local operational experience and infrastructure, and don’t know how to navigate the legal and regulatory environment. All of this results in increased costs for foreign firms, and places them at a competitive disadvantage vis-a-vis their domestic counterparts.
4. Tesco is competing as a foreign entrant in an industry with razor thin operating margins, so there’s little room for error.

Interestingly enough (you had to know this was going somewhere), I came across this article from last week’s edition of the OC Register (see Tesco’s Fresh & Easy Off to Rocky Start). This article seems to suggest that Tesco is facing many of the difficulties I identified. These issues have manifest as worse than expected results. As Nancy Luna details:

…despite developing a loyal crop of fans since launching in November under huge fanfare, Fresh & Easy [Tesco’s U.S. stores] faces some not–so-easy problems, critics and industry experts say.

This week, a Piper Jaffray analyst said Fresh & Easy sales are falling short by at least $30,000 a week. The report comes only days after a Florida-based supermarket consultant told a group of British investors that Tesco has miscalculated the needs of American shoppers with its confusing grocery concept. Prevor [the Florida-based supermarket consultant] estimates that stores are generating average weekly sales of $50,000. The Piper Jaffray report was much more generous, predicting revenue of about $170,000 a week – just below Fresh & Easy’s sales goal of $200,000.

…industry watchers say Fresh & Easy has missed the mark. Among the chief problems: shoppers are put off by labels…Many also complain that the stores are bare bones with very few brand selections. “Fresh & Easy is trying to be an easy store,” said Jim Prevor…”It’s hard to be convenient, if people don’t feel (stores) meet their needs.” As a result, the 10,000-square-foot stores are often described as ghost towns with eager to please clerks often outnumbering shoppers…many [consumers] are bothered by [Tesco’s] Fresh & Easy’s confusing labeling system…”It’s a catastrophe for them”…

It’s not all bad news for Tesco. In all fairness, we certainly can’t attribute all of their poor results to mis-management. We can chalk a portion of it up to poor timing - it’s not as if the middle of a credit crunch is the best time to enter the U.S. retail business. Unless, of course, you consider poor timing a result of mis-management. But I guess that ultimately depends upon whether you believe the credit crunch was forseeable to Tesco’s managers ex ante. I’d like to give them the benefit of the doubt. Nevertheless, I still believe that Tesco faces some serious headwinds in the U.S. market (a market that already faces some serious headwinds of its own).

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…