How Companies Should Invest in a Downturn
Technology firms’ stock prices have declined recently, bringing memories of the early 2000s’ dotcom bust. For example, the value of Cathie Wood’s Ark Innovation ETF has declined by 75% from its peak. This downfall is quite similar to the 78% decline in Nasdaq from March 2000 to October 2002, which was followed by a recession.
Stock price declines aren’t limited to just technology stocks. Retail stocks, a barometer for the wider economy, have also lost a third of their value since their recent peaks. Economists have started warning about both a U.S. recession and a global recession.
Furthermore, interest rates have risen and will continue to rise in the near future. Credit availability is becoming tighter. Supply chain issues resulting from China’s zero-covid policy and Russia’s attack on Ukraine remain burning problems. So far, 2022 is turning out to be gloomier than anyone’s expectations about a Covid-recovery economy.
How should companies respond to these economic developments? A natural impulse is to cut costs across the board by postponing new projects; reducing discretionary expenditures like research and development, marketing, and employee training; freezing new hiring; and reducing headcounts. And because digital stocks have suffered the most dramatic declines in stock prices recently, one may erroneously conclude that this is the end of the digital revolution, and some firms could start cutting back on their digital transformation efforts accordingly. We believe that these aren’t necessarily the best strategies for the current times. On the contrary, current developments offer unique opportunities to judiciously invest in the future. Here are three ways managers can benefit from and even plan for growth in this volatile environment.
1. Study success cases. First, recessions are typically short-lived and followed by long periods of growth and prosperity. The period after World War II, for example, is considered the greatest expansionary phase in modern times. Similar points can be made for the years after the OPEC oil embargo recession (1973 to 1975), the energy crisis recession (1981 to 1982), the Gulf War recession (1990 to 1991), the dotcom bust (2000 to 2002), and the Great Recession (2008 to 2009). Each recession was followed by a longer period of growth than the period of recession.
But more important, recessions present an opportunity because they separate wheat from the chaff, the winners from the losers. Recall that the dotcom bust was a reversal of the large-scale listing of companies, many of which had nothing more than a promising business idea, like Pets.com, eToys.com, and Webvan, all of which had little or no revenues. They were burning cash while experimenting with half-baked business ideas. The number of such listings increased dramatically during the early 1990s, leading to a peak in the number of listed firms in 1997, at about 7,400. The dotcom bust led to bankruptcies and delistings of numerous companies that had been buoyed by euphoric markets, and the technology companies that survived the dotcom bust and the Great Recession went on to become the greatest wealth creators for investors in the recorded history (for example, Facebook, Apple, Amazon, Netflix, Nvidia, Google, and Microsoft).
So, our appeal to managers is, despite the undeniable adversity, dream big to separate yourself from the crowd, and plan for the next expansionary phase. Begin by studying what the surviving companies did differently during past recessions. More importantly, study the examples of those that not only survived but emerged from recessions as winners.
For example, consider Samsung. During the great recession of 2008 to 2009, Samsung reorganized its business to focus on profitability and efficiency, as did most other players. But it also did something different by redoubling its efforts to improve the quality of a reduced set of products: semiconductors, LCDs, and mobile phones. It aimed to be a global leader in that limited set of products and anticipated that consumers would shift to higher-quality products out of fear that companies with low-quality products wouldn’t last as long in a recession. It increased its R&D and marketing expenses and hired the best brand managers and emerged as a formidable player in all three markets.
2. Expand while competitors are cutting back. A recession is the best time to acquire resources for the forthcoming expansion, all while your competitors are cutting back. The biggest and most important resource — talent — is more readily available now than during an expansionary phase. While it is true that we’re still in the midst of a talent shortage, we’re beginning to see massive layoffs in tech sector. As firms cut R&D and new projects, reduce headcounts, and cut down employee salaries and bonuses and as declining stock prices pull stock options under the water, the same talent that was joining startups or fintechs and enjoying hefty bonuses and stock options is now looking for steadier employment opportunities.
It’s also an opportune time to acquire companies and buy assets at fire-sale prices. For example, some biotechnology companies are now available for less than their cash holdings. As a result, big pharma has upped its acquisitions for digital health technologies such as apps and wearables. From 2008 to 2010, big tech acquired hundreds of new companies and patents. In addition to gaining employees and assets, it’s the right time to gain market share by attracting dissatisfied customers from competitors as they cut down on customer services. 3. Accelerate digital transformation.
A decline in digital stock prices does not mean the end of the digital revolution. Almost every company has a digital strategy, which enabled companies to run their operations as normally as possible during the Covid pandemic. The benefits of a well-thought-out digital strategy are well documented: improved visibility of resources and better resource management, enhanced flexibility and organization agility, lower costs, smoother supply chain management, better customer experience, improved productivity, faster product development, and superior human resource planning.
A meltdown in digital companies’ stock prices does not mean that those benefits don’t accrue. It is not the time to slow digital transformation. On the contrary, it’s the time to accelerate it. The volatile environment is throwing up more challenges that can best be addressed by digital transformation, as well as opportunities that facilitate digital transformation. Take the example of traditional retail companies that now face complex supply chain issues, which have deteriorated their revenue fulfillment and increased costs. Digital transformation may not solve all the problems, but it can mitigate them. For example, machine learning can enable retailers to identify shopping patterns, understand buying behaviors, adjust promotions and special offers, personalize product recommendations, tweak pricing on the fly, and balance supply with fast-changing demand and customer preferences.
More importantly, companies can now hire those engineering and information technology professionals who are being laid off from the tech sector as they begin looking for steadier employment opportunities. . . . The recent meltdown in stock prices has created unique opportunities and threats for both tech companies and main street. Times are undeniably tough, and the near future doesn’t look rosy. But history has shown us time and again that downturns tend to be short-lived and followed by long periods of expansion. The winners emerge during these challenging times are those that capitalize on the opportunities and acquire the right assets, customers, talent, and competencies at the right prices. It’s also an opportune time for industrial companies to accelerate their digital transformations, as there is enhanced need for it, and the resource availability to do those transformations has never been better.
Read More at https://hbr.org/2022/06/how-companies-should-invest-in-a-downturn