It’s now official: the
There is only one problem with this advice: it’s wrong. It reflects a number of entrenched orthodoxies — deeply held and widely shared beliefs about how to succeed — that may have been right a long time ago, but are now outdated. Unless your organization is on the brink of immediate collapse, reacting to recessions through these knee-jerk strategies can have deadly consequences. Long-term success requires challenging these orthodoxies, and in most cases overturning them.
Orthodoxy #1: Cutting costs aggressively is the way to succeed in tough times. The economy is down, customers aren’t buying, sales are declining, inventories are bulging - it seems obvious that the only way to avoid a financial disaster is to cut costs aggressively. Indeed, an Accenture survey of business executives conducted during the last recession, in 2002, shows that at the time cost cutting was a top priority for 53% of executives while developing new services was a top priority for only 15%.
Actively searching for opportunities to reduce costs should be a normal part of business activities even in good times. But you should distinguish between pruning and hacking. Evidence from several sources suggests that aggressive cost cutting results in serious long term problems. A Mercer Management Consulting study of 116 companies that cut costs aggressively during the 1990-91 recession showed that in a subsequent five year period, 46% saw a decline in sales and profits - this at a time when the US economy was booming. Clearly, the aggressive cost cuts had endangered the companies’ future prosperity.
Aggressive cost cutting often has a deep negative impact because of its impact on people. An American Management Association study of firms that downsized between 1989 and 1994 shows that productivity increased in 34%, stayed the same in 26%, and decreased in 30% — hardly a resounding success. At the same time, morale declined in 86% of these firms.
The lesson: Reduce costs selectively, not indiscriminately, and monitor carefully the impact of cost cuts on your people.
Orthodoxy #2: Investing during a recession is irresponsible. Axing investments is another way to preserve badly needed cash. An analysis from the Bureau of Economic Analysis shows that after rising sharply between 1993 and 2000, business investment declined in 2001 and again in 2002 as the economy slipped into recession.
But the evidence suggests that smart investments in a recessionary environment pay off. A McKinsey analysis of 1,000
There’s also a silver lining about investing during a recession – talent, assets and even whole companies are cheap. Witness
The lesson: Don’t stop investing - instead look for undervalued assets and for opportunities to upend your rivals who only think of retrenching.
Orthodoxy #3: Don’t innovate during recessions, because innovation is risky and costly. In 2003, Strategos surveyed over 500 executives about the main obstacles to their companies’ ability to extract value from innovation. Two of the top six barriers mentioned were high cost and high risk. But innovation doesn’t have to be risky or costly.
As explained in a recent article “Funding Growth in an Age of Austerity2,” there are a number of ways to innovate on the cheap. Two among them are particularly noteworthy in recessionary times: Raising the ratio of externally sourced innovation to internally sourced innovation - in other words, embracing “Open Innovation”; and raising the ratio of knowledge over investment in innovation projects through a series of well thought out, low cost experiments. The latter has the double advantage of reducing both cost and risk, as illustrated below.
P&G’s Chairman and CEO A.G. Lafley certainly doesn’t believe that innovation should stop during recessions. In a recent interview with Business Week3, he said “(Entering a recession) really doesn’t change my thinking on innovation… I would argue that innovation is even more important in a recession.” Jeff Immelt, Chairman and CEO of GE, sings the same tune: “Companies and countries that really play offense vis-Ã -vis technology and innovation are going to come out ahead4.”
The lesson: De-risk and lower the costs of your innovation efforts by reaching outside your company and by conducting well-designed experiments.
McKinsey Quarterly, 2002 Special Edition: Risk and Resilience “Learning to Love Recessions”
- Harvard Business Review, July-August 2004
- Business Week,
April 17, 2008 Quoted in The Economist, November 22, 2008 Business 2.0, April 2003