Many economists are forecasting a downturn, if not a full-blown recession, over the next 12-24 months. We have seen one of the longest expansionary phases in recent history, leading indicators have softened in many countries, stock markets are volatile, and several risks cloud the horizon. Naturally, business leaders are considering how to best position themselves for harsher macroeconomic conditions.

If history is any guide, many companies will prepare too little, too late, and too defensively. Yet our analysis of more than 5,000 companies across the last four business cycles suggests that slowdowns bring opportunities as well as challenges: some companies were able to actually benefit competitively during and after a downturn, and a common set of actions led to that success.

Today’s business landscape has several unique features, which will add new complexities on top of the historical playbook. This makes it important for business leaders to prepare for the specific circumstances of the next downturn, as well as exploiting the right lessons from the past.

Some companies gain an advantage in economic downturns

We studied all U.S. public companies with greater than $50 million in annual sales during the last four downturns—including not only recessions but also periods of substantially slowing growth (we define downturns to include recessions (periods of negative GDP growth) as well as periods of cumulative decline in annual GDP growth of at least 1 percentage point over two years) —and found that nearly three-quarters of those companies experienced a decline in revenue growth. However, 14% of companies were able to not only accelerate growth but also increase profitability.

The competitive stakes are high: that 14 % of outperformers grew sales by 9% annually during the downturn and increased earnings before interest and taxes (EBIT) margin by 3 percentage points on average, while all other companies’ sales declined by 2% and EBIT margin declined by 2 percentage points. Competitive volatility—as measured by the change in composition and ranking of the Fortune 100—rose by 30% in recent downturns, also suggesting an opportunity for some. Notably, competitive volatility rose by just as much during more moderate downturns as in deeper recessions.

The companies that weather downturns successfully tended to respond differently on a few key dimensions:

They acted early. Leaders may understandably be reluctant to take major actions until they see clear evidence that they are affected by economic headwinds. However, we found that the companies that proactively recognized the threat—by discussing the possibility of a downturn in their earnings calls before the economic recession officially began in Dec. 2007—achieved 6 percentage points better Total Shareholder Return (defined as total returns to investors including capital gains and dividends) in the downturn than companies that did not address the challenge early.

They took a long-term perspective. Leaders have to attend to short-term issues during a downturn to make sure their business remains solvent. But substantial competitive opportunities await the leaders who can also keep one eye on the long-run picture. We used natural language processing algorithms to assess companies’ long-term orientation from SEC filings, and we found that companies with a longer-term perspective achieved 4 percentage points higher annual growth during the downturn as well as 2 percentage points higher total shareholder return.

They focused on growth, not just cost-cutting. To go beyond survival and gain a sustainable advantage, companies need a balanced approach to performance. The small minority of companies that achieved double-digit annualized Total Shareholder Return in downturns pursued efficiencies, improving their profit margins. But the most important driver was revenue growth, which accounted for nearly 50% of their shareholder return—twice as large as the impact of cost reductions. (The remainder was driven by investor expectations.)

Current risks to the economy

Though historical lessons can help business leaders prepare for a slowdown, there are several unique features of today’s business landscape which also need to be taken into account.

Economic forecasting is an inexact science at the best of times, but views are particularly divergent today, ranging from the possibility that the worst may already be over to the prospect of a more severe recession in the near-term. The uncertainty is driven by elevated risks on many fronts: technological risks, including cybersecurity and trust; economic policy risks, including challenges to international institutions; social risks, including increasing inequality in many countries; and planetary risks, including climate change. As Christine Lagarde, Chair of the International Monetary Fund, said recently, “The global economy is facing significantly higher risks … [and] these risks are now increasingly intertwined.”

We organize the current critical risks to the economy into these categories:

1. Technology, including AI governance, data privacy, and trust
2. Economy, including growth, uncertainty, trade, U.S. versus China
3. Society, including the future of work, inequality, inclusion, and cohesion
4. Planet, including plastics, global warming, clean water

In many past downturns, falling economic growth was the dominant issue. In the next downturn, however, decelerating growth should be thought of as only one disruptive force — and probably not the most important one. Leaders will need to continue contending with technological disruption and its effects on competition, supply-chain disruption driven by trade barriers, and competitive disruption driven by players with new business models.

The spread of performance across companies, as measured by the average difference in EBIT margin between companies in the top quartile of their industries compared to the bottom quartile, is greater than at any time in recent history. Corporate cash and debt are both at record highs, and companies at extremes of the balance-sheet spectrum will have different concerns: highly leveraged companies perform significantly worse during downturns, controlling for industry and other factors. Because businesses are stating from very disparate positions, they will need to customize their responses accordingly.

How to prepare for the next downturn 

By combining what we know about company performance in past downturns with the special features of the current situation, we can identify several things companies should consider in preparing for the next one:

De-average your response. A company’s various geographic and business units may be affected very differently by a downturn. For example, although growth is expected to slow in most developing countries, the IMF projects it will accelerate in India and Africa and remain strong in Southeast Asia. Downturns will also have sector-specific effects: while discretionary consumer products sectors have been strongly affected by past downturns, consumer staples sectors (like food products) have been less exposed. Leaders need to understand the specific environment in which each of their businesses operates and choose their resource allocation, as well as their approach to strategy, accordingly.

Build resilience to the unexpected. There’s a lot of uncertainty facing the global economy. Leaders need to ensure that their business can withstand many different scenarios, not only a singular forecast. For example, companies that preserve financial buffers will be better able to respond to unanticipated threats or opportunities, and those with shorter planning cycles can better adapt to new information. And stress testing against a range of scenarios can help test resilience.

Invest in growth. Downturns make growth more difficult in the short term, but they should not undermine the potential for long-term growth—unless leaders starve their companies of the necessary investment. Sustained growth is more difficult to achieve than ever, but our study shows that companies that continue to invest in R&D and innovation will have the best chance to successfully grow in the long run.

Don’t lose sight of your long-term transformation agenda. As economist Paul Romer once said, “A crisis is a terrible thing to waste.” Downturns can shine a spotlight on the long-term health of a business, revealing vulnerabilities that might not have been as visible in good times. Leaders should use the downturn as an opportunity to create a sense of urgency within their organizations, helping drive the large-scale change that will be necessary to succeed in the future.

Focus on technological competitiveness. Technological change is reshaping all industries and causing competitive positions to become more fragile. Downturns also tend to amplify competitive volatility, which means the next downturn is likely to increase the potential risks and rewards of digital disruption even further. Technological progress will not stop during a downturn; neither, therefore, can companies afford to put their digital change agendas on hold.

Contribute to common problems collaboratively. Today’s pressing technological, economic, social, and environmental risks cannot be solved without collective action. However, the next downturn may inflame social tensions and reduce governments’ ability to act on such issues. Business leaders need to play a proactive role in addressing the biggest challenges of our time, collaborating with all stakeholders and moving from discussion to pragmatic action.

The next downturn will challenge many companies, but a few will emerge stronger, competitively and financially. Leaders who leverage lessons from the winners in previous downturns, as well as attending to the unique features of today’s environment will be in the best position to succeed.

source: https://hbr.org/2019/04/companies-need-to-prepare-for-the-next-economic-downturn?ab=hero-main-text