In an economic downturn, decision-making is distilled in to a clear-cut choice: Do you go on the offensive, aggressively pursuing growth, or do you become defensive, protecting your revenues and profit margins? In CBCG’s experience, the decision is determined by a firm’s competitive position and ability to counteract income-statement and balance-sheet stresses caused by the downturn. Imagine then that you’ve just won the coin toss. Should you receive or kick off?
Lessons learned from the last recession, the dotcom bust of 2001 and 2002, provide hope for survival and some guidance for success. They show that while the impact of economic downturns is wide-ranging across industries and companies, it seldom creates a level playing field: in a downturn, some companies clearly outperform others (see Figure 1).
For example, in retail, while thousands of stores closed across the United States in 2001, and companies such as Kmart and Ames filed for bankruptcy, retailers such as JCPenney and Kohl’s outperformed the competition.
Given that there are such opportunities to outperform even during severe downturns, in 2009 most retailer’s are facing this crucial question: How do we approach those decisions that will allow us to outsmart our competitors?
The choice: Offense or Defense?
Severe economic downturns cause numerous stresses on income statements and balance sheets, led by declining revenues and margins, productivity problems and cash shortages, among others. The current downturn certainly has its own unique DNA, with credit contraction, bank failures, rapid declines in housing values and low consumer confidence impacting nearly every aspect of business. Given this challenge, CEOs looking to the future face a difficult question: Should they go on the offensive, taking advantage of the downturn to buy struggling competitors, or are they better off playing defense, hunkering down and protecting existing revenues and operating margins?
The question does not have a simple answer. The right choice between defense and offense may differ for each particular problem. In some cases, offensive strategies such as pursuing revenue growth in a key market segment or strategic investment in a particular business unit may be the right choices; in others, aggressive protection of revenues, profit margins and the balance sheet may be the correct.
With limited resources available during times of economic distress, the key question is which option to pick and how to plan the execution.
Going on the offensive is a restricted option
Several factors determine a company’s ability to go on the offensive during downturns. First and foremost is the ability of the core business to withstand the stresses created by the downturn. For example, countercyclical revenue streams can allow a retailer to withstand a downturn in one product category if it is successful in another; strong innovations can help to maintain pricing power; sufficient variability in cost structure can help protect margins, and a sound capital structure can give a company the financial flexibility to expand or acquire competitors. Companies that developed these traits in boom times are generally in the best position to take the offensive. Moreover, these traits have been in place for some time before the economic downturn and the related headwinds began.
In some cases, luck or timing can have a significant impact on the ability to get aggressive on go on the offence. Consider this: What if Microsoft had succeeded in buying Yahoo! in February, 2008 for $45 billion, a premium of 62 percent at the time? By the end of the year, Yahoo’s stock had fallen an additional 50 percent, leaving Microsoft in a much better position.
In other cases however, the ability to go on the offensive is purely a result of prudent business strategies put in place prior to the downturn. Before the recession of 2001 hit, Kohl’s focus on a low-cost structure, a unique merchandising philosophy, lean staffing levels and sophisticated management of information systems led to growth that significantly outpaced the retail industry (see Figure 3). When the downturn began, Kohl’s was strongly positioned for an offensive strategy. While other competitors, such as Ames and Kmart, were declaring bankruptcy, Kohl’s step-by-step expansion included organic growth and a series of acquisitions. Eventually, Kohl’s emerged from the downturn with 50 percent more retail space and access to numerous new major metropolitan areas.
Figure 2: Kohl's Goes On Offense And Successfully Outpaces Industry Throughout The 2001 Downturn
Kohl’s Continues its methodical, step-by-step expansion strategy throughout the downturn:
· 137 new store openings, with the total square feet of selling space increasing 46% to 34.5 million ft.²
· 40% growth in number of employees
· Acquisition of existing locations from Bradlee Stores and Caldor Stores as an entry strategy into new markets
· New market entry into major metropolitan areas such as Houston, Phoenix, Boston, Los Angeles etc.
Going on the offensive, however, is not for everyone. While the success stories of pursuing growth during downturns appear seductive, companies with a weak competitive position going into a downturn have little possibility of forming an offense strategy.
A Solid defense: Protecting the core business
Companies facing significant income statement or balance sheet stresses during a downturn will find that its best strategy is to protect its core business by strengthening its defenses. Such a strategy can protect revenue streams and profit margins, or preserve the balance sheet. For example, revenues and margins can be protected with targeted or segmented pricing incentives, strategic sourcing or SGA reduction; balance sheet strength can be preserved by restructuring assets or managing working capital more effectively.
At first glance, defensive actions such as cost-cutting might sound like weaker strategic alternatives compared to offensive moves such as acquiring a struggling competitor. However, analysis indicates that a well-executed defense can in fact present an opportunity to clean house in the short term, and prepare the company for potentially significant growth down the road. Operational strategy and cost transformation highlights two priorities a retailer needs to have to ensure a successful defense during a downturn: 1) Be aggressive with cost-transformation initiatives, in order to step ahead of the downturn, 2) Prepare the business to go on the offensive at the end of the recession.
1. Aggressive targeting of costs
To be successful in the short-term and create longer-term strategic advantages, retailers have to look beyond the “low hanging fruit” for cost transformation and develop an all encompassing strategy. Instead of simply targeting headcount or minimizing inventory, retailers should seek a comprehensive set of changes that can drive success both sooner and later.
Finally, aggressiveness also relates to the velocity of action necessary to implement cost-cutting initiatives. Severe economic downturns create a need for long-term realignment in the way retailers do business. The speed with which owners respond determines how fast they emerge from the downturn.
2. A strong defense means preparing to take the offensive
While the short-term objective for CEOs may be to halt the decline in revenue or margins, the best defense prepares the company to go on the offense when the downturn ends. The strategy adopted by the executive team at JCPenney during the 2001 economic downturn is an outstanding example of such an approach.
As shown in Figure 3, JC Penney sputtered into the economic downturn following a history of several years of declining profitability and operating margins at levels below most of its competitors. JCPenney had missed the “retail wave” of the 1990s because of a host of problems, including poor merchandise selection, an unproven marketing message, and a decentralized operating model. Furthermore, management’s lack of faith in its retail assets led it to use the company’s capital to diversify into the drugstore business with the purchase of Eckerd, which became a drag on profits. Under the leadership of a new management team, a five-year turnaround strategy was launched to turn the ship. The early initiatives were classic defensive moves: staff reductions, the closing of unprofitable stores, the introduction of more effective inventory management, and the eventual sale of non-core assets, such as Eckerd.
Figure 3. JC Penney’s Defense Strategy Led To A Remarkable Turnaround
However, JC Penney’s defensive strategy also focused on the creation of long-term strategic advantages that would eventually enable the company to go on the offensive. The company invested in a new distribution system to decrease long-term transportation costs in the supply chain, a costly move but one that was critical to its long-term growth. After almost 100 years of decentralized store management, JC Penney transformed itself into a centralized company that included a unified marketing message, more targeted merchandising, updated technology, new store layouts and improved store operations. All these initiatives, coupled with a renewed focus on consumer preferences led to a remarkable transformation in the years following the recession.
The lesson for retailers who choose the defensive option for withstanding an economic downturn is crucial: Be aggressive with the turnaround plan, but also ensure that any plan for remaining on the defensive includes details for switching strategies and going on the offensive once the downturn shows signs of coming to an end.
Putting the plan in place
There are significant opportunities to improve competitive position during a downturn, regardless of the strategy chosen. On the one hand, companies that go on the offensive can either continue to follow their existing growth strategy or leverage their strong competitive positions to adopt even more aggressive strategies, such as acquiring weaker competitors at a discount. On the other hand, an aggressive, well-executed turnaround plan can create a sustainable advantage for a company and potentially position it to outperform even its stronger competitors by the end of the downturn.
No one knows how deep and long the current recession will be. Competitors could fail, creating unforeseen opportunities, consumer confidence could sink even further, or the balance sheet could be in worse state than previously thought. Retailers are hearing about the choices and challenges of this environment from every direction—family, friends, lenders, investors, the media and others. Meeting these challenges requires any retailer to answer this important question: Do I choose to receive the ball and start with the offense or do I kick off and put my defense on the field?
Source: Ivey Business Journal, CBCG and ATK
