Recessions usually start, I hear, in the corporate sector – falls in consumer or public spending then follow those business reversals, rather than the opposite. It can also be shown that an industry can fall into big cycles with no variability at all in underlying demand growth. If this happens in one sector, then both the boom and the bust infect other sectors, making the problem still worse, and a recession ensues. This was a topic at a small conference, featuring iconoclastic economist Paul Ormerod, back in February – here is a rather basic [sorry] recording.

If we are so smart at developing strategy, how come so many companies failed to see that their over-heated markets were no basis for what turned out to be gross over-expansion? If a general recession is the sum of down-turns in many sectors, then this strategic error was nearly universal –in retail, banking, telecoms, transportation, raw materials, real-estate … Strategic incompetence in, say, US subprime lending or Northern Rock is rather clear, but similar if smaller errors must have been happening all over.

So, as a strategy profession, where did we fail? Did we not provide the tools for management to prevent these mistakes? Did we ourselves fail  – or did we indeed warn of the emerging problem but get ignored? Or did some of us actually do pretty well [I think Canadian banks largely avoided the crisis, for example]?

Then, what are we doing now to help strategic recovery of the businesses we support, and hence of the economy? Have we helped design smaller but more powerful business strategies – or are companies stuck with crude cost-cutting instead? Recessions are often a great time for strong companies to pick up weaker rivals or cheap assets, or steal business – which if widely done should speed the recovery – so are we playing our part to make that happen?

Perhaps we need much more of the smart strategy modeling at Boeing?

www.strategydynamics.com

Perhaps my original post to them was not clear enough.  I meant to say that, as I understand it, investors are interested in the present value of future cash-flows – not growth per se. There is no point in simply growing market share or revenues if it does not ultimately improve future cash flows [the error that followed misuse of the growth-share notions from BCG in the 70s]. But as we speak, companies are understandably trying hard to maintain revenues In the current recession [i.e. minimise negative growth] as well as hold up profitability.

If this is right, the recession makes no difference to the fundamental point. If cash flows with poor or average strategy would likely decline sharply, and good strategic management would lead to a better cash-flow trajectory, then that is what will be best for investors and what management should be pursuing. Profitability [ROIC or similar] is but one lever to achieve that – and one that comes with big dangers. If your ROIC was previously 10% and recession hits it down to -5%, then investors would no doubt like to see it back up to, say, 5% … unless 5% and no subsequent growth was all they would ever see thereafter.

Percentages are not at all helpful in all this. If this scenario meant that your 10% ROIC corresponded to profits [or more strictly free cash-flows] of $10m/year, investors should prefer you to accept the minus-$5m if it meant that next year you get back to say, zero, then $10m, then $15m etc rather than $5m/year for ever.

Maybe the main reason firms pursue dangerous cost-cutting in a desperate attempt to prop up profitability is precisely because the naïve analysts who comment on their performance understand so little about the link from good strategic management to a firm’s value, and constantly bully management for ‘poor profitability’, rather than asking whether current profitability is actually in investors’ best interests. For an example, see my blog-post on what looks like a big strategic error by Starbucks, who are trying to sustain profitability by cutting costs sharply – including the costs of supporting exactly the ‘sustained competitive advantage’ that drove their historic strong growth in cash flows .. their unique investment in staff rewards and training which features in so many great case studies on the company.

To see a powerful and lucid explanation of why growth in free cash-flow is the right measure for investors and executives [and strategy researchers!] to focus on, see the statement from Jeff Bezos, founder and CEO of Amazon.com that opens the company’s 2004 Annual Report . Prior to founding Amazon.com, Jeff was a star Wall St analyst .. to be distinguished from the more average folk in that world.

Professional guidance on the same issue features in many finance reference books, e.g. Copeland, Koller, and Murrin, Valuation—Measuring and Managing the Value of Companies, Wiley, Chichester .. . It’s not perfect – e.g. the section on forecasting growth is way off, but as regards how firm performance is valued, it looks like essential reading for anyone planning to teach strategy.

LEADING THROUGH UNCERTAINTY

STRATEGY IN A ‘STRUCTURAL BREAK’

THE DOWNTURN’S NEW RULES FOR MARKETERS

MAINTAINING THE CUSTOMER EXPERIENCE

INDUSTRY TRENDS IN RECESSIONS

I couldn’t find much in Leading through uncertainty on what to actually do, though it does offer some broad scenarios of how the future might play out, depending on the depth of the global recession and recovery of financial markets. 

Strategy in a ‘structural break’ argues that this downturn is qualitatively different than others – in some sectors, things look very unlikely ever to return to where they were. ‘Structural break’ is a phrase from econometrics denoting the point in time-series data when trends and the patterns of associations among variables change.  It’s the second part of this that is so dangerous, because it may disable policies and strategies that previously worked. But not sure it all hangs together:

• It asserts that “the most important element of a strategy is a coherent viewpoint about the forces at work, not a plan” – sounds smart, but a coherent view with no idea what to do in response seems inadequate. 
• Surely, on its definition above, the internet revolution imposed sructural breaks on many more industries and business models than the current banking crisis and recession. It’s not clear this downturn meets those conditions in more than a few sectors. This is important, because the structural break argument is being used by consultants and writers to push firms into looking  for changes to their business models that is mostly inadvisable. This article argues that “The wrong way forward in a structural break during hard times is to try more of the same. The break and the hard times are sure indications that an old pattern has already been pushed to its limits and is destroying value.” True, but that’s not what most firms are currently facing.
• Some good points it raises though … complexity may have grown, and needs to be sorted out – that was an important part of the case in my ‘Strategic Recovery‘ article ..  the first task is to understand how a business has survived, competed, and made money in the past, and if the business is too complex to comprehend, break it into comprehensible parts.

The downturn’s new rules for marketers has good pointers I don’t have time to go into.

A fresh look at strategy under uncertainty interviews Hugh Courtney on his excellent book 20/20 Foresight: Crafting Strategy in an Uncertain World, published in 2001. The book outlines four levels of uncertainty – a clear future, a few clear alternatives, a wider range of scenarios, up to complete lack of any idea how things might play out. Hugh points out that the present situation does not feature widespread level-4 uncertainty for most of us. If so, the radical revision of business models being advocated by others is just plain bad advice. Instead, Hugh advises some thoughtful scenario-planning, and faster, more active strategic management [more substantial decisions, more often] – which of course is where strategy dynamics is so helpful. The last point I’d make is that strong firms don’t wait to see how the future will play out – they make it happen the way they want.