More than 70% of economists expect the United States to enter a recession by the end of 2021, according to an August 2019 survey by the National Association for Business Economics. At this late stage of the economic cycle, it may seem like exactly the wrong time to think about investments that would improve your operations or strengthen your balance sheet. A recession may lead to budget cuts or layoffs, which would mean fewer internal resources to allocate to analyzing processes and work streams. At the same time, lower demand for goods and services could put pressure on your margins and create a more competitive industry environment.
In fact, many companies will respond to these pressures by taking what may seem like a safe approach. They will tighten budgets, take fewer risks on new ideas, make less investment in new technology and hope to ride out the rough seas. Beware that a passive approach puts your organization at the mercy of the prevailing economic winds and gives you little control over where your company is headed.
Savvy companies, on the other hand, are proactive in the face of a downturn. They reassess priorities and take steps to keep their organizations moving forward. While continuous improvement is always valuable, a proactive approach to increasing efficiency may be even more important when top-line growth is slowing. Operational weaknesses that might have been masked by a few extra employees or looser budgets can become critical flaws in highly competitive environments. In addition, there is an opportunity cost to inaction, as an assertive approach to finding and keeping clients during a downturn may allow you to gain market share from less-prepared competitors.
Balance Cutting with Investing for Long-Term Growth
Following the merger of Heinz and Kraft in 2015, the combined company began cutting costs in an effort to increase profitability. These cuts prevented the company from investing an adequate amount in innovation, and as a result, it “struggled to improve its products to satisfy shifting consumer tastes,” as noted in The Wall Street Journal[1]. Four years later, the food maker reported falling sales and net income, booked an impairment of $15.4 billion in February 2019, one of the largest in corporate history, and wrote down the value of its brands by another $1.2 billion in August 2019, as the stock fell to an all-time low.
This stark example underscores how companies that focus on short-term savings at the expense of innovation can get trapped in a vicious cycle of cost-cutting that ultimately reduces their competitiveness. While some budget reductions may be necessary during a downturn, a better way to remain viable for the long term is to combine highly targeted and strategic cost-cutting with similarly precise investments in technology and innovation.
This discipline to keep improving during a downturn offers a significant competitive advantage, as it will not only yield results in the short term, it will also continue to drive growth over time. A Harvard Business Review study of recessions during the past few decades found that only 9% of almost 5,000 public companies actually flourished during those downturns, outperforming competitors by 10% or more in sales and profits2. What did the 9% do right? They not only cut, but they re-balanced their remaining spending to focus on strengthening long-term goals.
For example, in the office supply space, Office Depot and Staples took different approaches leading up to and through the 2000 recession, according to the Harvard study. Office Depot cut 6% of its workforce but wasn’t able to significantly reduce operating costs. In contrast, Staples closed some under-performing facilities, but increased its workforce by 10%. By 2003, Staples had doubled its 1997 sales figure, and in the three years following the recession, Staples’ profits exceeded those of Office Depot by an average of 30%[2].
Seize Opportunities—Small or Large
While no one ever hopes for a recession, a downturn often offers a window of opportunity for an organization to make meaningful positive change. When operations aren’t running at maximum capacity, it may be easier to shift personnel and other resources to improvement efforts without cannibalizing core business operations. Furthermore, declining revenues and cash flows may highlight the need for change and make employees more open to digital or other transformations that increase efficiency.
You don’t need to completely transform your operations to strengthen your business. Below we offer several simple ideas for small steps that can lead to meaningful improvements.
THE POWER OF DATA: USING ANALYTICS TO DRIVE YOU THROUGH THE NEXT DOWNTURN
In a recession, it is easy to become fixated on declining revenue and the resulting impact on your balance sheet. But these figures provide only a surface-level description of your company’s financial position and trajectory. For the full picture, you need to dig deeper into your data. By employing robust data analytics, you can better understand the details of costs and revenue across your organization and gain valuable insight into the factors that drive profit margins. While you can’t control the ups and downs of the broader economic environment, you can leverage your data to gain control over your profitability.
Turn Data into Actionable Insight
By taking into account all the factors that impact your profit margins, including how they interrelate, you can make fact-based decisions—about what to sell, how to price it, which clients to target and when—to maximize growth.
For example, a retail product manufacturer that wants to allocate its production capacity most efficiently should examine the sales and profitability data of its entire product line. The company might learn that most of its sales of one product occur in conjunction with the sale of a better-selling, complementary item. That insight might lead to a decision to strengthen cross-selling efforts rather than discontinue production of the poorer-performing product.
Follow a Proven Approach to Building Analytics
Data analytics has the potential to provide powerful business intelligence. However, building a data-analytics process that will deliver a tangible return on investment (rather than serving as something like a science experiment) isn’t as simple as adopting a new technology tool. Most important is putting the right foundation in place, including the right organizational infrastructure. Following are the key steps to using analytics to drive profitability:
SCORING PROFITABILITY POINTS: APPLYING THE 80/20 RULE AHEAD OF A RECESSION
Business leaders often assume that more business means more profits. But not every transaction adds equal value to the bottom line. Across industries, nearly every company and non-profit organization, is subject to the Pareto Principle, also known as the 80/20 rule, which states that roughly 80% of effects come from 20% of causes. In a business context, evidence of the principle often appears across multiple dimensions. Most of your revenues come from a limited number of products and services. Most of your sales can be attributed to the efforts of your best performers on your sales team. Most of your profits are generated by a relatively small subset of customers. Most of your supply chain value is delivered by a select handful of vendors.
When companies start to struggle financially, they often look to strengthen the weakest links. But the 80/20 rule suggests the opposite approach. Rather than spending limited resources to improve the least-profitable segments, or to shore up all segments equally, you should focus on enhancing those that you know will have the biggest positive impact on your bottom line.
Even if you have already initiated a continuous improvement program intended to eliminate waste and defects, such as lean manufacturing or Six Sigma, an 80/20 lens adds value by helping direct those efforts where they will have the greatest impact.
While it is always valuable to look for opportunities to apply 80/20 thinking to your business, it is especially important do this before a downturn starts. The best time to sharpen your focus on your most profitable customers, business lines and markets is before the economic environment becomes more challenging. Not only will this help you weather the storm, it will enable you to act from a position of strength while your competitors may be struggling to survive. During a downturn, companies that have implemented 80/20 principles will be positioned to continue moving forward—including gaining market share and adding talented professionals from companies that haven’t been disciplined about focusing their efforts.
Find 80/20 Insight in Your Data
The foundation of an 80/20 approach is a sound data analytics capability that generates reliable KPIs. You can use those measures to quantify the relative profitability of each of your customers, products and services, employees and processes. At the same time, your data holds clues about the factors, or combinations of factors, that contribute to the profitability or performance of each.
Invest in Motivating and Equipping Your Top Employees
Because an equal investment in all employees will yield unequal results, let your data about the relative performance of individuals and teams guide your decisions about where and how those resources should be allocated.
Identify employees with the greatest aptitude, then develop customized development programs to help them reach their full potential. Give your super-star performers the additional incentives and tools they can use to build on their success. And just as you critically examined your lowest tier of customers, determine where you might need to sever ties—or whether a relatively small investment of tools and training might make these employees more valuable.
Reduce Complexity in Your Supply Chain
For many years, businesses favored a multi-source approach as a way to manage risk and encourage price competition among suppliers. But a supply chain that is larger and more complex than you need is inefficient. When you use an 80/20 lens to consolidate spending among your best vendors, you may be able to optimize inventory levels and leverage greater volume discounts, freeing up additional capital you can invest more strategically.
Replicate and Build on Success
In addition to revealing your most profitable products and services, customers and employees, your data can also help you expand each of those top tiers. Dig into your data to identify the factors that contribute to the success of your best performers. Combine that insight with an 80/20 view to make decisions about which new products and services to add to your operational portfolio, which prospective customers to target and which job candidates to select or recruit.
Focus on Flawless Execution
The 80/20 concept isn’t new—it was coined in 1895—and it isn’t complex, but understanding a principle doesn’t guarantee that you can apply it successfully. Most people know that losing weight “simply” requires burning more calories than you consume, yet most of us still struggle to shed extra pounds. It isn’t enough to make a few changes in behavior or add some tasks to employees’ to-do lists. Long-term success hinges on executing well and consistently over time. The best results are achieved when 80/20 thinking becomes ingrained in the company culture, so it guides decisions large and small.
That shift in mindset across the organization starts from the very top—with buy-in from the C-suite and as a part of the strategic planning process. But all employees should understand what needs to change, how they can further the goals and how the changes will affect them. Create a detailed action plan that spells out quantifiable metrics and the teams that will drive each of the top objectives. Maintain rigor and accountability by instituting regular reporting on progress. And equip employees with the training and time they need to learn to take an 80/20 view, to see old processes in a new way.
Small and mid-sized companies with limited resources may want to consider engaging an external partner with expertise in 80/20 principles to help develop and execute a plan that aligns with your organization’s goals. At a time when internal resources might be stretched thin, an external partner represents flexible additional bandwidth. In addition, the objectivity of an outside perspective can be invaluable when evaluating your company’s strengths and weaknesses, in particular to overcome any potential emotional connections to customers, suppliers or products that don’t support the organization’s renewed focus on maximizing profitability.
POWER YOUR GROWTH INTO—AND THROUGH—A DOWNTURN
Through all stages of the economic cycle, business leaders should focus on powering their company’s long-term sustainable growth and profitability. With a downturn potentially around the corner, it is especially important to take action now to strengthen your company’s ability to withstand adverse market forces.
Significant organizational changes—whether adopting an 80/20 mindset or leveraging the power of data analytics to strengthen your operations—take time and effort. But change for the better is always worth the investment.
[1] The Wall Street Journal. Haddon, H. and Maidenberg, M. August 8, 2019. “Kraft Heinz Writes Down $1.2 Billion as Brands Wither.” https://www.wsj.com/articles/kraft-heinz-books-1-22 billion-in-impairmentcharges-11565267075
[2] Harvard Business Review. “Roaring Out of Recession.”
For questions or assistance, contact us at 717-569-2900.