by Aaron Butler Senior Director, Business Advisory
If you’ve been listening to earnings calls of late, you’ve no doubt noticed disparate posturing around the state of the global economy. “We believe that…” is a common utterance, followed by some quantitative analysis and a conclusion about what the company will do about it. It all sounds convincing until one realizes that similar companies looking at the same data are coming to different conclusions: a recession is coming, we’re already in a recession, or the fundamentals of the economy indicate that recession fears are unwarranted.
Somebody is wrong.
What do we know for certain? Nothing, of course, but it’s fair to say that the near-term economic future is more uncertain than at any time in the last decade. Risk is the quantifiable portion of uncertainty, defined as the product of the probability of an event occurring and the severity of the consequences should it occur. The less we’re certain of, the higher the risk that our strategic decisions fail to realize our desired outcomes. If we frame our thinking in the context of probability and consequence and seek to understand these components of risk, can we discern something about the current state of the economy that compels us to act in a certain way?
Probability
Former treasury secretary Larry Summers observed that whenever inflation has risen above 4% and unemployment has dipped below 4%, the United States has suffered a recession within two years. These two thresholds, when breached, indicate economic overheating. We are well across both right now.
History books may one day be written about how the state of the global economy in 2022 bucked every historical trend. Or the current recession debate could become self-fulfilling as a loss of confidence in the economy drives consumers to stop buying and companies to stop spending. After all, John Maynard Keynes once said, the markets are moved by animal spirits, and not by reason.
For those of us living through this uncertainty and seeking to prepare in light of it, anticipating a recession, and finding a way to navigate it is simply playing the odds. If we are to err, let us err on the side of a recession as a near-term probability and prepare for it.
Consequence
How grave are the consequences to a company ill-prepared for a recession? Pretty grave. Roaring Out of Recession , an analysis published in a 2010 Harvard Business Review, states that during the 2010 recession, 17% of public companies went bankrupt, private, or were acquired. The analysis also cites that many survivors of that economic downturn were very slow to recover; 80% of survivors hadn't hit their prerecession revenue growth and profit after three years.
Risk is high, in part, due to the probability of an economic downturn, and the consequences can be as grave as ceasing to exist. So, what do we do about it?
To act, or not to act? That is the question.
Humans are interesting creatures. Omission bias causes us to view actions as worse than inaction, even when both action and inaction have adverse consequences.
Its counterpoint, action bias, is the phenomenon in which we tend to prefer action over inaction, despite no evidence to support that action will result in a more favorable result. If we subscribe to the notion that corporate groupthink is the manifestation of its constituent actors (we do), and the people in the C-suites and boardrooms primarily exhibit action bias (they do), it's no wonder that most companies tend to respond to external forces like economic turbulence with action.
"If you choose not to decide, you still have made a choice." - Rush
But not all actions are created equal. The findings published in Roaring Out of Recession paint a picture of a combination of actions that have historically resulted in better outcomes.
Companies that cut more costs than their peers through a reduction in COGS, not headcount, and who made greater-than-peer investments in growth-related through CAPEX and SG&A were more likely to end up in a better post-recession market position than companies that executed a different combination of cost saving and growth investment actions. It's the Goldilocks version of corporate action in the face of economic turbulence.
While we can look to recessions of the past to inform if and how we might act in broad brush strokes, the difference is we now have new tools that didn't exist even as recently as the Great Recession of 2007-2009.
For example:
Some old truths still hold. Companies with access to capital now are exceedingly well-positioned to make strategic bets on acquisitions, product development, market expansion, and taking advantage of weirdness in supply chain and real estate markets.
Now is the time to take action, informed by lessons of the past and executed with the superior tools of the present. But what if there is no recession? The time is always right to find efficiencies in your business, retain your best talent, and make strategic investments in growth.
Three lefts still make a right.
Slalom’s long-term goal is that when we reach the other side of this turbulence, our clients will say we were there for them, helped their people through the storm, and empowered them to not just survive–but thrive in the uncertainty.
Need help thriving in the turbulence? Fill out this form and we will be in touch!