Strategic responses to a changing economy

A management consultant shares his views on today’s economy

Hans Dekkers believes this is a time of opportunities. — Photo courtesy Hans Dekkers

Our global financial system is under great stress.

We have seen landmark corporations go bankrupt, and others book record losses.

In North America, Japan and in the EU the GDPs are shrinking.

Unemployment is rising, with fears of double-digit figures.

Nobody can truly predict where it is going to end.

But let us not approach challenges with fatalism.

Rather, let us prove the bad news wrong, and use this strong headwind to grow stronger and come out victorious.

This is our time to demonstrate entrepreneurial character and resilience.

There are lessons to be learned, changes to be made, and initiatives to be taken.

But it all starts with a proper diagnosis—we need to identify inescapable realities and answer them.

These differ for each industry, but some are shared by all. Those that we share are these.

We are all facing a market that has lost a lot of money, and a market that is not really eager to spend what is left, and where credit is limited.

All this brings sales volumes down. These changes, for now, are structural. And for those that deal B2B with public companies—know that these base all their choices currently on their effects on their stock value.

They are cost-cutting, consolidating and bracing. They have no appetite for speculative innovations. It is not the first time this has happened in Western history.

For alert executives and business owners in the Kootenays the changes do not need to translate into bad news. But fail to apply wisdom, and fail to repent of bad policy and it will inevitably mean very bad news indeed.

What is going on?

I mentioned that some changes are structural and set to change market dynamics. What are they?

One is constantly in the news, the other is rarely discussed so far. The well-known yet not fully understood one is the credit crisis.

The hidden one is the dawn of an era of shortages in quality staff.

A concise briefing on the credit crisis

In the last two centuries there have been several occasions in which inflated land/property prices, easy access credit and high leverage have proved to be a dangerous mix.

Professor Richard P. Rumelt, chaired professor at UCLA’s Anderson School of Management, researched this dangerous mix and identified it as the underlying cause beneath several historic downturns: the U.S. depression of 1819; the land mortgage crisis of 1873-1877; the long depression of 1893-1897; as well as Japan’s recent “lost decade” of 1995-2004.

Leverage in finance is the practice of investing borrowed money with the expectation that your profits will exceed the cost of borrowing.

Opportune when it works—foolish when it doesn’t. The leverage ratio (simplified: debt over equity) indicates the risk level.

Up to 2004, the U.S. Securities and Exchange Committee limited Wall Street’s large firms—with tentacles all over the global economy—to a 12:1 ratio, where 12:1 was regarded as the highest permissible risk.

But in 2004, the committee exempted these firms and allowed them to regulate themselves.

The result—the top firms’ leverage ratio in 2007 grew to a highly irresponsible average of 30:1. In simple terms—consumers and businesses could easily borrow money (for consumption or investment), because financial firms loved to lend them money, as they made money on lending money.

To cover their risks, they insured themselves. Insurers loved to insure them, because they were making money off the premiums, and in turn, reinsured themselves against non-fulfillment.

The debtors on the spending end of this domino chain considered themselves safe, because they expected higher returns. And creditors considered themselves safe and secure because they enjoyed risk insurance.

Nobody in the chain really cared whether extended loans would ever be paid back, for they were all making (and collecting) strong profits.

Executive and management performance reward structures proved to be a fatal catalyst. Rewarding immediate and short-term results, these structures lacked self-regulating mechanisms to assure that long-term health remained the overall objective.

There are profound lessons to be learned here, which we all should apply in our businesses. Whilst everybody was spending and enjoying—looking the other way—it was merely a matter of time for the system to collapse.

And collapsed it now has, triggering a global crisis of unparalleled scale.

Major financial institutions have and are still going bankrupt, major employment industries are struggling, governments are spending unprecedented amounts to help cushion the fall (dramatically increasing their deficits), currency and commodities market rankings are shifting, unemployment figures are rising in most Western nations, business and consumer credit availability is under pressure, stock values have dramatically come down, and consumer confidence is low.

On top—the crisis landscape is constantly changing, with nobody really knowing where it will end.

Early March saw giant AIG book a historic record loss of US$61.7 billion. AIG was one of those on the debt-insurance end of the house of cards.

This is a time of reckoning and judgment for the financial industry. The outcome of all this is a market that has lost a tremendous amount of money that otherwise could have been spent, and a market where lenders think twice before putting cash in a borrower’s pocket.

For the next few years these changes may be expected to be structural.

What about shortages in qualified staff?

You need people to have a team. The B.C. demographics of 2008 demonstrate an upcoming shortage of available people in general, and leaders (age group 30 to 50) in particular [source: Stats Canada Stats].

When we consult the projection tables of Stats Canada, we are presented with a more positive picture, i.e. a picture with relatively stable population numbers in all age groups, but these predictions are based on past immigration trends.

Every Western immigrant source country, however, shows the same trend, reducing the number of 30- to 50-year-old prospective immigrants.

Further, in view of global economic developments, including the rise in value of the euro on the currency market, few Europeans will choose to immigrate to North America.

And resources enabling Asians to immigrate are set to dwindle.

Name it—talent shortage or management shortage—you will do well to revisit your perspectives on HR hiring, contracting and retaining and adjust them to reflect the dynamics of a market in which an applicant enjoys the luxury of choice.

A ray of sunshine for B.C. and the Kootenays

For Kootenay companies there are a few factors that warm us up a bit.

The B.C. GDP, compared to other Canadian provinces, is one of the least dependent on export (only 29.8 per cent as compared, for example, to Ontario’s 46.5 per cent).

Further, our Kootenay region enjoys the cushioning effect of an isolated economy—the concept of money pumped-around.

A fair share of our local economy depends on the natural circulation of money within our own region. Further, our provincial government is in better shape than our troubled neighbours south of the border.

President Barack Obama’s team is planning to overspend US$1.75 billion in his first year in office.

In comparison, our own B.C. government forecasts a mere C$495 million budget deficit. Corrected for exchange rate and population size, the B.C. budget deficit sits at a relative three per cent of President Obama’s overspending spree.

That is, President Obama’s overspending is a good 30 times more than that of our provincial government. And that bill will inevitably come and affect us all.

Let’s talk strategy

As a management consultant with my roots in the military, I think in terms of strategy.

Strategy is your defined plan of action with which you are determined to successfully address a challenge. It’s a plan of attack with which you expect to overcome—a prerequisite being a thorough understanding of the challenges (which differ per industry).

Further, when we talk business strategy, it is important to note that your strategy must be sustainable.

Sustainability not only requires that you have the resources to finance it, but also that your strategy contains several components that are difficult to copy by your competitors; you need to pursue sustainable competitiveness.

Everybody can lower prices and everybody can offer more smiles and a free cup of coffee to customers. There is nothing strategic about that.

To measure is to know

The 19th century mathematical physicist Lord Kelvin coined the above statement. He also said, “If you cannot measure it, you cannot improve it.”

I cannot agree more. Tjero Zomer worked at Transavia Airlines for 35 years, the last two decades as their CFO. Transavia Airlines holds a unique position in commercial aviation, making profits for the last 30 years.

Recently asked for the secret of their success, Zomer answered, “Keep looking out the window.” What Lord Kelvin and Zomer are getting at is this—do not hide yourself behind your computer screen, making decisions on assumptions and wishful thinking, but get in touch with your market.

Speak to partners in your industry, speak with your customers, speak with your suppliers.

Get hard figures on your desk so you actually know what is going on in your part of the forest. Keep looking out the window and both react and act ( = initiate) on what you see.

Only the facts, please.

Revisit the issue of structural debt

On centre stage in this epic financial drama stands the false notion that structural living on debt makes sense. And our Western society has embraced that fallacy more than ever before.

It makes no sense pointing the finger south of the border, or to our government, or to “the system” when you actually choose to make debt a structural component of your business model.

You need to face it, repent of it, and deal with it. The truth is that zero-debt business models make a lot of sense. Businesses operating on zero-debt are much more profitable in good times and profoundly more resilient in the bad times.

Zero debt companies finance growth using internal cash-flow, not by using borrowed money.

It’s slower in the beginning, but pays off in the long run. Do the math and be surprised. Want some positive examples? My figures come from an earlier project I did in late 2007, but the argument still stands. Microsoft, SAP, Texas Instruments, Nvidia and T. Rowe Price were all 100% debt-free and delivered on average an 18 per cent return.

In contrast, Goldman Sachs, Morgan Stanley, Lehman Brothers…familiar names?…as well as Echostar and SLM Corporation were high-debt companies that delivered an average return of minus 6.9 per cent.

The old adage still stands—live within your means.

Deliver true value

Your customers, whether consumers or businesses, will be more cautious to spend money.

They will continue spending money on essentials and inescapables, but will be more hesitant to spend money on non-essentials.

Naturally everybody applies these labels (essentials; non-essentials) differently, but whatever your product is, make sure you deliver genuine value and operate with high integrity.

Do not disappoint your customers. In the heydays, one could fool himself to think that one could get away with pushing for a product sale only, operating false scales, deploying deceptive advertising and sales techniques.

The market was tolerant and prone to forget. Tomorrow’s market will be less so.

Address the absolutes

Though the market is changing, absolutes never change. The boom decade lured many businesses into over-rewarding, over-spending, over-reporting, over-diversifying and over-sizing.

Ask yourself the hard questions and act on the answers.

Over-rewarding: Ask yourself how you reward performance. Performance rewards should never stimulate penny-wise, pound-foolish behaviour.

In the last decade many companies rewarded performance on the basis of results. But sustainable performance structures must include means to weigh the employee’s performance in view of your company’s future profitability.

A sales person pushing great sales today may do this at the expense of tomorrow’s market share. Likewise, you may have been frustrating and under-rewarding a travelling sales rep who was carefully nurturing healthy, long-term relationships at the perceived expense of relatively low sales volumes today.

In other departments in your business, make sure you reward ideas, initiatives and innovations that strengthen your long-term efficiency and profitability.

Over-spending: Ask administrators to produce a categorized overview of expenses. Cut everything that does not strengthen your business model.

Think in terms of total cost of ownership—demands on your cash are rarely limited to the initial investment. A word of caution on cutting expenses on staff. Ask anybody in the venture capital business—your staff is your greatest asset.

No staff, or bad staff, equals no results. You will be much better off tightening the belt around your own waist, than force-tightening the belts of your employees or sending them off to EI.

When you role-model financial discipline and sacrifice, they will soon follow. In contrast—you role-model unrelenting comfort whilst robbing them of a free cup of coffee, and they will grab their first opportunity to be gone.

Over-reporting: Companies in growth days are like bureaucracies. Paperwork tends to grow. As a decision maker, make sure you sit down and identify the key indicators you need to be aware of.

Make sure you establish solid ways to get these to you, and slice the rest. As a consultant I am often shocked to discover that decision makers are unable to name key figures off the top of their head.

To measure is to know. Make sure you govern on truth and facts.

Over-diversification: Realize that market booms cause many businesses to sprawl into too many areas.

Undo such sprawls. Sit down and identify which components of your business generate the bulk of your turnover. Then evaluate how these components are going to be affected by a cautious and conservative market.

Thus define your business focus and build your choices around it.

Over-sizing: Boom economies lure companies into growth. But the business game of successful sustained growth is more difficult than most realize.

To name just two pitfalls typically overlooked: (1) Loss in efficiency. The more staff you employ, the greater the organizational overhead; and (2) When things go well for everybody, established larger companies may allow you to make a good income and allow you to co-develop the market. But as soon as things get tougher and you are robbing them of turnover, they will set their sights on you.

The result—market combat. Winner takes all. Make sure your company size is sustainable. If not, dare to down-scale.

Have an emergency plan

Take the time to prepare for the possible worst.

Group up with a team and speculate on worst-case scenarios.

Set firm limits to allowable performance downturns, in order to avoid the temptation of trying a little longer and a little longer still, burning up valuable resources.

Have steps in place that direct you when you cross each limit.

And include an exit strategy—when and how to shut down business with maximum return and minimum loss.

Offensive steps

Any successful strategy must include offensive steps. Don’t just retreat. Sit down with experienced staff and advisors and brainstorm on offensive steps.

What can you do today that will create opportunities tomorrow?

Having a plan and pushing for it is more effective than having no plan, or forever trying to come up with the best plan.

Lead on facts, and make decisions

As stated in a previous paragraph, don’t assume period.

Gather the facts. Look out the window. What is going on in my industry, and what do I have in terms of resources to deal with it?

Dare to make well-pondered, yet courageous decisions. Formulate them, explain them to your team, rally the team around them, execute them and push hard to let your decisions deliver what you made them for.

I am a strong advocate of seeking counsel. I believe it is always wise to bounce off ideas and ask others for their viewpoints on them.

But (a big, big BUT), you decide and you lead. Corporate leadership is not a democracy and is not about minimizing any and all risks.

Corporate leadership is about vision and the drive to make it happen.

Innovate

As business slows down, use the available time to critically review your business processes and apply structural improvements.

Now is the time to increase efficiencies. Now is the time to install, and train everybody on new office automation processes.

If you have the money, now is the time to replace old equipment and invest in more efficient and more potent ones. This 2009 will be a great opportunity to procure assets at discount values.

Research your own industry and identify products or services that may do well in a more conscious, more restrained economy. Use your staff in the process. You will be amazed how much they can contribute to innovation.

With business being slow, why not sit down together and brainstorm on possible innovations. What can we do, or add, or do better to strengthen the outlook of our business?

Improve HR

Invest in your staff. As stated earlier, no matter what your business is, your staff is your most valuable asset.

Invest in training and be creative in doing so. You can run training sessions in-house, or contract a trainer.

You can offer employees a benefit if they increase their schooling or certification. Ask them where their interests lay.

Sit down for coaching sessions with your candidate managers of tomorrow. Share expertise. Sit down with your staff to discuss what makes them tick, what stimulates them to perform and advance, and what keeps them dedicated to your company.

Most companies simply confront their employees with their remuneration and reward structures. Don’t!

People are as diverse as everything else in creation. Explain that you want the entire company to come out of the economic doldrums as winners, and let them know that you are convinced that we must do this together.

Don’t limit yourself to senior staff. There are many examples of great input from the supposed lowest levels. And, as we all know, there are many examples of great folly from the highest levels.

Truth is truth, no matter who communicates it. Develop a human resources strategy that will actually attract qualified management staff to come and work for your company.

As the B.C. demographics show, the employee market will experience a thinning out of available leaders. Make sure applicants smell and your staff can attest that working for your company is rewarding in more ways than just money.

Manager-type people need appreciation, opportunities to grow and develop; they need to see a future that appeals to them and their family.

A word of encouragement to new entrepreneurs

Did you know that tough economic circumstances and very little money makes for outstanding business plans? It forces you to think things over twice, to cut away anything and everything that is not truly essential, it commands you to go the extra mile, it makes you very aware that every dollar can only be spent once.

Such circumstances build the best of companies and the best breed to lead them. Press on with your ideas and prove the crisis wrong.

Our continent has become big thanks to the likes of you. I hold entrepreneurs in the highest regard.

North America boasts more of them than any other region in the world. If you have great ideas, it will be my honour to be your strategy sounding board. Let’s get moving!

Failure is no option

This article has been seeking to provide you with some generic guidelines. Remember that every industry and every operation is different and uniquely affected by today’s challenges.

Of all places in North America, the Kootenay region is fairly strongly positioned to navigate the economic storm.

But strongly positioned or not—adjustments are necessary. Sit down and properly diagnose where you stand and what you can do to make the most out of the current opportunities.

Challenges are the proving grounds of character. Let’s not wait for government and the world to solve our problems.

Let’s take ownership of our situation and press on. As a business community, let’s encourage one another, help one another and come out stronger than before.

Hans Dekkers is a management consultant with Praotes Development Corporation, a company that specializes in management consultancy and project management. His fields of expertise include strategy, market positioning, Internet and new ventures. As well, Praotes is the organizer of the Cranbrook Fightermeet Airshow. To learn more about the company, visit www.praotes.net