Harold L. Sirkin: Recession Lessons: Read, React, Win

Journalists and economists will be writing the story of the Great Recession for decades to come. One of the most important stories, which we can start writing today, involves the lessons we can learn about managing through a severe downturn. These lessons should be studied in B-schools and boardrooms everywhere, because recessions are inevitable. Whether executives need to apply the lessons as early as next year—due to a dreaded double-dip, or W-shaped downturn—or during some future cyclical recession is not important. What is important is that they understand that business as usual won't do and that simple cost-cutting and belt tightening are not the way to achieve a competitive advantage. Some companies realized this early on. They behaved very differently during this recession than in previous downturns and are achieving promising results. They knew they had built up a layer of fat during the prior seven years—and knew they could use the recession to get down to fighting weight. But most important, they asked themselves fundamental questions: "What if our sales drop by 25% or even 40%? How do we prepare ourselves for the unthinkable?" As they started answering these questions, they got scared. They realized their companies, no matter how strong, were ill-prepared to weather an economic storm of this magnitude. The good ones quickly recognized that if things got very bad and they did not act quickly, they might run out of cash and not have the access to capital when needed. Cash (not debt) would once again be king. Future ReturnsThe good ones also knew that now was the time to invest in their futures because the returns would be at an all-time high. They needed to focus investments in customers and customer service, in getting lean and making their operations more effective, in drawing down inventories and managing capital more effectively, in restructuring their manufacturing and distribution assets, in new-product development, and in identifying areas in which they might want to make acquisitions so when prices fell or companies got distressed, they could do the deals fast. A few forward-thinking companies hadn't waited until December 2008 (when the National Bureau of Economic Research finally confirmed that a recession had begun in December 2007). They decided six to nine months earlier that the recession was real and reacted quickly and decisively. Consider the example of Milwaukee-based Brady Corp. (BRC). With about $1.2 billion in sales and operations in 26 countries, Brady is an international manufacturer and marketer of complete solutions that identify and protect premises, products, and people. Its products include high-performance labels and signs, safety devices, printing systems and software, and precision die-cut materials (primarily for mobile phones and hard-disk drives). About 40% of the company's revenues come from the U.S., 35% from Europe, and 25% from Asia. With a reported 500,000 customers worldwide, Brady has been very successful, outperforming the Standard & Poor's 500-stock index by a factor of two during the past 25 years and the Russell 2000 by a factor of three. (Disclosure: Brady is a client of my employer, the Boston Consulting Group.) Anticipating the WorstIn mid-2008, Brady, like other companies, began to see signs of a recession. Unlike many companies, whose management teams talked themselves into a "wait-and-see" attitude, Brady wasted little time. After a sleepless night, Chief Financial Officer Tom Felmer presented scenarios for sales declines of 10% and a once-unthinkable 25% to the Brady executive team. The projected impact of such declines on the company's profit, cash flow, and debt covenants was severe. Everyone in the room knew that Brady wasn't ready for such a dramatic deterioration of business conditions and that the company would be in serious trouble if it didn't act. They also realized that "doing something" would create an opportunity to clean up inefficiencies that had developed during the past six high-growth years.After letting his executives digest these doomsday scenarios for a couple of days, Frank Jaehnert, Brady's CEO, called together his executive team to talk about how to respond to the threat. He made it clear there wouldn't be a debate whether to do something or to do nothing and wait how things might unfold; this would be a discussion about how much to do (how deep to cut). Jaehnert challenged his colleagues to think boldly. Fortunately, the majority of his team had been together for many years and most remembered the 2001-2002 recession well. Brady hadn't reacted quickly, and it suffered through that recession. It was determined to react swiftly this time. Tricky TimingThe management team all knew there was tremendous risk in not acting but little risk in action. Better to move aggressively and later pull back some if necessary than to do too little, they decided. They had only one problem: Brady was just about to report record earnings and growth. How could they possibly announce layoffs and cutbacks in the same press release and earnings call that would be touting success? And there were no other industrial manufacturers signaling weakness in sales or a restructuring. Brady, because of its off-cycle calendar year, would be one of the first industrial companies breaking bad news. Investors and employees alike would be taken by surprise. Jaehnert and Felmer called for a special session with the board to present their projections and debate pros and cons of their recession plan—a focus on reducing costs and capacity to meet the new realities that Brady would be facing combined with an approach that would allow the company to take advantage of the opportunities that the recession would create, including new acquisition possibilities and investments in capabilities. After a diligent assessment, the board agreed and encouraged management to proceed with the bold move. First, they would act quickly before things got worse. Second, they would not just reduce payroll, as many companies do during downturns. They would move broadly in a number of different ways that would strengthen the company—using some of their savings to invest in the future. Companywide SavingsThe plan was thorough and deep. To conserve cash and prevent the accumulation of obsolete products that later would be difficult to sell, they decided to reduce inventories. They would halt acquisitions and planned investments in new plants and equipment. They reduced discretionary spending and imposed a companywide salary freeze and canceled all bonuses including their own. They found ways to squeeze more capacity out of existing operations and negotiated price concessions with their vendors. And, yes, they reduced their global workforce, cutting 10% during the second quarter of fiscal year 2009 (October through December 2008) and eventually reducing staff by a total of 25% (including contract labor). They also decided to restructure or shut down low-performing operations. But they also planned to invest: accelerating a long overdue "lean" program that would help them improve productivity and plant responsiveness. They would push forward with the development of new products that customers would need when business picked up and prepare research and perform initial due diligence on acquisition opportunities and potential new markets that could boost growth when the global economy recovered. CEO Jaehnert was convinced that committing to major investments in the middle of a recession would not only provide Brady with a competitive advantage but also keep the employees focused on the future instead of the negative aspects of the recession, i.e. reduction in force, salary freezes, etc. Avoiding Doom and GloomAs he was making these decisions, he told me: "You cannot motivate your employees if all you talk about and do is reduce costs and close facilities. You have to provide a vision for the future and demonstrate it with investments. That way, you shift the focus and the minds of employees from doom and gloom to how great the company will be." In spite of a major decline in sales and big investments for the future, the company's financials were still respectable, especially compared with what could have been if not for the quick and bold actions of the management team in the first two months. Jaehnert summarized Brady's activities in a statement accompanying the company's Fiscal Year 2009 Year-End Financial Report (issued in September). The CEO said the company's worst fears were realized. "After a strong first quarter," he said, "the global economic downturn caused a 27% drop in our sales over the balance of the year." Despite this, the company earned $90 million in net income excluding restructuring charges and generated $127 million in cash flow from operations. They were able to do this because they anticipated what was happening, organized their response, and executed. While many different lessons will be drawn from the Great Recession, three clear ones come from the Brady experience: 1) During challenging times, you need to prepare for the worst, not a rosy outcome. Measures to control costs should be implemented quickly and cuts should be deep. Waiting is precisely the wrong thing to do. There's never a bad time to trim fat. If you cut some muscle in the process, you can build it back up later. 2) Use the opportunity to do all the difficult things you know you should do but have avoided in the past because business was good. Cut underperforming people and operations. Reduce payroll costs. Reduce inventories. Halt expansion plans. Conserve cash. To show your employees the pain is being shared, freeze executive salaries and eliminate bonuses. Employees are far more receptive to tough medicine in tough times if they know the pain is being felt at the top, too. You need to lead by example. 3) Re-invest to win in the upswing. Managing to win during a recession is not just a matter of circling the wagons. There is also an offensive component—seeking possible merger-and-acquisition opportunities, keeping your eyes open for newly available top talent, stepping up product development and research-and-development activities. The important thing is to take control. To the greatest degree possible, the recession shouldn't dictate what you do. You need to anticipate. Have your own agenda and execute. As difficult as Great Recession has been, it will be easy to forget when the economy fully recovers. That will be the biggest mistake of all: forgetting. The lessons you learn from this recession can create an advantage for you in the next. As the saying goes, those who don't remember history are doomed to repeat it.

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