The only way is up
Just because the economy is in a downturn, doesn't mean that managers cannot be upbeat about their organisation's future prospects. Don Sull's new book The Upside of Turbulence provides a positive route map into the future. Don Sull talks 'upside' to London Views.
Can you begin by offering some context on our turbulent times?
Everyone agrees that the global economy is flying through a patch of extreme turbulence. Recall that Lehman Brothers, which was founded in 1850, successfully weathered the American Civil War, multiple recessions, four financial panics, two world wars, depressions, oil crises, and 9/11. But the storied firm could not survive the seizure of global capital markets in 2008.
The present economic crisis has been so dramatic, that many people think it caused the volatility roiling markets. If the crisis triggered turbulence, according to this line of thinking, then the global economy should return to a period of stability once the worst of the downturn is behind us. But turbulence did not begin on September 9th, 2008. And it will not end when the global economy pulls out of recession. The current economic crisis is not the cause of market turbulence; it is simply the latest symptom of the volatility inherent in global markets.
Consider how much has changed in the decade or so before Lehman's collapse. When PricewaterhouseCoopers began their annual chief executive survey in 1996, less than a third of CEOs regularly logged onto the internet, and few saw China, Russia or India as priority markets. The intervening decade saw the dot com boom and bust, major currencies crises in Asia and Russia, 9/11, two wars in the Middle East, unexpected jumps in commodity prices, and the rapid rise of emerging markets. And all of this before Lehman imploded. A variety of studies, by scholars from different fields using diverse data sources and methods has converged on a remarkably robust conclusion. Individual firms face volatility that has risen between two and four-fold in recent decades.
A comprehensive study of equities traded on all major stock US markets found that the volatility in returns of individual stocks more than doubled between the early 1960s and the late 1990s, spiking when the economy entered recession and when stock markets crashed. Research by Harvard's Diego Comin and his co-authors document that the volatility of revenues, profitability, and employment of publicly-traded firms in the United States have more than doubled between 1960 and 2000. (Greater volatility at the firm level has not increased aggregate volatility in stock markets as a whole, because the more violent upward and downward movements of individual shares cancelled one another out.)
Other measures of turbulence show an even larger increase in recent decades. The probability that a public firm disappears in any ten-year period more than doubled from the 1960s to the 1990s. The odds that a high-performing firm would be dethroned from industry leadership tripled between the 1970s and the 1990s.
Another study by Comin found the spread between corporate bonds and ten-year treasury bills, another measure of firm-level risk, increased four-fold over the same period. The global economy experienced nearly 250 currency crises between 1978 and 2003.
A World Bank analysis found the speed with which technological breakthroughs spread globally increased four-fold between the first half of the twentieth century and the period after 1975. According to a recent study by the IMF, there were four global economic crises between 1870 and 1980. By their reckoning there have been the same number between 1980 and the present. The increase in turbulence is neither uniform across industries or countries nor steady over time. The broad trend of turbulence rising is unmistakable. The downturn will end, but turbulence is here to stay. For me, the central challenge for any executive right now is to lead in these turbulent times.
And what does that involve?
For the past decade, I have studied exactly that question. Along with colleagues, I have sought out some of the most volatile markets in the world - Brazil, China, Europe's fast fashion industry, and others - and studied what differentiates more and less successful firms. My core advice is to:
Recognize the upside of turbulence. Many managers focus exclusively and the risks lurking in volatile markets, but turbulence produces opportunities as well. Firms like Mittal Steel have succeeded not despite turbulence, but because of it, by seizing the opportunities volatile markets generate.
Explore anomalies to identify opportunities. Unexpected events signal a gap between strategy and competitive realities. By exploring anomalies, managers can spot opportunities before others.
Collect "rush" data. Compile information that is real-time, unfiltered, shared across the organization and holistic enough to provide a multifaceted view of a complex situation - to spot threats and opportunities.
Be agile. Rather than trying to predict an unknowable future, build an organization capable of seizing unexpected opportunities as they arise. The book introduces three types of agility-operational, portfolio, and strategic-and provides practical tips for enhancing them.
Execute by commitments. At its heart, an organization is a dynamic network of commitments up and down the chain of command, across units and to external stakeholders. Cultivate and coordinate commitments to execute in a systematic way, even as circumstances change.
Balance agility with absorption. No company is so agile that they spot all opportunities and threats and respond quickly enough. Leaders should build their organization's absorption, or the ability to weather changes, to buy time to adapt and outlast rivals.
Talking specifically about the current downturn, you have identified five myths about business failure in a recession. Can you explain?
Many companies are suffering in the current recession, and their leaders blame their struggles on the financial crisis. Many of these explanations are too simplistic. Leaders should be careful that they are not lapsing into believing any of these myths:
Myth 1: The downturn caused our problems. For most industries facing serious problems right now, including big losers like automobiles and print media, the recession is not the ultimate cause of their suffering. Instead the downturn reveals (and aggravates) fundamental flaws in their business model. When the tide goes out, as Warren Buffett famously observed, you find out who has been swimming naked. These business models were broken long before Lehman filed for bankruptcy and will remain broken unless executives use the downturn to begin fixing them. Take General Motors. The automaker's problems certainly did not originate with the current drop in consumer demand or higher retiree and medical costs. GM's problems arise from the company's inability, over decades, to make cars people wanted to buy. US car and light truck registrations more than doubled between 1970 (104 million) and 2006 (235 million). At the same time, GM's market share collapsed from nearly 45 per cent in 1970 to under 20 per cent in 2009.
Myth 2: Companies fail quickly. Companies make the news when they abruptly file for bankruptcy. While firms file quickly, they fail slowly. As a junior consultant at McKinsey 20 years ago, I remember a presentation to a Detroit automaker highlighting many of the problems that plague the industry today, including poor product quality, high cost structure, and slow response to shifting consumer trends. The executives did not respond with indignation or denial, but indifference. One manager dismissed the report by saying "there is nothing new here." That was in 1988. Some companies do fail quickly, particularly trading firms such as Lehman Brothers or Long Term Capital Management that rely on their ability to raise short-term funds. When counterparties lose confidence and withhold cash, they fuel a vicious downward circle. Most companies fail like GM, however, not Lehman. Slow decline is both good news and bad news for leaders. It provides them with the time to experiment with new business models and implement change but can also sap the urgency needed for change.
Myth 3: No one saw it coming. If by "it" people mean the current recession, this is true. But the downturn is the proximate rather than the ultimate cause of most business failures. The newspaper industry, for example, responded with dismay when the Tribune company, owner of the Chicago Tribune and the Los Angeles Times, filed for bankruptcy late last year. When might they have seen the fallout of digital technology coming? Maybe in 1995, when the Nieman foundation hosted a conference on the "online era" that included Arthur Sulzberger Jr., the publisher of The New York Times? Or in 1981, when the Thomson Corporation, which then published over 100 newspapers in North America, bought a medical information business and sold The Times newspaper, beginning its transformation into a digital media powerhouse that culminated in its 2007 acquisition of Reuters? Or might print executives have noticed the signs in 1978, when Knight Ridder recognized the imminent emergence of digital media and launched videotex, which loaded news over a dedicated telephone connection? The reality is that the newspaper industry has had at least three decades of clues that their business model was at risk. The problem wasn't that they couldn't see the writing on the wall, but that executives at most newspapers failed to experiment creatively or drive transformation aggressively.
Myth 4: Things will return to normal after the downturn. Successive cohorts of executives in the automobile and airline industries, among others, have consoled themselves and appeased their investors with this myth. In many realities, the situation is likely to be worse, and stay worse, after the downturn. Consumers and corporations do not stop spending altogether in a recession, but they do seek out value for money. As a result, they are more likely to move away from companies that offer poor value for money and experiment with alternatives. Shoppers at ASDA, for example, are increasingly turning to the company's George budget clothing line and, if they are satisfied with the quality, may not return to higher-priced brands. Homeowners who cut out real estate agents to save costs may find the process of buying or selling a house without a middleman is not only cheaper, but more straightforward and quicker. Consumers who try alternatives are unlikely to flock back to business models that do not add value after the recession.
Myth 5: It couldn't happen to us. Some executives resort to schadenfreude to lift their spirits in a downturn. To feel better about the woes in their industry, book publishers snicker at newspapers, and even print executives can look down on their unfortunate counterparts in the music industry. In reality, leading companies in many industries, including law firms, pharmaceuticals, fast moving consumer goods and executive education, are persisting in very flawed business models, even if the severity of their problems is not yet apparent to everyone. The best way to ensure corporate failure is to assume it could never happen to you.
What is the bottom line of this book for readers?
Turbulence is here to stay, but there are concrete steps managers can take to seize the opportunities that arise out of turbulent markets.
Don Sull (dsull@london.edu) is Faculty Director, Executive Education and Professor of Management Practice in Strategic and International Management at London Business School.
The Upside of Turbulence is published by HarperBusiness.