What's a CEO to do in this downturn?
Financial Express, 29 January 2009
The world enjoyed a benign macroeconomic environment in 1983-2007, which is termed `the great moderation'. Intuition rooted in that period needs to be treated as suspect, for we are now in new territory. So what is a CEO to do?
- The first theme to emphasise is external financing.
- In good times, Indian firms were producing a lot of cash internally. In bad times, operating profit margins will suffer, and many firms will have operating losses. The modifications of business strategy that will restore profitability take time. In the short run, survival will often require external financing, whether it be debt or equity capital. External financing is also essential for opportunistically buying cheap assets. CEOs should realistically assess their requirements for external financing, based on the experience of five months from September till January, and either bring in external financing right away or start laying the groundwork for it.
Last year, getting external financing was easy: all it required was a phone call to SBI or Goldman Sachs. Banks are highly leveraged and can easily fall into distress. Hence, the sensible banks are lending cautiously. Among investment banks, the masters of the universe are struggling for survival. Hence, getting external financing is now hard.
The great frontier that is worth exploring is the vast Indian household sector. By and large, household balance sheets in India are in good shape. With financial firms either wounded or cowering, it makes sense to go over the heads of intermediaries and directly reach out to households. CEOs need to take the trouble to engage with households and sell shares and corporate bonds to them.
- The second theme is taking care of your ecosystem.
- Surrounding every large firm is an upstream ecosystem of suppliers of raw materials and services, and a downstream ecosystem of dealers, distributors and value adders. Given the infirmities of India's financial system, small firms face brutal financing constraints. Large firms must see that the survival of their ecosystem is important to them. The CEO of a large firm must pull in external financing that is adequate not just for himself but adequate for delivering the breath of life to the dozens or hundreds of small firms in his ecosystem.
- The third theme to emphasise is that of price flexibility.
- Wages rose dramatically in recent years. Commodity prices had changed dramatically. All firms were struggling to figure out the optimal business strategy under such drastically changed prices of all inputs and outputs. Now the dust is settling with cheaper raw materials, cheaper labour and reduced output prices. CEOs must rapidly get out of production plans and price structures that were adopted in 2007 and 2008, and re-calibrate for the conditions seen over September-January. Firms which are best able to question all assumptions, and able to have the most flexible prices for inputs and outputs, will do better.
- The fourth theme to emphasise is R&D.
- This is a time for cost cutting on many fronts: lower wages, economy class plane tickets, and meetings conducted over Skype. But in these difficult times, survival and profits will critically hinge on a continuous flow of R&D. R&D is required for process innovations that reduce cost and thus make possible price cuts that competitors cannot match. R&D is required for product innovation. Firms which have their backs against the wall and cut corners on R&D expenses are more likely to die when their competitors press on with process improvements and product innovation through strong R&D. When good times return, the firms with the best R&D will spring back to high operating profits the best.
- The fifth and last theme is triage.
- Not everyone is going to make it across the downturn. Every CEO needs to carefully look at his business partners and think about which ones will make it and which ones won't. The vulnerable firms are those which do not have a solid and well-run business, that are engaging in accounting fraud, that are more focused on putting out press releases rather than actually running a business. The CEO needs to coldly assess his own chances. If his firm won't make it across the downturn, it is better to sell off brands, factories or the company rather than destroy value by hanging on.
The 1997-2002 period was a difficult time in India. Thousands of Indian companies did not make it through that period. The survivors emerged stronger, and flourished in the 2002-2007 period. In similar fashion, 2009 and 2010 are going to be difficult. The better firms will pull in adequate external financing, not just for themselves but for their entire ecosystem; the better firms will have flexibility on all prices and think from scratch about business strategy at the prices prevailing today; the better firms will step up R&D expenses, for survival in bad times requires more innovations on cost cutting and product development. Finally, the better firms will cold bloodedly assess the chances of their business partners and of themselves.
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