What Really Prevents Companies from Thriving in a Recession
Even in the best of times, many companies fail to fund and staff new opportunities. As decades of research have shown, leaders fear threats to their status and power and so become attached to existing businesses and budgets, regarding them as entitlements and as a baseline for determining what’s “fair.” So, what might break the lethargy? An external trauma or force, such as a global pandemic or other crisis event, certainly helps. But two key measures to enhance their agility and flexibility include setting the strategic frame for resource reallocation decisions by focusing people on a positive vision of the future and reforming the budgeting process to outline metrics that be used to evaluate both existing and potential projects.
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Business leaders know they should “never let a good crisis go to waste,” but very few of them actually live this maxim. In a study of companies’ performance during and after the past several recessions, one of us found that 17 % didn’t survive (because they filed for bankruptcy, were acquired, or went private), and of those that did, the vast majority — 80% — were still struggling three years later to match their pre-recession growth. Only 9% of surviving companies “roared out of the recession,” posting results that exceeded both their peers and their pre-recession performance. These firms managed a delicate dance, playing both offense (investing in growth opportunities including new businesses) and defense (cutting costs and finding operational efficiencies) in response to external shifts. Even while reducing overall spending, they were able to carve out resources for new endeavors.
Aware of the need to respond more adroitly to sudden shocks, leaders have since pushed to make their companies flatter, more “agile,” and more “disruption proof.” Yet even firms that have adopted these approaches struggle to respond quickly and proactively enough when crises arise. In our research (Ranjay) and personal experience (Mark), we’ve found that the problem is ultimately a systemic one. Your strategic posture depends on how you deploy your resources, so to truly leverage a crisis to your advantage, you must change basic processes of resource allocation in your organization.
Even in the best of times, many companies fail to fund and staff new opportunities, and not for lack of good ideas. Some leaders at public companies blame investor pressures — the “capitalizing versus expensing” dilemma. In their view, markets favor companies that take a hit on their balance sheet for acquisitions (capitalizing) over companies that present poor income statements thanks to increased spending on internal innovation projects (expensing). In practice, it’s often easier to make a $1 billion acquisition than to find $10 million to internally respond to or prepare for market shifts.
This seemingly reasonable explanation fails under scrutiny. Leaders could seize new opportunities not by increasing expenses overall but by shifting existing funds, leaving their income statements untouched. And yet, most of the time, they refuse to make even mild changes in existing budgets. This, many leaders like to argue, has to do with concrete budget calculations and processes. These decisions hinge, after all, on quantified analysis of projected internal rates of return. New opportunities, exciting as they might be, simply fail to meet existing thresholds for risk. When leaders run the numbers, adapting to change seems like a bad bet.
But this explanation also falls flat, for it assumes that organizations are perfectly rational places where Excel spreadsheets and ROIs rule the day. Quantification of risk or return isn’t as easy or reliable as it might seem nor does it truly drive decision making. Rather, leaders often make choices based on impressions and enthusiasms — gut feeling, intuition. Much of the time, projected numbers are simply used to justify and socialize their preferences.
To understand why large organizations don’t always invest in new opportunities and hence why they struggle to play both offense and defense when crises arise, we must analyze the emotions that bear on resource allocation decisions. For reallocation to happen, deallocation must also occur. As decades of research have shown, leaders fear threats to their status and power and so become attached to existing businesses and budgets, regarding them as entitlements and as a baseline for determining what’s “fair.”
Leaders fear losing not just money, but also people and focus. Individual business owners within an enterprise want to protect the top talent they have wherever they are, rather than shift them to different areas or bring in new people. Or maybe they’ve built a strategy around certain things and worry that trying anything else will divert too much time and energy from the core.
The emotional dynamics leading to inertia in budgeting become amplified in some contexts more than others. Companies that focus on delivering “premium” offerings to customers, for instance, may have a harder time diverting scarce resources away from existing operations. Their attention remains fixed on adding value, even in areas that might not matter to customers. Subtraction just isn’t in their DNA.
So, what might break the lethargy in firms? An external trauma or force, such as a global pandemic or other crisis event, certainly helps. But here are two key measures leaders might adopt to further enhance their agility and flexibility in times of crisis, so that they can play both offense and defense effectively.
First, leaders can set the strategic frame for resource reallocation decisions. By focusing people on a positive vision of the future, rather than holding onto what they have done in the past, they can foster more alignment for future reallocation of resources. Entrenched turf battles deescalate, moderating the fears deallocation can trigger. Assurances of safety and security can further tamp down fears.
Leaders can also break the mentality of entitlement by reforming the budgeting process. With the strategic frame firmly in place, they should lay out new “rules of the game” for resource decisions, delineating which types of projects the organization will and will not fund and what metrics will be used to evaluate both existing and potential projects. At the extreme, they might force change by breaking the connection between budgets from year to year, establishing that only perhaps 70% to 80% of the previous annual budget will carry over. Publicly committing to ranges allays fears by capping how much existing unit and team heads stand to lose.
Reallocation isn’t the only answer for companies, either. When faced with a declining business, leaders might decide to simply run it down, expanding their margins and returning cash to shareholders. Although leaders usually shrink from this option, it, too, stands as a legitimate choice in certain situations. What isn’t legitimate is the default at most organizations today: stubbornly investing in the same old ways even as markets change.
H.G. Wells famously wrote: “Adapt or perish, now as ever, is nature’s inexorable imperative.” Covid-19 will not be the last crisis to confront global business with this choice — maybe not even the last this year. To protect your company, you must go beyond relatively superficial reforms such as implementation of agile structures and instead address the internal dynamics that affect how the organization deploys resources. Leaders must prod themselves free from the powerful emotional forces that prevent them from a readiness to respond to and innovate in crisis. If you want a vaccine that will inoculate you against the ever-shifting threats posed by volatility, this is the best you’ve got.
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Ranjay Gulati is the Paul R. Lawrence MBA Class of 1942 Professor of Business Administration at Harvard Business School.
Mark Wiedman is a senior managing director and head of international and corporate strategy at BlackRock. He is also a member of the firm’s Global Executive Committee.
What Really Prevents Companies from Thriving in a Recession
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