heroes in a downturn: strategies from the front lines · offense is the best form of defense heroes...

Offense is the best form of defense

By Sam Israelit, Chris Brahm and Dianne Ledingham

Heroes in a downturn: strategies from the front lines

Copyright © 2009 Bain & Company, Inc. All rights reserved.Content: Manjari Raman, Elaine CummingsLayout: Global Design

Sam Israelit is a partner with Bain & Company in San Francisco and a leader of Bain’s Performance Improvement practice. Chris Brahm is a partner withBain in San Francisco and heads Bain’s Technology practice in the Americas.Dianne Ledingham is a partner with Bain in Boston and a leader in theTechnology, Media and Telecom practice areas.

The authors would like to thank Josh Rutberg, Melissa Artabane and Meredith Brenholdt for their contributions to this report.

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Heroes in a downturn: strategies from thefront lines

Adversity always shuffles the deck in the techindustry—and the 2008–2009 downturnalready shows signs of disruption that mightcreate new winners in the future. Intel’s intro-duction of the low-cost Atom microprocessor,Cisco’s expansion into the datacenter businessand Microsoft’s push to make Xbox LIVE aplatform for digital media distribution—theseare just some of the potential game-changingmoves this recession is ushering in. But thebig churn is still around the corner. A recentBain survey of leading tech companies revealsthat most companies are still reacting defen-sively to the recession—and only a few areaggressively preparing to go on the offenseor actively planning disruption (See Figure 1).It is these select leaders who will not justsurvive the downturn; they will race ahead ofthe competition as the economy improves.

To track the tectonic shifts that might alreadybe underway in the tech industry, we inter-viewed CFOs and CEOs in 27 technologycompanies—hardware, semiconductors,software, services and Internet companies—with revenues ranging from $50 million to$50 billion. As expected, all tech executivesreported that the downturn had a significantimpact on their business in 2009. Most didnot expect the recovery to start in earnestbefore mid-2010.

As we probed further, the difference in perspec-tives began to emerge. Many companies hadnot yet crafted the playbook to move from arecession to a recovery; these companies aremost vulnerable to disruptive moves fromthe competition. A few have moved beyondthe early shock waves and are actively usingturbulence to get ahead of the competition;these companies are taking advantage of thecurrent situation to execute new strategies thatstrengthen their position. Said a recovery-focused CFO, “A good downturn is a terriblething to waste.”

Strategy

Identifygame�changing M&As

Seek opportunities fordisruptive innovation

Identify leadershipsegments in portfolio

Organization

Ensure the righttalent is in place

Simplify theorganization structure

Focus on effectivedecision making

and strengthen theorganization’s culture

Reduce functionalcosts basedon scenarios

Identify opportunitiesfor restructuringthe value chain

Reduce complexityand focus

on structuralcost reduction

Operations

Focus on investmentsthat reinforce

customer loyalty

Build sales effectivenessand target

competitive share gain

Revenue

Price proactivelyto gain share

or increase revenue

Figure 1: Pulling the right levers to win in this downturn

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Consider the widening chasm between poten-tial winners and losers in the survey findings:

• Although 50 percent of executives claimedthat revenues will be more severely hit in2009 than they originally anticipated—and 30 percent felt unsure of meetingcurrent revenue projections—most com-panies still hoped their initial actions forcoping with the downturn were going tobe sufficient. Only 20 percent had a back-up plan in place to respond to the possi-bility of a continued recessionary envi-ronment or a slow, drawn out recovery.

• All the companies surveyed had takensome action to reduce costs. But less than40 percent had undertaken initiatives tosteal market share from competitors,build customer loyalty or improve theeffectiveness of their salesforce.

• The surveyed companies reduced SG&Aexpenses between the first quarter of 2007and the last quarter of 2008 by an average8 percent. While companies continue to

focus on reducing costs in the future,many are grappling with how deep thecuts should be, especially in industrysegments that are expected to decline bymore than 10 percent. In the less severe2000–2002 downturn for example, morethan 60 percent of the tech companieslowered SG&A expenses by an average22 percent (See Figure 2).

• About 60 percent of the companies indi-cated they were open to acquiring a dis-tressed company. However, most had notplanned the specific scenarios under whichthey would trigger such action, nor hadthey thought through how competitorsmight react.

What the past foretells

For some in the tech industry, these signs arefamiliar—and point to an impending shakeout.Bain’s research shows that downturns create“heroes” and “casualties”—companies whosetotal shareholder return jumps or falls two ormore quartiles among peers—and that this

Publicly held tech companies havetargeted SG&A spend…

Note: Prior downturn includes US public tech companies with all data available for last downturn analysis Source: OneSource, Capital IQ, Bain Analysis

...not enough compared with actiontaken during the last downturn

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Figure 2: Tech companies have reduced expenses, but most will need to cut more

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shuffling of the leader-board happens at doublethe rate in a downturn as in periods of growth(See Figure 3). In fact, our analysis of publiclylisted technology, media, and telecom compa-nies shows that despite the challenges of2000–2002, 48 percent of the companies were“heroes” and gained ground substantially. Thatwas twice as much disruption compared withother industries. In contrast, during the stabletimes of 2003–2005, only 24 percent of thecompanies could pull ahead of the pack.

The same holds true for the casualties. Wefound that companies experienced moredramatic loss in share during downturnsthan compared with growth periods. While44 percent of the companies were “casualties”of the challenging 2000–2002 days, only 11percent of the companies declined in perform-ance during the relative calm of 2003–2005.Further, we found that the decline in casual-ties and the rise of heroes tended to continueeven after the economy rebounded.

The implications for most tech companies areclear—companies proactively need to protecttheir turf and seek ways to use the downturnto their advantage and position their companyfor growth. Between 1989 and 2009, leadingelectronics manufacturing service (EMS)companies, for example, often tripped duringturbulence. Sanmina-SCI lost leadership inthe early 1990s recession, allowing Solectronto dominate the EMS market. Then Solectronwas hit hard by the 2000–2002 downturn andultimately merged with Flextronics. All thewhile, Taiwan-based Hon Hai steadily grewto become the world’s largest electronics man-ufacturing services provider, successfully steer-ing through business cycles over the last 10years. Today, Hon Hai dominates the EMSprofit pool.

Clearly, within a given industry, not everycompany suffers equally, even in severe down-turns. Each company has its particular strengthsand vulnerabilities, but each also faces a sim-ilar set of questions: What is our plan for most-likely and worst-case scenarios? What is required

to retain our most important customers andemployees? How can we fully take advantage ofthe downturn by “going on the offense” instrategy, sales, operations, and organization?What are our acquisition priorities and underwhat conditions should we initiate deals? Howdoes our business model need to change for thelong term? How will our industry profit poolchange? How can we be a catalyst and benefitfrom change? In our experience, companiesthat face these questions squarely, that under-stand the relative strengths and weaknesses,and that identify the right levers to pull are theones that successfully steer out of turbulenceand gain competitive ground.

How to win in this downturn

At times, fortunes in the tech industry seemto shift by chance. However, when we studiedcompanies who were successful in grabbingthe lead in a downturn and maintaining it onthe upturn, we found that some consistentpatterns emerge. Heroes strike the right bal-ance between relentless focus on executionin their core business and aggressively investingin the future. Moreover, they were willing totake risk to disrupt and shape the future. Everytime their market’s “profit pools” shifted, theywere right there in the new space ready for thenext phase of growth. It didn't matter whetherthey were the catalyst of change or not, theyspeedily embraced the change either organi-cally or through mergers and acquisitions.Operationally too, they were ahead of the gamein how they managed cash and costs, R&D,pricing, and sales effectiveness.

Our research shows that companies that winover the long term capitalize on turbulencewith the following five rules:

Rule 1: Execute Plan A—but prepare forPlan B

While most tech CFOs and CEOs foresee anuncertain future most were still not takingenough action to prepare for what mightcome. A systems company CFO remarked,

Downturn (’00–’02)

�60

�40

�20

0

20

40

60%

Casualties

Heroes

48%

�44%

Figure 3:Companies makemore dramaticgains—and losses—during downturnsthan in boom times

Note: Heroes are companies that performed significantly below average at the beginning of the period and significantly above at the end; similarly, casualties showed a significant decline in performance; compares relative performance (sales growth, profit margin, TSR) by industry category, for US tech, media and telecom companiesSource: Sustained Value Creator Database/Worldscope; Bain Analysis

�60

�40

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Stable period (’03–’05)

24%

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HeroesPercent of bottom performersthat rose to the top

CasualtiesPercent of top performersthat fell to the bottom

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“Cutting executive bonuses and furloughingworkers is not a long-term cost reduction. Weneed to think about structural reductions.”

More than two-thirds of the organizationssurveyed had not developed any plan for addi-tional structural cost reduction—and some werealready wincing as a consequence. One hard-ware company’s CFO admitted, “Initially, wethought we would be down by 5–10 percent, butwithin a month we had to revise it to 20 percent.It kept getting worse, and eventually, we wereall-hands-on-deck to find more cash.”

Some tech companies claimed they were con-servative in their reductions because they didn’twant to make the wrong decisions underpressure. In sharp contrast, a few forward-thinking companies mapped scenarios thatclearly highlighted what circumstances wouldtrigger what action—as well as the impact ofthose actions. Managers in these companiesnot only had a firm grip on costs but wereequipped to make hard choices in worseningcircumstances without panic. “We were veryproactive in developing scenarios and contin-gency plans,” said the CFO of a midsize enter-prise software company. “We have a ‘def-con’chart of various stages: business as usual, stormyseas, nuclear winter. That helped us to reactquickly as events played out over the summer.”

Such planning is important when the rangeof forecasts for IT spending vary so widely—from a depressing negative 12.0 percent to flatin 2009 and from negative 4.5 percent to 1.1percent in 2010. While recent forecasts showsigns of stabilization and some even suggestimprovement in the second half of 2009, theyalso indicate wide divergence by sector—a clearsignal that acting on “Plan B” might yet becomenecessary for companies in certain sectors orcompanies in a weak strategic and financialposition. While it is impossible to predict thetrajectory of the IT sector with any certaintyover the next 12 to 24 months, the best pre-pared companies have already made plansto cover the full range of scenarios.

Rule 2: Selectively invest to grow

Managers usually take serious defensiveactions—cutting costs, reducing workingcapital, shrinking headcount, reducing over-head, and more recently, off shoring and out-sourcing—to respond to downturns. But Bainresearch shows that tech companies that becameheroes did not just cut costs in the last down-turn—they generated cash, which they theninvested to spur growth. Some increased R&Dinvestments by an average 9 percent—evenas they cut elsewhere. When the economypicked up, so did their revenues. These com-panies grew, on average, 30 percent fasterthan the tech industry’s overall growth. Othersthat used the cash for strategic M&A werealso rewarded: returns on tech acquisitionsmade during the last downturn were doublethe returns for tech acquisitions done beforeor after the downturn (See Figure 4).

Our Bain survey for this downturn indicatesthat tech companies are taking five times asmany actions related to reducing cost comparedwith those increasing revenue and share (SeeFigure 5). One services company CFO said,“We have no visibility into revenue right now.If it comes, it comes. In this environment, wefeel we have to get ahead on costs.”

In sharp contrast, one CEO explained that assoon as his enterprise software company gota grip on costs by consolidating sites, reduc-ing headcount, and slashing expenses—it setitself a growth challenge. Despite the down-turn, what can the company do to increaseearnings by 5 percent compared with the pre-vious year? First, the company hiked its mar-keting budget to fund a new campaign in thespring to differentiate itself from the compe-tition. Then it pumped up the pace of productdevelopment to target new customers overthe next few quarters. Finally, it raised incen-tives to motivate the salesforce. Today, thecompany’s earnings are 12–18 percent aheadof last year. “We realized we’re not going to

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0

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Indexed cash flows from operations(Base 100: 2000)

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‘00 ‘01 ‘02 ‘03 ‘04

How heroes used the cash

Aquisitions

CAPEX

Shareholder return

Adjust the balance sheet

Reinvestment activities

Share repurchase

Paid�down debt

Dividends

Note: Heroes are companies that performed significantly below average at the beginning of the period and significantly above at the end; similarly, casualties showed a significant decline in performance; compares relative performance (sales growth, profit margin, TSR), for US tech companies Source: Sustained Value Creator Database/Worldscope; OneSource; Bain Analysis

…and generated cash to reinvest in the business

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Casualties

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Indexed sales(Base 100: 2000)

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Figure 4: In the last downturn, winning tech companies invested in R&D, increased revenues...

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solve our problems by just watching costsanymore. We’re going to have to drive revenue,”says a company executive. “What excites menow is that when the economy improves, ourearnings will go through the roof!”

Rule 3: Retain old customers—andacquire new ones

At the best of times, companies ignore cus-tomers at their peril; in a downturn, the dan-ger doubles. A company must now worry aboutretaining current customers, as well as increas-ing market share, all with limited resources.In the last downturn, Yahoo and Google gainedground by redefining the value they broughtto their customers, while AOL struggledbecause it lost its focus on finding new waysto offer customers value.

In this down cycle, many tech companies areyet to turn their attention to customer loyalty.Though 85 percent of the companies surveyedwere taking at least one action to drive revenue

in the short term, few companies mentioned“the customer” as a critical priority withoutbeing prompted. Less than 40 percent of thesurvey respondents admitted to using pricingstrategies to boost demand—and most pricereductions were reactive rather than to gainmarket share.

One software company in the survey stood out:It was actively using every tool at its disposalto focus on customers. Its sales force was outaggressively promoting new modules, withflexibility in offering discounts such as anextended warranty. The frontline was workingwith customers helping them figure out howthe government’s stimulus plan can benefitthem. Said the CEO, “We have a competitiveattack plan.” Another CFO shared the plansto beat their competitor in the next 12 months.“We have identified 20 key accounts we aregoing to take from them and have assignedteams to go after each one. We have customizedplans for each of them and a majority of ourbonus is based on winning them over.”

Most tech companiesare focused on cost�cutting…

Source: Bain interviews of tech industry CFOs & CEOs

…and only a few are taking actionsto increase revenue

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Figure 5: Winners cut costs—but also focus on revenue growth

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Rule 4: Be the disruption

Recessions offer tremendous opportunities fordisrupting the status quo. Two kinds of disrup-tions stand out for how they reshape industries:new value propositions and industry consoli-dation. In downturns, customers are morewilling to take risk in search of more value—so new, discontinuous value propositions area real and present danger. One CFO remarked,“A couple of years ago we would have consid-ered a cloud-based email solution just too risky.Now we have no choice. We have to consideralternatives that reduce costs for the customer.”

Sometimes these disruptions are business-model-driven; sometimes they are technology-driven. For example, Indian systems integratorsgained market-share in both the last recessionand this one, by simply offering lower pricesbased on their significant cost advantage.Similarly, the TV industry shifted to LCD andplasma technology in the last recession, reshap-ing the competitive dynamics. In the currentrecession, already there is a growing list ofpossible technology disruptors. To name just afew: behavioral advertising, smart phones andmobile internet devices, cloud-computing, inter-net video, location-based services, eBooks, solidstate storage, low-cost camera modules, smartgrid and low-cost outsourced design services.

While all the CFOs surveyed could name anumber of the possible disruptors for themarkets they compete in, most admitted theyhad not adequately planned to deal with theirimpact on their industry. Said one softwareCFO, “We can see how many of these tech-nology and business model disruptions couldimpact our business. But we do not yet havea clear strategy to take advantage of them.”

In addition, there are mergers and acquisitions,which can substantially redraw the competitivelandscape. Our research shows that in 2001,“heroes” saved more than $15 billion in cash,of which nearly 80 percent was used for capitalinvestments, dividends and buybacks—and

acquisitions. Some of the bigger deals: Googleacquired YouTube to build a leadership posi-tion in video, eBay bought PayPal to enhancethe functionality of its marketplaces, andHP purchased Compaq to broaden its productofferings for consumer PCs and low-endservers. While the ultimate value created bysome of these deals is subject to debate, it isundeniable that consolidation follows in thewake of a downturn.

While almost all the survey respondents saidthey would be open to acquisitions—and somehave even created war-chests—less than a thirdhad analyzed which companies they wouldacquire, and under what circumstances (SeeFigure 6). One hardware company stood outfor the thorough job it had done to identifypotential acquisitions. Said the CFO: “We havea pipeline of targets in businesses adjacent toour business. We update this on a regular basisand currently, there are two areas we are mon-itoring closely.” Another semiconductor com-

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Intention to acquire

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Done—consideringadditional

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considering20

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No

Yes

Source: Bain interviews of tech industry CFOs

Percent of mentions

Figure 6: Many tech companies are considering acquisitions, but few have a plan of action

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pany is watching a clutch of related companieswith balance sheet problems—and will strikewhen the price is right. Says the CFO: “Thesecompanies don’t have the ability to accesscapital. Our balance sheet is strong, we havethe advantage.”

Rule 5: Build a winning team

As might be expected, more than 75 percentof all publicly held tech companies laid offemployees between February 2008 and April2009. According to the Bain survey, about25 percent of firms cut their workforce by10 percent or more. In general, within theindustry, hardware companies made the deep-est cuts, followed by media companies andthen software. The survey revealed they sharea common concern about the impact of lay-offs on company morale. Says the CFO of asemiconductor equipment company: “We arereally concerned about losing the hearts andminds of our employees. This recession hasbeen brutal for our organization. Our biggestchallenge is getting ready for the recovery. Weneed to maintain a strong talent pool, reduceemployee turnover, and get our people excit-ed despite the continued uncertainty.”

A leading hardware company CFO describedthe company’s plans to build the organizationover the next 12 months: Keep people moti-vated, and make sure the best performers areengaged. The top management is dramaticallyincreasing the amount of “walking the halls.”It is engaging employees through small groupwork sessions, soliciting open feedback andinvolving them in solving the challenges ofthe business. The company is aggressivelyreviewing its talent pipeline and doublingdown on investment in its top performers.

Other surveyed companies mentioned thatthey are using employee forums and onlinetools to engage employees and address criti-cal issues. One company is using the down-turn to provide development opportunitiesfor its key employees. It is assigning specialprojects—such as economic impact assess-

ments, new product brainstorming and processredesign—to engage key individuals to helpaddress specific challenges.

At a few companies, leaders are capitalizingon a market flush with talent—particularlycompetitors’ employees facing uncertainty—to upgrade capability. “We are replacing theunderperforming with the performing,” saidthe CFO of a large software company, adding:“We are hiring at many levels of the organi-zation, even the most senior. We want to fillthe skills and competencies we don’t have,especially in businesses where we may beweak.” Whatever the approach, the best com-panies are taking nothing for granted andinvesting aggressively in their people to ensuretheir organization is stronger coming out ofthe downturn than going into it.

The will to win

None of these strategies is easy, especially inthe tech industry, where even in boom timesthe competitive pressure can be intense. WesternDigital came out of the last downturn a hero,partly because it quickly moved to a lower-cost business model as the hard-drive marketmatured. The lower overhead and faster devel-opment times quickly translated into marketshare and higher margins in the growth years.On the other hand, Sun Microsystems exitedthe last downturn a hero, but its slow pace inevolving its proprietary hardware-based busi-ness model left it vulnerable to a takeover inthis downturn.

In a recession this deep and long-lasting, thestress and strain on leadership teams is extraor-dinary. In these circumstances, it is not justenough to understand which strategic, opera-tional or organizational levers to pull—leadersalso have to find resourceful ways to get theorganization to execute despite duress. Event-ually, when the dust settles, no one remem-bers how strong a company was going intoturbulence—everyone points to the heroescoming out of the downturn.

Bain’s business is helping make companies more valuable.

Founded in 1973 on the principle that consultants must measure their success in terms of their clients’ financial results, Bain works with top management teams to beat competitors and generate substantial, lasting financial impact. Our clients have historically outperformed the stock market by 4:1.

Who we work with

Our clients are typically bold, ambitious business leaders. They have the talent, the will and the open-mindedness required to succeed. They are not satisfied with the status quo.

What we do

We help companies find where to make their money, make more of it faster and sustain its growth longer. We help management make the big decisions: on strategy, operations, technology, mergers and acquisitions and organization. Where appropriate, we work withthem to make it happen.

How we do it

We realize that helping an organization change requires more than just a recommendation. So we try to put ourselves in our clients’ shoes and focus on practical actions.


For more information, please visit www.bain.com

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