What strategic investments should you make during a recession to gain competitive advantage in the recovery?

Keith Roberts

Keith Roberts is Managing Director of PIMS Associates (info@pimsconsulting.com). Now based in London, he rst joined the company in its US ofce in 1979 and was responsible for the development of many of the benchmarking models used by PIMS consultants. In addition to coordinating the new product activities of PIMS, he currently consults with leading international companies.

In the US, the term ``recession'' is usually only applied to a general economic downturn lasting two quarters or more. In contrast, PIMS researchers use the words ``market recession'' to characterize a product sales dip that continues for at least two years and then recovers. Obviously, a market recession is likely to occur during an economic downturn, but it can also happen independently. It is always stressful to undertake expensive new product launches or make major investments in corporate capability during a market recession lasting two years or more. PIMS research helps by providing guidance into which investments contribute the most to competitive advantage when the recovery arrives. Before investing, management needs to carefully distinguish between a temporary recession and a decline due to competitive innovation, substitute products, or adverse demographics. n a recession, dare to invest aggressively in marketing, innovation and customer quality'', is the clear message to be drawn from PIMS (Prot Impact of Market Strategy) research into which business strategies aid success during and after a market downturn lasting several years. For strong businesses, such bold strategies are the way to continue thriving, and for weak businesses they are the surest means of survival. The study, based on the PIMS Database of business performance, points to very clear strategies for securing the future both during and after a recession in other words how to maintain protability through the bad times and achieve superior sustainable growth during recovery. The evidence is drawn from those businesses in the PIMS Database of business performance that have experienced recession and recovery from the 1970s to the 1990s. For this study, a market in ``recession'' is dened as experiencing two years decline in volume followed by two years of growth. It's important to note that this denition excludes markets that are in terminal decline. Also note that the study monitored total markets that experienced decline and recovery in volume demand. That does not necessarily mean that the sales volume of a single, successful business fell, only that the total market demand for its type of products/services declined and then grew again. Nearly 1,000 businesses in the PIMS Database meet these criteria. A detailed analysis of these businesses and the strategic decisions taken by them during a market recession shows that electing different strategic options has profound implications for prot and market share outcomes once recovery starts. So to maximize growth out of recession and maintain or increase market share, should rms, for example, increase or decrease marketing spending? Should they shelve new product launches or push on full steam ahead?

``I

# Alistair Davidson. www.alistairdavidson.com

DOI 10.1108/10878570310483960

VOL. 31 NO. 4 2003, pp. 31-39, MCB UP Limited, ISSN 1087-8572

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The PIMS study investigates all areas of a business to establish where investment pays off during a market recession and where it does not. PIMS' evidence distinguishes between ``good costs'', ``bad costs'' and ``it depends costs''. ``Good costs'' are those that should be increased and intensied during recession. ``Bad costs'' are those, which, of course, need to be pruned hard in recession. ``It depends costs'' are those where the strategic position of an individual business at the time recession begins determine what actions should be taken.

The source of the evidence

The PIMS Database captures the real experiences and performance of an ever-increasing number of businesses. At the end of 2002, the PIMS Database encompassed approximately 4,000 businesses from a wide range of industries in North America, Europe and other parts of the world (Exhibit 1). PIMS data on each of these businesses captures characteristics about the markets they serve, their market shares and the shares of their main competitors, the resources required by the businesses and their costs and nancial performance. For each of these businesses, at least four consecutive years of data are compiled on a number of key factors: J Market environment factors: growth, concentration, innovation, logistical complexity, customer power. J Competitive position factors: market share, patents, relative customer preference, channel coverage. J Resource structure and utilization: capital turnover, asset exibility labor productivity, outsourcing. This research study focuses on three measures to distinguish between successful and unsuccessful strategies for the 1,000 businesses: (1) average protability during recession, dened as ``return on capital employed''; (2) change in protability (ROCE) during rst two years of recovery; and (3) change in market share during rst two years of recovery.

Exhibit 1 Businesses in the main PIMS Database cover a wide range of industries
Durables

Consumer
Non-durables Capital goods

Raw & semi-finished materials

Business-to-Business
Components Supplies

Services and distribution

Start up businesses
0 200 400 600 800

No. of Businesses

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businesses `` The natural reaction of many to cut costs experiencing a downturn in their revenue is in areas like

advertising and promotion. Our ndings prove that they should do exactly the opposite if they are to ride out the recession and thrive thereafter.

''

Successful strategies: the evidence

The ``good costs'' are those associated with marketing, quality and new products/services. The ``bad costs'' include high manufacturing and administration costs and high working and xed capital. The following data and charts demonstrate the degree of the impact of getting cost decisions right or wrong. Let's look, rst of all, at what have proved to be ``good costs'' during recession. The most pointed of these ndings is the importance of marketing. The natural reaction of many businesses experiencing a downturn in their revenue is to cut costs in areas like advertising and promotion. Our ndings prove that they should do exactly the opposite if they are to ride out the recession and thrive thereafter. We divided the 1,000 PIMS businesses between those that cut, maintained and increased marketing budgets during recession. As the chart below shows, those businesses that increased marketing spending were not signicantly less protable during recession. However, their prots increased dramatically faster once recovery started, unlike ``cutters'' of marketing budgets whose protability actually fell when recovery began! Furthermore, businesses that increased marketing spending in recession, gained market share three times as fast as ``cutters'' once recovery began! (see Exhibit 2). For marketing spending to be effective, of course, it needs to be based on a sound customer proposition. Those businesses, which, in their customers' eyes, provide better value-for-money than their competitors, are both more protable during recession and grow faster once recovery

Exhibit 2 Marketing spend does not damage ROCE signicantly in a recession and helps set the platform for strong recovery
Inflation-corrected ROCE during recession (%)
20%

Increase in ROCE during recovery (% pts.)

6 5
4.3

Market share change in first 2 years of recovery (% pts.)

3

15%

4 3 2
1.7

10%

10% 9% 8%

2 1 0
0.6

1
-0.8 0.6

0.9

5%

-1 -2

0%

-3

cut

maintain

increase

cut

maintain

increase

cut

maintain

increase

Marketing spend (as % of market size)

Marketing spend (as % of market size)

Marketing spend (as % of market size)

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starts. During a market recession, improving customer perceived quality of your offering relative to competitors also pays off in better prots and growth (see Exhibits 3 and 4).

Olympia Antiques Fair achieves success through higher quality and intensied marketing
To illustrate the importance and benets of increased marketing spending, superior quality offering and value-for-money during recession, let's look at a business that manages exhibitions for antiques, a market that is quite sensitive to general economic downturns.

Exhibit 3 Moving ahead of competitors on customer-perceived quality pays off handsomely through into recovery
Inflation-corrected ROCE during recession (%)
20%

Increase in ROCE during recovery (% pts.)

6 5

Market share change in first 2 years of recovery (% pts.)

3

15%

4 3
2.8 1.7 1.3

10%

10% 9% 9%

2 1 0

1
-0.4 0.6 0.6

5%

-1 -2

0%

-3

cut

maintain

increase

cut

maintain

increase

cut

maintain

increase

Customer-perceived quality vs. competitors

Customer-perceived quality vs. competitors

Customer-perceived quality vs. competitors

Exhibit 4 Superior value-for-money pays off through a recession (as always)

Inflation-corrected ROCE during recession (%)
20%

Increase in ROCE during recovery (% pts.)

6 5
4.3

Market share change in first 2 years of recovery (% pts.)

3

15%

4 3 2

2.1

10%
7%

10% 9%

2 1
0.1

0 5% -1 -2 0% -3

-0.1

1
0.6 0.6

worse

same

better

worse

same

better

worse

same

better

Customer-perceived value vs. competition

Customer-perceived value vs. competition

Customer-perceived value vs. competition

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`` During a market recession, improving customer perceived quality of your offering relative to competitors also pays off in better prots and growth. ''
The case of the Olympia Antiques Fair
When recession hits, exhibitions are one of the rst areas of scrutiny in the marketing budgets of many companies. The Olympia Antiques Fair faced a potential crisis of fewer exhibitors and a lower number of visitors at the outset of the 1990 recession. The Olympia Antiques Fair had been the largest public fair of its kind and second only in prestige in the UK to the Grosvenor House Fair. Olympia, however, had had problems immediately prior to 1990 with claims of stolen goods, heavy-handed security staff, etc. The response of the Olympia Antiques Fair management team was to re-package and enhance the quality of the fair, both for exhibitors and visitors, and substantially to increase budget and activities surrounding the marketing and promotion of the Olympia Fairs. The successful outcome has resulted in the Olympia Antiques Fair regaining its prestige status. Its fairs are now taking place three times a year with both a waiting list of exhibitors and everincreasing visitor numbers and purchases.

Innovation pays off

What about product innovation during recession? R&D spending in recession, both in absolute terms and relative to competition, pays off handsomely (Exhibit 5). R&D spending is such a particularly ``good cost'' during recession because successful, new product introductions during recession are crucial to strong recovery in protability and growth (Exhibit 6). So, what are some good examples of successful businesses investing heavily in R&D and new product launches during a recession?

Exhibit 5 Recessions are a good time for product R&D initiatives

Inflation-corrected ROCE during recession (%)
20%

Increase in ROCE during recovery (% pts.)

6 5

Market share change in first 2 years of recovery (% pts.)

3

15%

4 3
2.8

2
1.4

10%

10% 9% 9%

2 1 0
0.6 0.8 1.1

0.8

5%

-1 -2

0%

-3

cut

maintain

increase

cut

maintain

increase

cut

maintain

increase

Product development spend (as % of market size)

Product development spend (as % of market size)

Product development spend (as % of market size)

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Exhibit 6 New products are crucial to prot recovery

Inflation-corrected ROCE during recession (%)
20%

Increase in ROCE during recovery (% pts.)

6
5.1

Market share change in first 2 years of recovery (% pts.)

3

5 15% 4 3 10%
10% 9% 8%

2.0

2 1 0
-0.1 -0.7

1
0.7 0.7

5%

-1 -2

0%

-3

low

average

high

low

average

high

low

average

high

% Sales from new products

% Sales from new products

% Sales from new products

The case of First Direct, an innovative telephone and Internet banking company
A high-prole case in point is Midland Bank's launch of First Direct the rst, successful 24hours-a-day full telephone banking service in the UK. By 1998, First Direct had over 850,000 existing customers, with new customers joining at the rate of 12,500 each month. First Direct is also a good example of a successful business increasing its marketing spending during recession and successfully providing superior quality offering and value-for-money. In a recent survey of First Direct's customers, ``86 percent said banking with First Direct was better than banking with other banks''.

Launching Gillette's Sensor brand in mid-recession

A second example of a successful business launching new products during a recession is Gillette's introduction in 1990 of its Gillette Sensor brand of shaving products. Since the initial marketing of Gillette Sensor products, more than 8 billion Sensor razor blade cartridges and 400 million Sensor razors have been sold. By 1997, a record 49 percent of Gillette's sales came from new products introduced in the previous ve years. In the same year, Gillette's annual R&D spending had reached $212 million.

Bad costs
Let's turn now to ``bad costs''. Investing in new xed assets during recession, supposedly to improve cost competitiveness and productivity, does not usually bring positive benets and if anything, the opposite is the case. Why should this be? This is because the supposed benets of new assets tend to get competed away in the form of lower prices and prot margins in an attempt to ll capacity (see Exhibit 7).

A paper manufacturer falls into capital investment trap

By the start of the UK's recession in the 1990s, a paper products manufacturer had invested a large capital sum to build a new state-of-the-art, automated warehouse. The prime justication for this large capital investment was to lower costs by reducing the number of warehouse employees and to improve the efciency of picking and dispatching customer orders. The reality proved to be very different. Prots for the company actually fell because of higher depreciation charges and the need to retain expensive consultants to ``de-bug'' the numerous

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Exhibit 7 New plant and equipment (which eats up cash) has no discernable positive effect on results . . . if anything, the opposite . . .
Inflation-corrected ROCE during recession (%)
20%

Increase in ROCE during recovery (% pts.)

6 5

Market share change in first 2 years of recovery (% pts.)

3

15%

4 3 2
1.4 1.7 1.2 1.0 1.1 1.0

10%

10% 9% 8%

2 1 0

5%

-1 -2

0%

-3

cut

maintain

increase

cut

maintain

increase

cut

maintain

increase

Newness (NBV/GBV) of plant & equipment

Newness (NBV/GBV) of plant & equipment

Newness (NBV/GBV) of plant & equipment

software systems problems that plagued the operation of the new warehouse in its early stages. Furthermore, the systems and procedures required by the new warehouse reduced the previous exibility in prioritizing and picking customer orders. This led to a noticeable reduction in quality of customer order fulllment, resulting in a loss of market share. The company then reduced prices in an attempt to regain volume, but it only succeeded in further reducing its margins and prots! Clearly, the paper company's original investment strategy backred. The right approach, as PIMS research shows, is to skillfully attack the prime targets for cost cutting during a recession. These are such ``bad costs'' as high working capital, high manufacturing costs and high administrative overheads. But care should be taken not to turn a cost reduction offensive, such as that initiated by the paper company, into one that generates costs.

Understanding when ``it depends''

There are certain recession investment strategies, such as cutting output capacity and outsourcing that may contribute positively or negatively to business performance during market recovery. This is because their eventual impact depends on the strategic position of a specic business. Cutting output capacity during recession (and, thus, people and costs) may seem a very appropriate strategy. For market leaders, however, the PIMS evidence suggests that cutting capacity holds back prot and share improvement during recovery (see Exhibit 8). This set of strategies ts most but not all rms
The PIMS evidence outlined above provides a guide for which strategies should prove successful during recession for many businesses much of the time. However they are not appropriate for all businesses in all circumstances. Indeed, for certain businesses, a set of ``opposite rules'' seems to apply. For example, we evaluated one type of business with a particular set of characteristics where a successful strategy in recession was to cut back on product launches and to increase investment in overheads to improve the quality of interaction with customers and suppliers!

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Exhibit 8 Market leaders can lose out on recovery if they chop too much capacity in the recession
Inflation-corrected ROCE during recession (%)
20%

Increase in ROCE during recovery (% pts.)

6 5 4.2 4
13%

Market share change in first 2 years of recovery (% pts.)

3 4.4

15%

15%

15%

3 2

3.1

1.9

10% 1 0 5% -1 -2 0% -3 0 1
1.0

1.3

cut

maintain

increase

cut

maintain

increase

cut

maintain

increase

Production capacity

Production capacity

Production capacity

NB: Market leaders only

Outsourcing is another issue

This is a rapidly increasing trend, partly to allow businesses to concentrate on their core competencies and partly to realize supposed cost savings and efciencies. So, what better time to out-source more of your services than in a recession? The PIMS evidence suggests that the positive impact of this strategy depends on your market position and whether your priority for recovery is prot or share improvement (see Exhibit 9).

Exhibit 9 Outsourcing depends on market position and recovery strategy

Inflation-corrected ROCE during recession (%)
20%
16%

Increase in ROCE during recovery (% pts.)

5
4.2 4.2

Market share change in first 2 years of recovery (% pts.)

3 Market leaders
3.2 2.4

4 Market leaders
14%

15%

13%

3 2
2.9

2
1.3 0.7 -0.2

10%
8%

1 0 -1
5% 4%

Market leaders
0.6 0.6 0.4 0.6

5% Market followers

Market followers

-2 -3 0

0%

Market followers

cut

maintain

increase

cut

maintain

increase

cut

maintain

increase

Vertical integration (make vs. buy)

Vertical integration (make vs. buy)

Vertical integration (make vs. buy)

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Exhibit 10 PIMS evidence: during a recession there are some costs where the optimum stays steady or even increases (``good costs'') and other costs where the optimum drops dramatically (``bad costs''). ``Optimum'' relates both to performance through the recession and to the recovery thereafter
"Good Costs in Recession" Marketing Quality Product development "Bad Costs in Recession" Fixed capital Working capital Manufacturing General & admin. Depends on strategic strength Retaining spare capacity Price aggression Outsourcing

In conclusion, the PIMs evidence indicates that rms with bold strategies to invest aggressively in marketing, innovation and customer quality will thrive during the market upturn (see Exhibit 10). Research shows that a few rms must be managed as exceptions to the general rules articulated in this article (see box ``This set of strategies ts most but not all rms''). To ensure that the bold strategies PIMS proposes in a market recession invest aggressively in marketing, innovation and customer quality will work for your businesses, you should research how well these strategies have served businesses analogous to your own in the past.

Acknowledgment
Photo credit: Photograph by Alistair Davison (www.alistairdavidson.com); e-mail address, alistair@eclicktick.com

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