Good management creates value in an uncertain economy

A new report says many Irish managers have an "ostrich-like" approach to the recent downturn, writes David Labanyi

MANAGERS IN many Irish companies are taking an "ostrich-like" approach to the current downturn, hoping economic conditions improve rather than responding to the changed circumstances.

That's the view of Brian McCarthy, a US-based senior management consultant with Accenture, who is advising "household-name Irish public companies" on responses to the current downturn.

He says there is no "one size-fits all" strategy, but stresses doing nothing is not an option.

Behind his approach is a principle outlined in his recent research report: "When good management shows: creating value in an uncertain economy."

The central finding is almost intuitive: companies that perform best over the longer term are those that develop more conservatively during a boom.

By conserving cash and concentrating on meeting customer needs during an upturn a firm can outperform during a downswing because it has placed itself in a position to gain market share from rivals that over-spent during an upswing.

The first draft of this research analysed the financial results of 850 of the largest US-based companies since the 1990 to 1991 recession, separating them into three groups: those that outperformed their sector in the six years after recession, those that underperformed and those in the middle.

The research was updated in 2002 after the dot.com slowdown and again at the start of this year to take account of the slowdown caused by the credit crunch.

The study found consistent, cross-sectoral similarities among high-performing companies and those in difficulties.

"We found 83 per cent of those companies that performed best had conservative financial management. In contrast, only 45 per cent of poorly-performing firms took this stance with their fiscal policy," says McCarthy.

"The winners build-up war chests, limit debt and focus on cash flow in the good times in order to remain flexible and unencumbered.

"They planned to succeed in a recession before a recession arrived."

Companies that pulled away from their competitors also tended to hold that advantage well into the next decade, suggesting that gains achieved during a downturn are not fragile.

In many cases this policy required management to take a contrarian stance and face down criticism from Wall Street.

Among the examples cited is US defence contractor Northrop Grumman.

In the early 1990s, during an up-cycle courtesy of the Gulf War, Northrop realised it would be more profitable to supply the electronics systems used in aircraft rather than build the planes. It used revenues provided by war orders to refocus its business around this strategy.

A second factor identified is that a downturn can create opportunities for change within an organisation.

The report says employee resistance to cost-cutting moves is lower during a recession so changes can be introduced that would destroy morale in other circumstances. McCarthy says in this area, as in all others, cutting the right costs is key.

Another factor is concentrating on the core businesses. Diverse conglomerates that narrowed their portfolio, even shedding profitable operations that did not contribute to a clearly advantageous position, performed better, the report found.

Instead of relying on portfolio diversification to smooth out business cycles strongly-performing companies concentrated assets and energies on the areas where they held a leadership position.

He sees unique elements in the challenge facing management teams of Irish-based companies looking to steer their firms through the current economic crisis.

"The speed and severity of the slowdown is exacerbated in Ireland because there was more of a bubble there than in other countries," he says.

A second issue is the relative lack of experience among Irish executives in managing through a recession.

"If you look at the Irish economy over the last 12 to 15 years, there really wasn't a correction of note. And before then it was an entirely different economy," McCarthy says, adding that much of his consultation work in Ireland has been with "financial services and consumer goods firms".

"The 2000 to 2001 downturn was hardly noticed in Ireland although it was a major correction in the US. Typically, what we have found is the management teams that have been through a correction tend to have the knowledge, skill and ability to more astutely predict what to do as things change."

This lack of experience contributes to hesitancy in some Irish companies, he suggests.

"The messages we are giving them are definitely resonating and some companies are taking them on board. Others, though, are still struggling with it and saying 'maybe the tide will rise again and we'll ride this one through'."

Although he does not say it specifically, McCarthy indicates this approach has little chance of success.

According to his estimates in roughly two years the differences between those firms that took the correct action and those that did not will become clear.

"The differences are exacerbated in the period right after the upturn."

Following a conservative growth approach requires a steadfast management policy and confidence from shareholders.

Although McCarthy does not reference Ryanair, the airline would appear to be a good example of his recommended approach.

It has €2.2 billion in cash on its balance sheet, is cutting frequency on some routes this winter to save money and is negotiating hard with aircraft suppliers for a possible order of up to 400 planes, mirroring the fleet expansion undertaken immediately after September 11th, 2001.

Investors punished the airline heavily, selling the stock aggressively to knock over 22 per cent off its share price when the airline published weak first-quarter results last month. However, it will be interesting to watch how the airline, with its massive reserves, fares over the next two years compared to its competitors.

One example McCarthy does mention is that of Dell during the collapse of the dot.com bubble when it shared PC manufacturing with HP, Compaq and Gateway among others.

"In the summer of 2000, Dell was the first to forecast demand was falling in the PC market. Its competitors said this was a problem unique to Dell and the market punished Dell. Dell cut prices and gained market share in a declining market. Their competitors then missed their quarterly earnings for the next two or three periods."

By taking appropriate action at the right time Dell emerged from the downturn ahead of its competitors.