Review

Since early 2008, business leaders around the world have been battling the worst economic and financial crisis for more than a generation. They have endured gut-wrenching asset prices falls (notwithstanding recent equity rallies), declining customer confidence and log-jammed credit markets, to name just a few. In recent months, we have seen General Motors, one of the largest and most familiar names in global business, filing for bankruptcy and a whole host of financial services companies either collapsing or being rescued in government bail-outs.

In an environment where major international businesses are preoccupied with survival, it may seem to be an inappropriate moment to think about growth. But for forward-thinking companies, the short-term goals of cost-cutting and navigating more immediate challenges are just one piece of the puzzle. These companies will also have one eye on the future, and be looking ahead to a time when the current recession is over, when access to finance will have eased, and when confidence returns to the market. Their management teams will be pressing for the continuation of strategic initiatives, eyeing up potential acquisition targets, and ensuring that they are well placed to achieve long-term sustainable growth.

To examine the opportunities and challenges of securing growth in a highly challenging environment, Economist Conferences organised the Business Growth Summit, which was held at the Marriott Hotel, Grosvenor Square, London on June 2, 2009. The event drew distinguished speakers from across the business world and included the chief executives of several large, global organisations. A high-level audience from across the corporate spectrum ensured that a diverse range of perspectives was represented, and provided important insight into the ways in which companies can make the most of opportunities at a time of great adversity.

Innovation in a downturn

In a difficult environment, it can be tempting for large multinationals to batten down the hatches and pull back from their innovation efforts. But as many of the speakers at the Business Growth Summit stressed, this is rarely a sensible strategy. Innovation often thrives in a challenging economic environment. The whole concept of “creative destruction”, whereby new market entrants with radical ideas unseat less agile incumbents, can be at its strongest when established players are preoccupied with survival and take their foot off the innovation pedal. Recessions are often a time for new ideas and creativity, and there are many individuals who are willing to take the risk of developing a new business when more mature firms are not.

The Great Depression of the 1930s provides a powerful illustration of the power of innovation during difficult times. Although this was a period of widespread bankruptcy and unemployment, when one might imagine that companies would have retreated from risk and investment, it was also an era of new ideas and entrepreneurial thinking. Some of the most prominent business names of the 20^th century were founded during the Great Depression, including HP, Polaroid, Motorola and Revlon.

The Great Depression was also a time when some companies chose to ramp up their investment in research and development – in defiance of the prevailing mood. The chemical company Dupont developed nylon during this time, along with a number of other key products. Indeed, Dupont’s product set was transformed by innovation that took place during the early 1930s – by 1937, 40% of its sales came from products that did not exist prior to 1929.

Just as innovation has been a powerful force during previous recessions, so we might see it become one of the key factors that lead us out of the current crisis. The UK is relatively well placed to benefit from this trend. Contrary to conventional wisdom, which sees the country as heavily skewed towards financial services, the UK has a broadly based economy, which has strengths across a number of key sectors, including pharmaceuticals, consumer goods, media and the creative industries. But while the UK has strengths with regard to innovation, there are also a number of important challenges that still need to be addressed, including the availability of venture capital and finance for fast-growing, small and medium-sized enterprises. Smaller companies have been disproportionately hit by the credit crisis, and particularly by the withdrawal of trade finance and credit insurance from the market. Policy-makers must ensure that they address the challenges of SMEs as they will be a vital force in leading the country out of recession

For one international food and beverage producer at the conference, innovation and investment remained a priority despite the challenging economic environment. The company, which has a large footprint in many emerging markets, has recalibrated its innovation efforts to ensure that its products continue to meet changing market needs. This has meant launching more affordable products and seeking ways of commercialising the bottom end of the market, such as exploring the junction between international products and cheaper, indigenous ones.

This highlights an important trend – namely that innovation in a difficult time means staying in touch with changing customer preferences. With unemployment rising and disposable incomes falling, the priorities of consumers are changing. Companies should follow these trends closely to ensure that they continue to meet the needs of their customer base. According to some commentators, we are seeing the emergence of a new kind of consumer, whose primary goal is to derive value for money from their purchases. Another common trend is a widespread decline in loyalty – consumers are shopping around to get the best deal and have gone from relying on company brands to relying on each other for information about potential purchases using tools such as social networking.

New product innovations should reflect the changing mood and resonate with this cost-conscious audience. Success is not always about coming up with radical, discontinuous ideas. Just as powerful can be more incremental changes to products and services that will attract new customers and help to retain existing ones. This could mean new formats or new pricing structures that speak to the customer’s desire to obtain value for money.

When the economy is in the midst of a major recession, it is easy to forget that, at some stage in the future, better times will return. Companies should be mindful of this and consider the potential timing of an upturn when they consider their innovation pipeline. Research and development work underway now could, depending on the industry, lead to a new product in two to three years’ time. By that stage, the recession will almost certainly be over and companies need to ensure that they have the right product mix to capitalise on a better economic environment.

The sources of future innovation will often be unexpected. As well as looking to traditional sources of R&D and external partners, companies should also seek new ideas from within their business. Employees can often be a vital source of innovation as they have the greatest day-to-day familiarity with products and services and are first in line to receive feedback from customers. Companies should ensure that they have a diverse set of employees and managers in place, as new ideas are more likely to emerge from a varied mixture of skills, experience and background.

The opportunity for transactions

During the downturn, we have seen the value and volume of mergers and acquisitions activity collapse. According to one commentator at the Business Growth Summit, transactions are down by 60% from their peak in 2007. With access to affordable finance significantly constrained, most companies have been forced to put M&A plans on hold until conditions improve. Up until summer 2007, the largest deals – and most private equity activity – relied on large amounts of leverage. Deals of this nature have become all but impossible in the current environment.

More broadly, there is a lack of confidence in the economy and in the boardroom, which is encouraging a retreat from risk and a pervasive sense of caution. For a company considering a transaction today, the cost of finance – even if it can be obtained – could easily be three times what it was in 2006. This creates significantly greater risks with execution and will deter many companies from considering deals at this time.

This is not to say, however, that M&A activity has entirely dried up. For companies with strong balance sheets that are able to finance deals without borrowing, and which do not have large pension deficits, the current downturn can be a time of opportunity to snap up targets at more attractive valuations. Recently, we have seen a number of high-profile M&A deals announced, including Oracle’s bid for Sun Microsystems, GlaxoSmithKline’s purchase of Stiefel Laboratories and Roche’s bid for the 51% it did not already own of Genentech. A number of companies are also looking beyond the current recession, and ensuring that they have clear, long-term M&A strategies in place to help them achieve growth objectives.

Between October 2008 and March 2009, we saw a dramatic fall in equity values across most industries and regions. This drop, however, has not yet fed through into a decline in sellers’ expectations of the price they will get as part of an M&A transaction. As a number of high-profile executives commented during the conference, buyers expect today’s valuations, but sellers continue to demand last year’s higher price. Some speakers felt that these expectations will need to become more synchronised before M&A volume picks up again.

Others at the conference felt, however, that sellers’ expectations would change over time and that this would fuel further M&A activity over the coming months. One speaker was confident that 2010 would see a much larger number of transactions than have been seen in 2008 and 2009.

The absence of external finance for M&A activity is encouraging some companies to adopt a more creative approach to funding deals. Some, for example, are considering structures including share for share, joint ventures, asset swaps and even deferred consideration and earn-outs. While many of these more innovative structures are being discussed, so far only a limited number of examples of them have come to market. Other companies are looking within the business itself to help them gain access to funds. For example, they may be looking to working capital as a source of finance, or shortening payback cycles and using the proceeds as a kind of quasi-capital to fund some deals.

The outlook for external finance is still fairly poor. There remain very significant constraints in the banking market, with lending continuing to contract on a net basis in key regions of the world. Many banks expect the quality of their loan books to deteriorate further, and this is affecting their willingness to lend. Another factor that could constrain availability of finance is the trend for many banks, under political pressure, to pull back from overseas lending and focus on helping domestic companies. Small and medium-sized enterprises are most likely to be affected by this phenomenon – as the chief financial officer of a major UK company explained, if certain relationship bankers do not answer the phone when he calls, what are the chances that they will do so for a company with only a handful of employees?

In the longer term, we may see sources of finance change. Companies in North America and Europe will increasingly be backed by funds and banks from countries such as China and India. Already in the current environment we are starting to see Chinese and Indian companies and funds using their relatively abundant liquidity as an opportunity to purchase overseas or distressed assets.

Sovereign wealth funds will remain a powerful force over the coming years and may continue to be an important source of finance for large companies. The scale of some of the largest sovereign wealth funds is staggering. There is an estimated US$3.5 trillion currently sitting in Middle East funds, and this is forecast to grow to US$12 trillion based on oil at US$50 a barrel.

Many SWFs made bad investment decisions last year when purchasing stakes in banks, and some of the Middle East funds have since sought to refocus their investments on domestic opportunities. Others, however, will continue to take advantage of the current environment and acquire stakes in US or European businesses at attractive prices. Already this year, we have seen Sheikh Mansour’s Abu Dhabi investment vehicle book a huge profit on the sale of Barclays’ shares that were purchased six months previously.

Private equity, which has endured a torrid time in recent months, will also return to the market. In the absence of debt financing, certain funds are instead looking at equity investment in the short term, such as the recent deal between Warburg Pincus and Premier Foods. Some funds are in better shape than others – those that made investments in 2007 at the top of the market and applied large amount of leverage are suffering the most, while those that started to pull back from deals in 2006 are in a comparatively stronger position. A lot of the debt that is currently out there in private equity deals will have to be refinanced or exited in the next couple of years, and this could be a painful time for many funds.

People and leadership

During the boom, there was widespread talk of a war for talent as companies competed for what was becoming an increasingly scarce resource. In 2009, with unemployment rising and companies scaling back recruitment plans, talent may have become less scarce as a commodity, but the importance of attracting, retaining and motivating the very best people at all levels of the organisation has never been greater.

Companies always need strong leadership, but during uncertain times, a firm hand on the tiller becomes essential. Employees will be worried about what the future has in store, and will look to the leaders of the company to provide direction and guidance. Of course, business leaders themselves will also be concerned – according to a recent survey of senior executives, 80% say that the pressure to perform has increased over the past year and many say that their private lives have been impacted.

Business leaders must be able to juggle immediate priorities with the need to execute strategic plans. In some cases, these requirements may conflict with each other. The immediate priority for many companies may be to cut costs, whereas the strategic goals may require investment in functions such as R&D to prepare the company for future growth. The ability to deal effectively with ambiguity and uncertainty has thus become a vital characteristic for today’s business leadership.

As business becomes more international in scope, it is becoming increasingly important for senior executives to be “globally literate” and be able to form effective alliances across geographical and cultural borders. Boards must also become more diverse – both to reflect the growing international and cultural diversity of business, but also to prevent “groupthink” from taking hold. In recent months, numerous commentators have argued that boards made up of individuals from a more diverse range of backgrounds would help to provide more rigorous and effective oversight of company management.

According to one speaker at the conference, management teams should contain a blend of experience and fresh ideas. Continuity is important, and it is vital that the leadership team contains members with longstanding service who have experienced difficult times before and have a deep familiarity with the business. Yet it is also important to avoid becoming stuck in the past. For this reason, management teams should always include some fresher faces who can help to provoke new thinking and ideas.

Business leaders should ensure that the values of the organisation are clearly expressed, especially during a downturn. As one chief executive at the conference explained, people want to be part of an organisation that does more than just make money. This highlights the need to stay focused on initiatives that form part of a company’s values, such as those related to corporate social responsibility. The temptation in a challenging economic environment is to pull back from these commitments, but speakers at this conference felt that to do so would be to undermine the commitment and engagement of the workforce to the broader role of the business.

One speaker highlighted the need to gain insight into the views of the workforce through frequent employee surveys. More importantly, however, management should demonstrate that it acts upon these surveys and makes concrete changes as a result of employee opinions. This was seen as particularly important given the changing composition of the workforce. Major demographic shifts are taking place and a new, more diverse generation of employees with a different set of values is emerging. To succeed over the long term, it was felt that companies must be able to fashion careers that will attract the most talented individuals among this highly heterogeneous group.

The value of employee engagement was widely recognised. By engaging employees and demonstrating that their ideas are valued, companies can foster powerful bonds of loyalty and commitment. There are various tools that can be used to strengthen engagement. One speaker said that his company made share ownership available to every employee in the company and described how this led to some of the most junior and low-paid employees in the company questioning him directly about what he was doing to increase the share price.

Employee engagement and a strong corporate culture can help to accelerate the acceptance of major, disruptive change. In the current environment, chief executives will often have to take difficult decisions around staffing and resources, which could prove to be highly damaging if support among the broader workforce is lacking. A strong culture can help to offset these problems, and ensure that employees appreciate the need for difficult decisions to be made for the good of the business.

The need for training and ongoing development of talent was highlighted by many participants at the conference. This is particularly important in light of the huge shift in skills that is taking place as countries such as China and India develop their educational standards and turn out a colossal number of highly skilled managers, engineers and workers.

One commentator at the conference highlighted what he saw as a window of opportunity for engineering and manufacturing firms. He explained that, until recently, the financial services industry was able to attract many of the best brains from the world’s universities and industries with the promise of generous salaries and bonuses. This had the effect of sucking talent out of other industries. But now, with financial services companies chastened and less able to attract the very best graduates and PhD students, other industries, including engineering and manufacturing, have the opportunity to step in and promote their sector as one where a rewarding long-term career can be enjoyed.

Securing the present and sustaining the future

The current crisis has highlighted the need to strike a balance between addressing short-term priorities – for cash, liquidity and even survival – and building a long-term future for the company. Often, these priorities can be in conflict because the former requires companies to scale back and cut costs while the latter demands sustainable investment to ensure future growth. Moreover, the speed and severity of the downturn has instilled a kind of paralysis among some companies. Rather than weighing up the options that are available to them and making the decisions that are required to achieve their objectives, executives may become a victim to inertia and fail to take decisive action.

It is tempting for business leaders to focus almost exclusively on their short-term priorities at a time like this. With many companies fighting for survival, the immediate challenges of liquidity, cash preservation and existing customer relationships can easily, and understandably, take precedence over more strategic concerns. As many speakers at the conference stressed, however, executives should resist this temptation and ensure that they keep one eye on the long-term future and strategic objectives of the business.

In particular, business leaders should be very reluctant to throw out their strategy just because times have become tough. A good strategy takes time to develop and requires the careful input of highly experienced individuals – indeed, strategy development is one of the most important roles that the board undertakes. Companies should therefore resist any pull towards a more short-termist approach that undermines a well-constructed business strategy. They should also remember that strategic growth is often the most challenging part of doing business. Finding people to carry out cost-cutting initiatives is relatively easy; it is less straightforward to identify good people who can an execute strategy effectively.

Keeping one eye on long-term strategy means that companies must keep up the pace with certain investments. As one chief executive at the conference explained, companies cannot save their way towards prosperity. While his company continued to examine costs, cash flow, marketing spend and effectiveness, it did not hold back from large-scale investments that it considered to be necessary to fulfil its longer-term strategy.

Of course, short-term priorities still remain very important. One chief executive of a leisure and retail group highlighted the importance of receiving and analysing daily sales figures. Only when armed with this kind of information can companies react to fast-changing consumer trends and ensure that they are allocating resources effectively on a short-term basis. As one chief executive at the conference explained, sometimes the small details matter and the key is “to focus on the inches as well as the yards”.

During the boom, there was perhaps too much of a tendency for companies to focus on the short term, but for different reasons than today. Some investors became accustomed to very high rates of growth, and expected companies to achieve these consistently. To achieve these targets, companies had to gear up balance sheets and focus on short-term performance metrics at the expense of longer-term considerations. As one speaker at the conference noted, investors need to recognise that this kind of growth is not realistic and be satisfied with a lower, but more consistent and sustainable growth over the longer term.

Wise managers need to know how to manage the so-called “animal spirits”, suggested one speaker. This means managing expectations with investors and other stakeholders, and ensuring that the long-term vision for the company is clearly articulated. Investors must be brought on side so that they support the vision of the company, and recognise that they will be rewarded for their loyalty.

Although investors can often be tarred with a reputation for being extremely short-termist, one chief executive at the conference felt that this was an unfair assessment. He said that, while the market may respond to short-term trends, shareholders were most likely to ask him about what the longer-term future had in store for the business and whether the company could achieve its strategic goals.

The challenge of change

Resistance to change appears to be hard-wired into human psychology. Our reluctance to embrace the unfamiliar, and our fears about its implications, can make it difficult for business leaders to make the case for change. Yet companies need to change in order to survive. If they do not, they fall victim to the powerful forces of creative destruction and get swept aside by newer, more agile entrants.

The difficulties associated with change mean that it is usually prompted by an external force. A recession is a good case in point – in order to survive, companies have no other choice than to take action. They must think harder and, in some cases, take more risks. The type of change required during a recession will depend on individual company circumstances. For some businesses, it may not make sense to carry out major cost-cutting initiatives while, for others, this could be the difference between survival and extinction.

The vice-chairman of a major UK company who spoke at the Business Growth Summit pointed out that, during good times, companies will often avoid making the changes that are necessary simply because they are not essential. Many change projects are difficult, and might involve redundancies or the need to re-engineer business processes. As a result, business leaders will tend to avoid them if they can. He added, however, that executives would do well to think constantly about the potential benefits of change – and not just when it is forced upon them.

Senior management can often be an inhibitor to change. More often than not, executive boards will be comprised of men and women in their late 50s. At this age, people often become more resistant to change and more protective of established ways of doing things. Companies need to ensure that there is a way allowing change to happen in such an environment – perhaps by ensuring that there is a culture that welcomes and nurtures new ideas.

Governance structures and regulations can also prevent change. Public companies have restrictions that can prevent them from certain courses of actions, and private companies also have constraints, although they are different. With policy-makers sharpening their focus on corporate governance, it is likely that the rules governing boards will be stricter. There is a danger that this could stifle change and innovation.

Change may be a constant, but it becomes imperative during a more challenging environment.  Executives would do well to use the current downturn as an opportunity to push through changes that will help the company emerge as a stronger, more sustainable entity. As White House Chief of Staff Rahm Emanuel said: “You never want a serious crisis to go to waste.”