Tuesday, January 22, 2008

Strategic Planning Analogy #149: Reaping in Recession

Potter Palmer got into the department store business in Chicago back in the mid 1800s with a store called P. Palmer & Company. When compared to other retailers of his day, Potter Palmer was quite an innovator. He was an early pioneer of having sales, which he called “bargain days.” Palmer instituted free home delivery of all purchases. In addition, he was a one of the first to offer money back guarantees regardless of reason, and having a policy that “the customer is always right.”

He was also one of the first department stores to actively go after the female customer. His store was the one place in Chicago where women could go unescorted.

In addition to all of these customer-oriented innovations, Palmer innovated in the back-room portion of his business. The Chicago economy in the second half of the 19th century had wild and frequent swings from boom to bust. Many of the busts originated with fires, like the great Chicago fire of 1871. Others were due to credit issues. Regardless of the reason, it seemed that about every three years or so the economy in Chicago during the mid 1800s would get very bad.

At each of these cycles, many of Palmer’s competitors and suppliers—who were highly leveraged into debt—would declare bankruptcy. Palmer tried to stay liquid and did not over-borrow during the good times. As a result, he always had cash during the bad times. As others around him were declaring bankruptcy, Potter Palmer was buying up their assets at pennies on the dollar. As a result, when the next boom time came, Palmer was in a stronger position than in the prior cycle.

Each economic cycle gave Palmer the ability buy low during the downturn and sell high in the subsequent boom. If it weren’t for his poor health, he could have kept this up for a long time. However, because of his health he sold the department store business in 1865. In 1881, one of the people Palmer sold to changed the name of the store to his own name—Marshall Field.

Economic Cycles are not a new phenomenon. Booms and busts have been around for generations. If you believe all of the press, there is a high likelihood that the next economic downturn into recession will happen in 2008.

Potter Palmer faced tough economic times as well. Yet, rather than have recessions hurt his business, Palmer found a way to use recessions to become an even stronger company. In this blog, we will look at what we can learn from Potter Palmer to help firms proper in the recessions to come.

The idea here is that if one acts strategically, one can often find ways to benefit from economic downturns. Here are three principles to help make recessions a positive impact on your business.

1) Don’t Assume Straight Lines Forever
Poor decisions are often the result of believing that the good times will last forever. The current housing loan crisis is due in large part to a false belief that housing prices would in general continue to rise forever.

Trends, however, do not last forever. Events rarely happen on an unending straight line angled slightly upward to ever bigger and better results. Life tends to be curvilinear, with both ups and downs.

When people think the good times are virtually forever, there is a tendency to borrow heavily to exploit the good times. When the good times end—and they always do—the debt cannot be paid. That happened in Potter Palmer’s time and it is happening today.

Palmer, however, did not assume that the good times would last forever. He tried to maintain a financial cushion to protect himself when the bad times came. Palmer was like the smart squirrel, who gathered nuts in the fall when they were plentiful and stored some away for the harsh winter coming ahead.

Strategic planning can be useful to help us protect ourselves from falling into the straight-line trap. First, it can help us take a longer-term perspective to our decision-making. The longer the perspective, the more likely a non-linear perspective will be entertained.

Second, strategic planning provides the opportunity for scenario planning. This gives a company time to contemplate the impact of various economic conditions on the business, so that one can prepare in advance for the down times.

Finally, strategic planning forces us to come to grips with our strategic weaknesses. The more we understand our vulnerabilities, the easier it is to foresee a time when someone could exploit our weaknesses and put us into an economic downturn. This provides incentive to shore up our weaknesses or take other actions to protect ourselves from the bad times.

2) Don’t just Ride the Crest—Build a Differentiation
During the good times, it is tempting to relax and just go along for the ride. Pretty much all companies do better in the good times, so long as you don’t do something stupid. Therefore, just don’t do anything stupid and ride the crest of good fortune.

Unfortunately, if all you are doing is riding that wave, you will end up riding it for the full cycle—crashing when the wave crashes. The good part of the cycle provides the time and cash for investing in a business model which favorably differentiates one’s self in the marketplace. Then, when the times go bad, the weaker players will be the ones losing out and you will survive based on your positive differentiation.

Potter Palmer invested in a number of differentiating strategies to stand out in the marketplace. These included free delivery and unconditional money-back guarantees. He didn’t need to do this. His competitors weren’t doing this. The customers were not demanding it. In addition, these differentiating strategies tended to increase his cost structure.

Yet Potter Palmer knew that if he invested in a strategy that “the customer is always right,” it would pay huge benefits in the long run. It gives people a reason to prefer your firm over the competition. That may not seem as essential when there is more than enough business to go around. But when the pickings are slim, it will ensure that you get a disproportionately higher share of the business available.

One of the primary benefits from strategic planning should be the discovery of the best path to create positive differentiation for your firm. This is one of your best protections in a down cycle.

3) Exploit the Unique Opportunities Only Available in a Recession
Not everything in a down cycle is bad. Potter Palmer found that he could use his cash during down cycles to accumulate inventory and other assets at remarkable savings. When fires destroyed portions of Chicago (including his store), Palmer could take advantage of the situation and build better stores in nicer locations.

One of the biggest advantages of an economic downturn is that it gets people’s attention and causes them to rethink what they do. It is one of the easiest times to increase market share, because economic hardship is a great incentive to change behavior. Customers will seek out greater value. Businesses may be more willing to outsource some peripheral activities. Those who relied on a firm that has now gone out of business need to find a replacement.

Studies have shown that those who out-invest their competition during down times have the greatest up tick in sales/market share when the economy rebounds. To those who are prepared, a recession can be a great long-term ally. With the proper planning, one can prepare in advance on how to exploit some of the unique benefits which a recession brings.

Business cycles are inevitable. Recessions will come. You can benefit from recessions if you a) accept the inevitability of recessions, b) build positive differentiation into your business, and c) exploit the unique opportunities available during recessions. However, you will miss many these opportunities if you do not plan for them in advance.

If done properly, it can become a virtuous cycle. Differentiating activity in the good times provide the market strength and cash to survive the downturn. Then, using the cash and strength during the down time, one can invest to build a stronger position for the next good time. This then allows you to afford even stronger competitive differentiation in the good times, which better positions you for downturn opportunities, and so on.

One of the greatest threats to this virtuous cycle is the temptation to take too many profits out of the business too quickly. If you suck out all of the cash during the good times, there is nothing to sustain the business during the bad. Prudent investments into the business can often provide greater long-term profits than if all the money is taken out today. (For more on this topic, see the blog “All Executives Should Have a Balloon in Their Office”.)

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