Transform now while market confusion gives you air cover
[NOTE: This post is made with a full understanding that many people are still facing serious, near-term concerns about their livelihood, both professionally and personally. It is not meant to dismiss this reality, but provide a vision of a more positive outcome down the line.]
The Optimist’s Playbook: Transform now while a confusing market provides air cover
Summary:
Industries are likely to fundamentally change in structure as we emerge from the initial tactical response to the coronavirus
Company strategies must change to prepare for a new operating environment
Investing in this type of transformation has been hard to sell to shareholders in the past
The current volatility and uncertainty in the market may give CEOs air cover to make the changes needed to be viable long-term, not just survive in the short-term
The best use of time and resources during the current chaos may not be getting your current business back up and running, but bootstrapping your future one.
Contingency planning is having its 15 minutes of fame right now. There is a lot of discussion right now about the failure of most large companies to “invest for a rainy day,” and new questions about whether some firms will learn from the pandemic about the value of risk management and resiliency. However, this failing is part of a broader ailment that has afflicted much of the corporate world over the past 20 years or more: toxic short-termism. An increased emphasis on short-term results to please investors (and incredible scrutiny over in-the-moment stock movements) has significantly constrained any large public company’s ability to invest in the future in any almost any capacity at all. Big, bold initiatives that do not squarely fit with a company’s historical way of doing business—or mental models of how their industry works—are risky to even mention, let alone pursue.*
This protective mindset explains why many companies always seem late to the game when faced with industry disruption. They may intuitively, or even explicitly, know it’s coming, but their hands are tied by the fear of what next quarter’s bottom line will look like if any money is spent on something new and less understood.
This is true even for those organizations (like my scenario planning clients) who do the hard work to look around the corner for change, and take the time to consider what their business might need to look like 3, 5 or even 10 years out. Their conclusions are often the same. At the end of our work together, everyone—including the CEO—acknowledges the following dilemma:
Our current strategy—where we play, how we win, the capabilities that are most important for our success—is already outdated, or is about to be in the next few years.
We should be investing in both a new core strategy and a select number of strategic side bets that will give us optionality to pivot as conditions evolve over time.
BUT…If I spend any money on this, especially internal resources that could otherwise be spent on the current core business, I will get hammered by investors.**
Some of these companies can overcome the near-term pressure and begin to shift budgets. Most others feel paralyzed.
No CEO wants to explain a dip in profit in a given quarter due to a “gamble” on a future business model, especially one that will require a pretty significant transformation. Very few companies have done this successfully. Amazon has made ‘the right to not show a profit’ a key competitive advantage over others who must allocate capital to show net income. Adobe was able to shift to a cloud subscription-based model by broadcasting to shareholders early on the reasons for the transition—that if it did not, it would likely go out of business eventually—well before it was in dire straits. message:
The list of large companies able to make this kind of pivot through disruptive times is a not a long one.*** Most executives end up stalling on their needed transformation, and are only able to make changes when things get pretty bad—not the best place to be when trying to raise even more money to invest in all the new people and assets needed to support a new model.
But, what if companies used the volatility and uncertainty in the markets today as air cover to begin shifting its strategy and investing real resources in its execution? (Think of it as a sort of jubilee for short-termism, where past constraints are removed with no questions asked.) Perhaps the best use of time and resources during the current chaos is not getting your current business back up and running, but bootstrapping your future one. Valuations are even more a crapshoot now than they are in “normal” times, and anything that happens—such as a few down quarters—can be readily chalked up to “external factors.” Activist shareholders—and predatory lawyers–will have a hard time making claims of mismanagement when fundamental market collapse is happening all around. And most employees will be too happy to still have a job at a viable firm to complain about stock compensation in the short run.
We are facing a disruption in consumer behavior, threats to supply chains (and globalization more generally), shifting perceptions about governments and regulation, questions about the role of the corporation, and other uncertainties that could tilt in many directions. Most companies, regardless of their tactical choices today, will likely find themselves in a new industry structure and competitive landscape on the other side of the immediate coronavirus event. If they do not adjust now, then they may find themselves not only behind the curve relative to others, but also trapped in an even more cautious and constraining environment as shareholders look to rapidly regain their losses.****
———-
*The reasons for short-termism have been well covered elsewhere, and there is a broader collective issue to resolve at a policy level. Some attempts at this include the Long-Term Stock Exchange, but it will take a range of other tax, compensation and other incentives to change this in the mainstream.
**One possible alternative is to invest in a new direction through M&A, where the impact on the bottom line can be spread over a number of years (i.e. capitalized and depreciated/amortized). But a high profile acquisition might still attract attention and questions.
***In pure economic theory, old firms should just give way to new, better suited ones, and money returned to shareholders who can do their own diversification—for instance, through buying back their own stock. But in reality, there is a) scaling infrastructure and knowledge that large firms possess that can help scale a new model; and b) agency issues, which means that managers will always want to preserve their jobs and status. So, those are the conditions under which these decisions are usually being scrutinized and why some form of new growth is always on the table instead of just giving up the ghost.
****Obviously, all of this applies to companies who have some cash reserves, or assets in the traditional business that are more liquid and re-deployable towards the new model. Some companies will need to be in pure survival mode for a little longer before pursuing transformation. But even these companies should take a real critical eye about where it is spending money it does not need to on the core business that could be used elsewhere.