Winter is coming: Inverted yield curves, rising interest rates, and a rash of layoff announcements have convinced many economists that the global economy is headed for a downturn.1 Recessions are bad for business, but downturns are not destiny.
The worst of times for the economy as a whole can be the best of times for individual companies to improve their fortunes. One study found that lagging companies are twice as likely to overtake industry leaders during a recession, relative to nonrecessionary periods.2 Another study, of nearly 4,000 global companies before, during, and after the Great Recession, found that the top decile of companies grew earnings by 17% per year during the downturn, while the laggards saw profits stagnate or decline.3 The difference between the companies in the two groups translated into $6 billion in enterprise value on average.
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How can the same recession cause some corporate empires to rise and others to fall? The short answer is that uncertainty surges dramatically during recessions — increasing roughly threefold at the company level compared with the relative calm before or after a downturn.4
“Chaos isn’t a pit,” explains Petyr “Littlefinger” Baelish in Game of Thrones. “Chaos is a ladder.” The chaos of a recession, however, is both a pit and a ladder. In the face of uncertainty, some companies retrench. They abandon attractive customers and promising markets, offload valuable assets at fire sales, cut prices, and seek new partners to bolster cash flow. Others start climbing. They seize opportunities and improve their fortunes.
Our research has identified three fundamental ways to manage uncertainty: resilience, local agility, and portfolio agility.5 Leaders can take a series of steps, such as building a strong balance sheet or diversifying cash flows, to boost an organization’s resilience and ability to withstand environmental shocks. Local agility is the ability of individual business units, functions, product teams, and geographies to respond quickly and effectively to changes in their specific circumstances.
Portfolio agility is an organization’s capability to quickly and effectively shift resources across different parts of the business. While local agility enables individual teams to spot and seize opportunities, portfolio agility enables the company as a whole to double down on its most promising investments. Portfolio agility is, by some estimates, the largest single driver of revenue growth and total shareholder returns for large companies.6 Quickly and effectively reallocating resources is valuable at any point in the business cycle, but it’s decisive during downturns, when internal cash flows dwindle and access to external funding dries up.
Resilience and agility are effective in isolation, but in combination, their impact is turbocharged. In the midst of a downturn, resilient companies can weather the storm to wait for opportunities to arise. Having a high level of resilience — by building a war chest of cash or obtaining secure access to funding — provides an organization with the wherewithal to fund emerging opportunities, but only if it is agile enough to seize those opportunities. Resilience without agility may ensure survival but will not position a company for future growth. Agile companies without resilience, in contrast, often lack the resources to exploit the opportunities they spot.
The remainder of this article lays out practical, evidence-based ways that leaders can improve resilience, local agility, and portfolio agility.
Assess and Build Organizational Resilience
When leaders think about resilience, they tend to focus on reducing debt and stockpiling cash. These are crucial steps, to be sure, but other sources of resilience are also important. The list below provides a broader perspective on ways to boost organizational resilience.
- A strong balance sheet allows leaders to avoid short-term choices — such as layoffs or cutbacks in R&D or marketing expenditures — that impair their organization’s long-term performance. During the Great Recession, the least leveraged companies laid off significantly fewer employees compared with competitors that had the heaviest debt loads.7 During a downturn, highly leveraged companies also are more likely to raise prices to generate cash, even if it means losing customers in the long term.8
- Secure access to external financing enables companies to invest for the future while competitors tighten their belts. Despite their high levels of debt, companies backed by private equity firms were able to invest more than comparable stand-alone companies when the capital markets froze up during the Great Recession.9 Portfolio companies could invest because their private equity owners helped them secure funding when competitors could not easily raise money. For small and midsized companies, a strong relationship with a healthy bank decreases the odds of layoffs during downturns.10
- Capitalizing on company size can help increase the odds of survival.11 Despite General Motors’ well-documented challenges with product quality, foreign competition, and profitability since World War II, the company survived 10 recessions before finally filing for bankruptcy in 2009. As the largest carmaker in the United States for much of that period, GM was viewed as too big to fail. In the face of a downturn, large companies can lobby for government support and also have more leeway to offload assets and reduce head count.
- Diversification generates diverse growth options and the resources to fund them. Diversification of business units, regions, customers, technologies, and markets provides a greater variety of options for potential growth. These growth options are more valuable in volatile markets, because turbulence increases the odds that events will unfold in a way that allows some of the options to pay off.12 Diversified cash flows also provide the internally generated resources to fund growth opportunities when external funding is hard to come by.13 Investors, who typically value diversified companies at a discount relative to more focused businesses, recognize the value of diversification during recessions.14 In a downturn, investors will pay a premium for diversified companies.15
- Low fixed costs enable companies to easily scale back operations in the face of declining demand and to remain profitable, even if prices drop. General cost discipline, of course, contributes to lower fixed costs, and so does making costs variable through outsourcing activities, hiring freelancers on a project basis, or moving IT infrastructure to pay-as-you-go platforms.
- Noncore assets, such as freestanding business units, brands, patents, real estate, and mineral reserves, act as stores of value that can be sold to raise cash. Offloading assets is an expensive source of funding, however, since companies that sell fixed assets recover only about one-third of their book value on average.16 The more that assets are specialized for a specific company, the greater the discount when they’re sold.
- Recession-resistant customers generate reliable sales through the business cycle. Recessions do not hit all industries with the same intensity. In the three most recent downturns, education, health care services, government, and utilities increased employment or avoided layoffs while manufacturers, distributors, retailers, construction companies, and financial services were laying people off and cutting costs.17
- Cuts to excess staff should be considered. Layoffs are an unfortunate, but in many cases necessary, step to align costs with revenues during a downturn. When organizations are overstaffed relative to the number of employees required to get the work done, layoffs tend to improve performance.18 In contrast, layoffs in companies running with limited slack cut muscle and bone rather than fat and impair rather than improve performance.
The best time to build resilience is, of course, before a recession begins. Once a downturn hits, it’s harder to stockpile cash, pay off debt, or avoid fire sales when offloading assets. Leaders can also take some steps to boost resilience in the middle of the storm, such as reducing fixed costs, cutting dividends to conserve cash, or expanding their business with customers who are not being as hard-hit by the recession.
A holistic and honest assessment of organizational resilience can help leaders decide how to navigate a recession. (See “How Resilient Is Your Company?”) Organizations with low resilience will have little margin for error. They might prudently enter a defensive crouch and aim for nothing more than surviving a downturn. More-resilient organizations can afford to go on the hunt for opportunities to improve their fortunes.
Decentralize Decision-Making While Providing a Clear Strategic Context
When faced with market turbulence, many managers reflexively centralize decision-making to drive tough choices from the top down. This instinct is understandable but misguided.
In complex organizations, the individual business units, product teams, functions, and geographies know more about the distinctive challenges and opportunities they face than the home office does. Empowering local managers to make decisions leverages their firsthand knowledge of the facts on the ground. This is why, after the dot-com bubble burst, top management at network technology company Cisco Systems prioritized freeing up cash but empowered middle managers to select the specific suppliers, channel partners, and products to prune.
Decentralization also increases the tempo of decision-making. Middle managers and front-line team leads can respond faster when they don’t have to escalate every issue up the chain of command, explain the situation, and wait for a top-down decision. Distributed leaders should, of course, seek the information they need to make good decisions, but in the end, the decisions should remain their call.
The link between decentralized decision-making and agility during a downturn was confirmed in a global sample of more than 3,000 midsized manufacturing companies during the Great Recession.19 It found that companies that centralized important decisions (capital expenditure, new products, sales and marketing, and hiring) suffered revenue declines three times larger than the losses experienced by decentralized companies.
Decentralization works only if distributed leaders understand the broader strategic context — that is, which priorities matter most to the company, why they are important, and how the company is performing. When middle managers and front-line supervisors understand the broader strategic context, they can adapt to local circumstances without losing sight of the company’s overall strategic priorities.
Clearly communicating strategy is particularly important in turbulent times. We found that during the first six months of the COVID-19 pandemic, organizations that distinguished themselves in terms of communication from top leadership, transparent sharing of information, and strategic clarity also excelled on multiple measures of agility, including experimentation with new ways of working and flexible processes.20
Heading into a recession, top management teams should commit to a handful of strategic priorities that provide clear guidance for navigating through the coming storm, and then ensure that those priorities are understood and used to guide choices throughout the organization. In an earlier study, we analyzed 69 factors to see which ones predicted whether managers and employees at all levels understood strategy. Two factors stood head and shoulders above the rest: that top leaders clearly and consistently communicated strategy, and that distributed leaders at every level explicitly linked their team’s objectives to the overall strategy.21
Top management teams should commit to a handful of strategic priorities that provide clear guidance for navigating through the coming storm.
While most decisions should be decentralized, some choices require a top-down approach. The sale of business units and large-scale reductions in capacity must typically be driven from the C-suite. While distributed leaders are well positioned to identify opportunities to prune within their businesses, they are much less likely to suggest that their entire business unit be shuttered or sold off.22 A bottom-up process that works well for investment often stalls in reverse, failing to produce proposals for major disinvestments.
Use Simple Rules to Enhance Portfolio Agility
When cash is constrained and markets are in turmoil, companies need portfolio agility to move resources (including cash, talent, and managerial attention) from the least promising uses and reinvest them in the most attractive opportunities.
This is easier said than done. Along with Rebecca Homkes, we administered a detailed survey on management practices to over 20,000 managers.23 On average, less than 20% of managers said their organization quickly and effectively reallocated money or people when circumstances changed, or cut their losses quickly enough when products, initiatives, or businesses failed. Managers often avoid reallocating resources to maintain a sense of fairness and minimize conflict across units, but this lack of portfolio agility comes at a high cost.24 According to one study, when companies fail to reallocate resources, weak businesses are overfunded by 28%.25
Portfolio agility represents the biggest difference between the most agile companies and the less agile companies we studied.26 In fact, three of the five biggest differences between the more and less agile companies in our study tracked back to their ability to reallocate resources. (See “Agile Companies Excel at Reallocating Resources, Especially Talent.”)
In a downturn, managers often try to spread the pain by imposing uniform cost-reduction targets across the company. Flat, across-the-board cuts, however, starve promising initiatives of resources at precisely the point when the company could overtake weakened competitors. To position their companies for post-downturn growth, leaders should reframe cost cutting as an exercise in resource reallocation. Rather than simply slashing costs, the objective should be to balance the short-term imperative to free resources with the opportunity to invest for long-term growth.
Simple rules are an evidence-based tool that can improve resource reallocation, particularly in volatile markets.27 A handful of simple rules provide a framework to quickly reallocate cash, talent, or management attention as circumstances change. They counterbalance the tendency to spread resources evenly or take historical allocations as a given and tweak them at the margin.
The first step in implementing simple rules is to identify a strategic bottleneck where resource constraints prevent the company from achieving one or more strategic priorities. The most important bottlenecks will vary by industry and company, but common pinch points include the allocation of capital expenditure, marketing funds, and talent, as well as decision-making related to which customers, markets, new products, and acquisitions to prioritize when resources are limited.
During the Great Recession, one equipment supplier to the oil industry suffered large losses in its Middle East and Africa division.28 The division’s managing director identified its process for prioritizing new projects as a strategic bottleneck: The division was pursuing more than 90% of the requests for proposals (RFPs) it received but winning less than 10% of its bids.
To ensure that the division was pursuing the right contracts and raise its win ratio, its management team developed a set of simple rules to prioritize RFPs. Two of the simple rules were explicitly linked to the company’s strategic priorities and deemed nonnegotiable: “Focus on turnkey projects including at least three large compressors and lasting multiple years” and “Grow the installed base in eight target countries.”
To derive the rest of the rules, the team analyzed historical projects to discover which factors predicted whether the company would win the bid and make a profit. They discovered three: a similar project within the preceding two years, a strong relationship with key decision makers at the customer, and a firm commitment from other functions (including engineering and project management) to provide the necessary resources to deliver the project.
The team then adopted a triage approach for applying the five rules. Any project that did not focus on large turnkey projects or fell outside the prioritized eight countries was a clear no; projects that met all five rules got first dibs on resources; and those that met the deal breaker rules but missed on one or more of the others were reviewed by the management team, who would decide which ones would receive any remaining resources.
Using those simple rules, the team reduced the percentage of projects it bid on from 90% to 60% and increased the division’s win rate fivefold. It also reduced the time needed to review the RFP pipeline from one day per week to one hour by avoiding long discussions about projects that should be quickly rejected or fast-tracked based on the rules.
The Great Recession ended more than a decade ago. Seasoned managers may have forgotten its hard-won lessons, while newer leaders are facing their first downturn. But now, with a recessionary winter looming once again, leaders would do well to bolster organizational resilience and local and portfolio agility.
A recession opens a window of opportunity to build agility for the long term. An economic crisis marks a clear break with the past, and employees accept the necessity of disrupting the status quo. A downturn creates a ready-made rationale to justify unpopular but necessary reallocation decisions. At the same time, investors and boards are more forgiving of short-term earnings dips from actions taken to improve the organization in the long term.
Rather than setting strategic priorities or reallocating resources on a one-off basis, you can use the recession to build enduring capabilities to set and communicate strategy, empower distributed leaders, and develop simple rules to reallocate resources. The agility built in hard times can turbocharge growth and value creation when the economy recovers.
1. H. Torry and A. DeBarros, “Economists Now Expect a Recession, Job Losses by Next Year,” The Wall Street Journal, Oct. 16, 2022, www.wsj.com. The article reports that a survey of economists put the average probability of a recession at 63% over the subsequent 12 months.
2. S.S. Baveja, S. Elli, and D. Rigby, “Taking Advantage of a Downturn,” Bain, March 1, 2008, www.bain.com. The authors studied 700 companies in a six-year period that included the 1990 recession. They found that during the 1990 recession, lagging companies were twice as likely to move into the top quartile of industry performance relative to their odds of ascending to industry leadership before or after a recession. Nick Bloom and his coauthors also found that factories’ relative ranking in terms of productivity were more likely to change during the Great Recession. See N. Bloom, M. Floetotto, N. Jaimovich, et al., “Really Uncertain Business Cycles,” Econometrica 86, no. 3 (May 2018): 1038.
3. T. Holland and J. Katzin, “Beyond the Downturn: Recession Strategies to Take the Lead,” Bain, May 16, 2019, www.bain.com. A Bain study measured changes in the annual growth rate of nominal EBIT for 3,864 global companies before, during, and after the Great Recession. This is consistent with the Gulati et al. finding that 9% of their sample companies improved growth in sales and profits compared with their performance before the recession. See R. Gulati, N. Nohria, and F. Wohlgezogen, “Roaring Out of Recession,” Harvard Business Review 88, no. 3 (March 2010): 62-69.
4. Bloom et al., “Really Uncertain Business Cycles,” 1033. The finding that uncertainty spikes during recessions is robust across different measures of uncertainty, time periods, and the countries or industries studied. See K. Jurado, S.C. Ludvigson, and S. Ng, “Measuring Uncertainty,” American Economic Review 105, no. 3 (March 2015): 1177-1216; D. Berger and J. Vavra, “Consumption Dynamics During Recessions,” Econometrica 83, no. 1 (January 2015): 101-154; and R. Bachmann and C. Bayer, “Investment Dispersion and the Business Cycle,” American Economic Review 104, no. 4 (April 2014): 1392-1416.
5. D. Sull, “The Upside of Turbulence: Seizing Opportunity in an Uncertain World” (New York: Harper Collins, 2009). This book first introduced the three types of agility as operational, portfolio, and strategic. We’ve renamed “operational agility” as “local agility” to emphasize that it focuses on opportunities and threats facing a specific unit in an organization.
6. Research by McKinsey found that portfolio agility was the single largest driver of revenue growth for large companies. See M. Baghai, S. Smit, and S.P. Viguerie, “The Granularity of Growth,” McKinsey Quarterly, May 1, 2007, www.mckinsey.com. McKinsey also reports that companies that actively reallocated resources delivered total shareholder returns of 10% over a 20-year period on average, compared with only 6% for the companies with the lowest levels of portfolio agility. See Y. Atsmon, “How Nimble Resource Allocation Can Double Your Company’s Value,” McKinsey, Aug. 30, 2016, www.mckinsey.com; and D. Lovallo, A.L. Brown, D.J. Teece, et al., “Resource Re-Allocation Capabilities in Internal Capital Markets: The Value of Overcoming Inertia,” Strategic Management Journal 41, no. 8 (August 2020): 1365-1380.
7. X. Giroud and H.M. Mueller, “Firm Leverage, Consumer Demand, and Employment Losses During the Great Recession,” Quarterly Journal of Economics 132, no. 1 (February 2017): 285. To estimate the impact of leverage, the authors calculate the elasticity of firm-level employment to economic shocks (measured by housing prices) and compare these elasticities for a firm in the 90th percentile of financial leverage to one in the 10th percentile.
8. S. Gilchrist, R. Schoenle, J. Sim, et al., “Inflation Dynamics During the Financial Crisis,” American Economic Review 107, no. 3 (March 2017): 785-823. The authors estimate that liquidity-constrained firms raised their prices by an annualized average of 25% compared with the prices of less leveraged firms.
9. S. Bernstein, J. Lerner, and F. Mezzanotti, “Private Equity and Financial Fragility During the Crisis,” The Review of Financial Studies 32, no. 4 (April 2019): 1309-1373.
10. G. Chodorow-Reich, “The Employment Effects of Credit Market Disruptions: Firm-Level Evidence From the 2008-9 Financial Crisis,” The Quarterly Journal of Economics 129, no. 1 (February 2014): 1-59.
11. For summaries of the large body of evidence that organizational size increases the odds of survival, see J. Sutton, “Gibrat’s Legacy,” Journal of Economic Literature 35, no. 1 (March 1997): 40-59; and R. Agarwal and D.B. Audretsch, “Does Entry Size Matter?: The Impact of the Life Cycle and Technology on Firm Survival,” The Journal of Industrial Economics 49, no. 1 (March 2001): 21-43.
12. G. Grullon, E. Lyandres, and A. Zhdanov, “Real Options, Volatility, and Stock Returns,” The Journal of Finance 67, no. 4 (August 2012): 1499-1537; and T.A. Dickler, T.B. Folta, M.S. Giarratana, et al., “The Value of Flexibility in Multi-Business Firms,” Strategic Management Journal 43, no. 12 (June 2022): 2602-2628.
13. V. Kuppuswamy and B. Villalonga, “Does Diversification Create Value in the Presence of External Financing Constraints? Evidence From the 2007-2009 Financial Crisis,” Management Science 62, no. 4 (April 2016): 905-923.
14. D.J. Denis, D.K. Denis, and K. Yost, “Global Diversification, Industrial Diversification, and Firm Value,” The Journal of Finance 57, no. 5 (October 2002): 1951-1979.
15. Kuppuswamy and Villalonga, “Does Diversification Create Value in the Presence of External Financing Constraints?” 905-923; C. Rudolph and B. Scwetzler, “Conglomerates on the Rise Again? A Cross-Regional Study on the Impact of the 2008-2009 Financial Crisis on the Diversification Discount,” Journal of Corporate Finance 22 (September 2013): 153-165; S. Chang, B. Kogut, and J. Yang, “Global Diversification Discount and Its Discontents: A Bit of Self-Selection Makes a World of Difference,” Strategic Management Journal 37, no. 11 (August 2016): 2254-2274. When volatility surges, diversified companies with more real options benefit twice as much as narrowly focused competitors. Also see Dickler et al., “The Value of Flexibility in Multi-Business Firms,” figure 2, which shows that a one standard deviation increase in the author’s measure of volatility is associated with a monthly average return of 1.01% for multibusiness companies and 0.44% for companies that compete in a single line of business.
16. A. Kermani and Y. Ma, “Asset Specificity of Nonfinancial Firms,” Quarterly Journal of Economics (July 2022): 1-50.
17. C.J. Goodman and S.M. Mance, “Employment Loss and the 2007-2009 Recession: An Overview,” Monthly Labor Review 134, no. 4 (April 2011): table 1.
18. E.G. Love and N. Nohria, “Reducing Slack: The Performance Consequences of Downsizing by Large Industrial Firms, 1977-93,” Strategic Management Journal 26, no. 12 (December 2005): 1087-1108.
19. P. Aghion, N. Bloom, B. Lucking, et al., “Turbulence, Firm Decentralization, and Growth in Bad Times,” American Economic Journal: Applied Economics 13, no. 1 (January 2021): 133-169. This study focused on midsized manufacturers with an average firm-level employment of 574 workers and $184 million in annual revenues.
20. D. Sull and C. Sull, “How Companies Are Winning on Culture During COVID-19,” MIT Sloan Management Review, Oct. 28, 2020, https://sloanreview.mit.edu.
21. D. Sull, S. Turconi, C. Sull, et al., “Turning Strategy Into Results,” MIT Sloan Management Review 59, no. 3 (spring 2018): 24-32.
22. D.N. Sull, “No Exit: The Failure of Bottom-Up Strategic Processes and the Role of Top-Down Disinvestment],” chap. 7 in “From Resource Allocation to Strategy,” eds. J.L. Bower and C.G. Gilbert (New York: Oxford University Press, 2007).
23. The structure of the survey, composition of respondents, sample, and methodology are described in D. Sull, R. Homkes, and C. Sull, “Why Strategy Execution Unravels — and What to Do About It,” Harvard Business Review 93, no. 3 (March 2015): 58-67.
24. H. Shin and R.M. Stulz, “Are Internal Capital Markets Efficient?” The Quarterly Journal of Economics 113, no. 2 (May 1998): 531-552; R. Rajan, H. Servaes, and L. Zingales, “The Cost of Diversity: The Diversification Discount and Inefficient Investment,” The Journal of Finance 55, no. 1 (February 2000): 35-80; and D.S. Scharfstein and J.C. Stein, “The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment,” The Journal of Finance 55, no. 6 (December 2000): 2537-2564.
25. G. Matvos and A. Seru, “Resource Allocation Within Firms and Financial Market Dislocation: Evidence From Diversified Conglomerates,” The Review of Financial Studies 27, no. 4 (April 2014): 1164.
26. To assess the drivers of organizational agility, we analyzed survey data from a subset of 333 large, for-profit companies headquartered in Organization for Economic Cooperation and Development member countries.
27. D. Sull and K.M. Eisenhardt, “Simple Rules: How to Thrive in a Complex World” (New York: Houghton Mifflin Harcourt, 2015); J.P. Davis, K.M. Eisenhardt, and C.B. Bingham, “Optimal Structure, Market Dynamism, and the Strategy of Simple Rules,” Administrative Science Quarterly 54, no. 3 (September 2009): 413-452; and C.B. Bingham and K.M. Eisenhardt, “Rational Heuristics: The ‘Simple Rules’ That Strategists Learn From Process Experience,” Strategic Management Journal 32, no. 13 (December 2011): 1437-1464.
28. D. Sull and S. Turconi, “Canadian Compression Corporation: Coping With Complexity,” London Business School case no. CS-13-012 (London: London Business School Publishing, 2013). The company name is disguised.