Preparing for and managing through a downturn

Here is a brief excerpt from the transctipt of a podcast conversation involving Tim Dickson and Sven Smit, featured in the McKinsey Quarterly, published by McKinsey & Company. To read the complete article, check out other resources, learn more about the firm, obtain subscription information, and register to receive email alerts, please click here.

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In this episode of the McKinsey Podcast, McKinsey Quarterly executive editor Tim Dickson speaks with senior partner Sven Smit about how companies can be more resilient in the face of an impending economic downturn.Simon London: Hello, and welcome to this episode of the McKinsey Podcast, with me, Simon London. Today we’re going to be talking about the next recession. When will it come? How will it come? And importantly, what do we know about managing through a downturn? While we can’t predict the future, we can learn lessons from history: how successful companies have positioned themselves going into a recession and the actions they take during and after the downswing. To talk about all of this, my McKinsey Publishing colleague Tim Dickson caught up in Amsterdam with Sven Smit. Sven is a McKinsey senior partner. He works on strategy across a range of industries and has helped clients navigate the twists and turns of the business cycle. Without further ado, over to Tim.Tim Dickson: Let’s start with the likelihood of a downturn. What do you think are the chances of a full-blown recession this year?Sven Smit: Well, clearly, Tim, people are talking a lot about it, and there’s more volatility in some of the broad measures that you could look at. The one thing I will say is that people who say you can predict when it’s going to happen are essentially not truthful because the evidence shows that there are no good predictors. In hindsight, there are some people that said they timed it [the last time].But I would say you should be very careful about making a prediction. Of course, you should listen to all the different pathways by which people are saying something might happen, because that ups your readiness. And yes, you could say it’s been a long time. So winter will come, and after that, summer will come again. But when winter will come is deeply unpredictable.

Tim Dickson: What are the things that people should be looking for? What’s most likely to precipitate a downturn, in your view?

Sven Smit: The pathway of uncertainty and downturns is also very often surprising. So here, again, you could look at a collection of things that might be, and then think there will still be one that’s surprising. I could imagine that we’re going through a very large experiment in monetary policy with quantitative easing that we’re partially unwinding. We’re changing interest rates. How does that work through?

Where will the next bubble sit? Is it a housing market? Is it tech? People will say that the trade stuff that’s happening might have an effect, and yes, that might have an effect. It might be that leverage at the moment is high in certain places, which might then mean that’s tight. And people have been raising a series of pathways, and one of them will—or many of them will, one way or the other—touch this.

Tim Dickson: A lot of people’s benchmark, of course, is the recession of 2008–09. I wonder if you could say how broadly you think the next downturn will be different from that one?

Sven Smit: I would say you can almost with certainty say it’s different, because I can’t recall similar recessions in my 28 years in business.

Tim Dickson: Each one is different?

Sven Smit: They’re all different. And they have different reactions. They hit different sectors. The financial system is always involved somehow. But global downturns start in different places. Some started geographically in Asia. Some started in the bond market. Some started in a mismatch in inflation. And interest pricing. So there are so many places where different recessions have started. The one thing that I feel fairly comfortable saying is this one will be different.

What business leaders can do to prepare

Tim Dickson: With all these uncertainties, at this particular point, at the beginning of 2019, are there some no-regrets moves, things that companies and chief executives can do at this stage before we know how it’s going to play out?

Sven Smit: The simple answer is the healthier your business is today, tomorrow, and the next quarter, the more resilient you will be in a downturn, in the sense that if your costs are lower, you have more buffer to take on stuff. If your balance sheet is not so leveraged, the more capacity you have to take things on and the more capacity you have to invest. That’s one thing.

The second thing is you could at least have some of the prework done; if not already, work it to say, what is the destination investment post crisis or post recession? And have the majority of your investment in that area so that you have good stuff that will be there and accelerate at the moment it moves out.

Tim Dickson: Once a downturn starts, we know from new McKinsey research that the fortunes of major companies varied last time. In particular, a group of resilient organizations dipped less in the downturn and widened their lead in the recovery. What, broadly, did those companies do differently than the rest?

Sven Smit: We found that there were 13 percent of companies that were more resilient. They had real outperformance and total returns to shareholders. Then we looked at what these companies did. They really were already moving a little bit ahead, but only ever so slightly, prerecession. They were already doing some good things. But they created a significant gap through the recovery, and then doubled that gap, or more, post recovery.

When you looked at the revenue profiles of the resilient and non-resilient companies, they were not that different. It is really on the margin side that you see that, way earlier, they showed improvements in margin during the downturn. So during the downturn you literally have the margins improving. The improvement rate dips a little bit, but it’s still going up—while the margin in profile of the non-resilient companies is going down during the downturn, and only one year after, starts to go up. That comes from far more proactive operating cost cutting, which the nonresilient companies postponed to post crisis. The resilient companies also worked hard at leverage, in particular through divestments. They got into a much better cash position that also allowed them to then invest in the future path. That was quite substantial.

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Here is a direct link to the complete article.

Sven Smit is a senior partner in McKinsey’s Amsterdam office. Tim Dickson is executive editor of the McKinsey Quarterly.

 

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