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Cost-slashing firms are more likely to fail in a financial crisis

"Many companies are discovering that the conventional response to recession guarantees that a business will lose."



Independent on SundayMargareta Pagano11 December 2011


Companies that made the most severe cuts to their costs to cope with the financial crisis are the ones which most often failed, according to new research carried out by PA Consulting.

A survey of 200 business leaders found that the firms which slashed costs, particularly staff costs, had a 10 per cent lower Total Shareholder Return than those which did not. By contrast, the research, led by PA's Mark Thomas, found that the minority of firms who saw the crisis as a time to gain market share – either by increasing money spent on marketing or by buying new assets – performed the strongest and had the highest TSR.

PA's findings are backed by Sir John Banham, a senior independent director at Invesco and former chairman of Johnson Matthey, who says in the survey that too many companies took too long to react to the financial crisis of 2008. Sir John pointed out that in the previous crisis, while chairman of Johnson Matthey, his company actually increased investment in capital and R&D, and came out of the downturn stronger as a result.

Mr Thomas said: "Many companies are discovering that the conventional response to recession guarantees that a business will lose. The reason for the failure of these conventional management strategies is that they are designed for conventional inventory-cycle recessions, and a balance-sheet recession is a completely different beast."

PA used TSR as a good measure of medium and long-term performance because it looks at the value the market places on a firm's stocks and shares over time, he added. The survey, "Managing Uncertainty", used data from 2007 to 2010, and looked at firms worldwide. It also concludes that most companies were too cost-focused, too slow and too passive. Those that cut costs drastically performed worse than those that adopted a moderate approach to cuts; many took 18 months to respond and they performed worse than those who acted quickly.

Only a third of the 200 business leaders interviewed saw the 2008 financial crisis as an opportunity, but those that did had a higher TSR by 10 per cent, claims PA. The survey also shows that decisions made quicker are better. Companies that made quick decisions had a TSR 13 per cent higher.

But the highest-performing companies, said Mr Thomas, took a different approach: they identified the crisis early and responded quickly: "They had a moderate approach to cost reduction, and they looked beyond this to focus on the opportunities to get ahead. A fundamentally different approach is what produces the highest performance and this needs to be heeded by companies."

PA has come up with four recommendations: avoid drastic, panic cost cutting; prepare ahead of time; develop contingency plans and secure financing – avoid fire sales at the lowest point of the economic cycle; and take opportunities – acquisitive and organic – to gain share in key markets.

PA’s Managing Uncertainty survey, conducted this summer, asked more than 200 senior business leaders from across the world how they had responded to the financial crisis and what management strategies had proved most effective. Our analysis establishes which actions added value and which did not. Find out more here

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