Downturn finance

Economic downturns can make the lives of financial managers hellish. Paradoxically, the steps financial managers take to overcome them probably make downturns worse.

As it turns out, financial managers’ instincts about downturns too often lead them to take almost precisely the wrong steps. Most firms view downturns as times to preserve their main strategic assumptions. They waste a lot of top talent time and energy trying to squeeze extra drops of margin from every operating process. And they become even more conservative about rewarding managers strictly for results.

Plain common sense, as well as years of experience with learning processes like continuous improvement and quality control, suggests we should be doing just the opposite. Consider each of these three steps in turn.

A firm’s key strategic assumptions – often made tacitly – are probably off target even in the best of times. They’re almost surely wrong for difficult environments since unpredictability is what generally makes environments difficult. So it’s perverse, if understandable, that firms become especially reluctant to tinker with their business models during downturns.

Financial managers’ instincts lead them to try to pinch every customer-facing process for incremental revenue – and every operating process for incremental cost savings. Every change in an established process can have unforeseen repercussions elsewhere in the business, however.
So finance teams end up setting multiple fires throughout their companies’ business systems for the sake of incremental benefits that they’ll probably consume in putting out the fires.

Most firms also tend to link pay more strictly to results in a downturn. It’s not clear, though, that results are more important in downturns than at any other time. What’s clear is that results are likely to decline. So companies drive out their top talent when they need it most.

Take airlines as an example. The point-to-point routes business travelers prefer are likely to remain popular through a downturn. The trips through multiple hubs that vacation travelers tolerate are more likely to dry up. And yet downturns, for some reason, seem to be the least likely time that airlines reconsider their basic route strategies.

Instead, they focus on cost cutting, which tempts them to channel more traffic through hubs. The resulting barrage of coordinated arrivals and departures stresses out staff – just as they’re raising the variability of compensation. So the best service managers change careers.

Fortunately, there is a much better way for CFOs, controllers, and treasurers to handle downturns. The challenge is that their instincts don’t necessarily lead them down the right path.

First, since the strategic assumptions on which the business rests may well be flawed, downturns actually are the perfect time to question those assumptions systematically. Finance executives can ask top managers to lay out alternative assumptions focusing on the issues that have always bothered them – but they haven’t had time to investigate.

Second, since incremental process changes often create as many immediate problems as they solve, downturns are a strange time to try to squeeze more out of them all at once. It makes more sense to focus top managers on a few key strategic bets – corresponding to the new assumptions they are testing – and keep as many standard processes intact as possible.

Third, since paying more strictly for results as they are declining will drive out the best people, firms should pay for something more useful in a downturn. Finance executives can adjust compensation to reward the truly valuable new insights into business models that top managers extract from the strategic bets they are pursuing.

In other words, finance executives should ask division heads and general managers three new questions. What might be wrong with your business model – as opposed to your operating processes? What big bets are worth making to find out? And what can we learn from any missed goals?

This, for example, is how Toyota has come to apply its “plan, do, check, act” learning loop adapted from the work of Edward Deming. Toyota rightly treats every quarter as a potential downturn. Possibly as a result, the company doesn’t seem to suffer so badly in the real ones.

David Apgar is the author of "Relevance: Hitting Your Goals by Knowing What Matters" (Jossey-Bass 2008)

Downturn talent management

It may be true downturns complicate talent management. But it's probably more true that bad talent management exacerbates downturns.

What's clear is that downturns are terrible news for talent management executives. Whole divisions get burned out as managers scramble to hit impossible goals. The best senior talent leaves. New senior talent doesn't work out. And most firms end up either comically or tragically unprepared for the eventual upturn.

Extensive work on performance management at the Corporate Executive Board and on relevant metrics through my own independent research has convinced me two tempting mistakes account for these cyclical calamities. The first is that we continue to pay managers for results through downturns rather than for problem solving. The second is that we think downturns are the wrong time for calculated risks even though risks are what downturns make unavoidable.

Start with paying managers for results through downturns. It's not even clear we should pay managers for results in upturns. It's our workforces, information resources, and investments that produce results. Managers figure out how to do it -- they solve problems. So why not pay managers for solving problems?

The answer is that up to now it has been hard to measure the difficulty of the strategic problems managers solve and their success in solving them. But no longer. As advanced practitioners focus more on the testability of plans, they're finding ways to separate the effect of errors in execution from errors in planning on performance surprises. And that means you can tell how much noise in results comes from an incomplete understanding of a company's strategic situation.

The way to pay managers for solving problems is to pay them for reducing strategic uncertainty. Uncertainty means volatility in the size and direction of performance surprises. Strategic uncertainty is how much of that volatility comes from something other than the main controllable and uncontrollable factors a manager has identified.

For example, Nestle lets its worldwide product managers and all-product regional managers renegotiate their goals. That leaves a huge number of targets for individual products in individual markets with roughly equal stretch or difficulty -- at least as far as the managers trading those goals back and forth can tell. As a result, the pattern of hits and misses across those product markets provides single-period tests of firmwide strategic initiatives with near-statistical validity.

Even so, paying managers for problem solving seems hard. But what's the alternative? Paying managers for results in a downturn means paying them to hit an impossible goal or paying them to hit a declining goal. The former burn out their divisions trying to keep up with an outdated standard. The latter get bored if they're enterprising and leave to learn something new.

And that sheds light on whether downturns are the wrong time to take risks. What's worse than burning out your divisions and losing your best talent?

When faced with a downturn, nevertheless, most firms start repeating the "stick to your knitting" mantra. And this is true in spite of the well-documented success enjoyed on upturns by firms like Toyota that invest and explore right through downturns.

The advantage of downturns is that talent to lead your firm in exploring new markets and new products can be cheap. Most talent managers shy away from downturn bargains but the reasoning is suspicious. Great talent is prepared to invest with you in the future if the opportunity you offer is interesting.

The reluctance of firms to pay less than top dollar for managers to lead new business developments is a big deal. For one thing, it is one of the only explanations why employment drops in recessions. Robert Hall and others have shown the rate of separation from jobs does NOT rise in recessions. What drops is new hiring -- and that usually means new hiring in new fields in downturns.

So how can you attract top talent to explore new business opportunities in a downturn when the results you might expect are both meager and uncertain? Pay those managers for problem solving. In other words, pay them for the amount by which they reduce the strategic uncertainty of the fledgling businesses you ask them to run.

That way, you're likely to attract the most creative people available and have at least some sense which way to turn when the market does.

David Apgar is the author of "Relevance: Hitting Your Goals by Knowing What Matters" (Jossey-Bass 2008).