Friday, April 17, 2009 0 comments ++[ CLICK TO COMMENT ]++

Should corporations tighten belts during recessions?

In the late nineteen-twenties, two companies—Kellogg and Post—dominated the market for packaged cereal. It was still a relatively new market: ready-to-eat cereal had been around for decades, but Americans didn’t see it as a real alternative to oatmeal or cream of wheat until the twenties. So, when the Depression hit, no one knew what would happen to consumer demand. Post did the predictable thing: it reined in expenses and cut back on advertising. But Kellogg doubled its ad budget, moved aggressively into radio advertising, and heavily pushed its new cereal, Rice Krispies. (Snap, Crackle, and Pop first appeared in the thirties.) By 1933, even as the economy cratered, Kellogg’s profits had risen almost thirty per cent and it had become what it remains today: the industry’s dominant player.

— James Surowiecki, The New Yorker

Reading that made me think of Isadore Sharp's strategy for Four Seasons, a high-end hotel chain, during the 1982 recession:

The recession in the latter part of 1981 dropped prices, including those of hotel rooms, while interest rates began heading the other way. Airfares climbed by 32 per cent in a single year.

Company executives traveled less frequently and entertained less while traveling, an additional impact on our food and beverage operations, which already were suffering from a falloff in company banquets and waning attendance at major conventions. Most hotel companies responded by cutting costs right and left. "Cut staff, forget the doorman, don't replace carpets," their managers ordered.

Some of our people thought we should follow suit. I listened to all their comments, but getting into a price war was a no-win situation. Layoffs might drop costs for a time, but revenue would fall even more and take much longer to come back.

True, luxury was no longer in vogue for middle managers and executives, but for most corporate leaders, the people who made up the bulk of our customers, reliable time-saving service was not a luxury but a necessity. And with travel more fatiguing and work more demanding, it was needed now more than ever.

Rather than cut back on service by laying people off, senior managers took a pay freeze and asked their employees to vote on flex hours: working four days a week instead of five.

Employees in almost every hotel voted nearly unanimously for it, so all of them would keep their jobs. They knew through the company grapevine that managers' salaries had been frozen and, knowing what other companies were doing, they felt our decisions were more than fair.

And sharing a common purpose created a camaraderie that made trying times not only pleasurable but also profitable, for as most of our rivals dipped into red ink, we remained in the black by delivering the quality service that our fledgling marketing division had begun promoting.

"While our competitors are dropping standards, we will raise ours," I said. "And we'll hold firm on pricing."

— Isadore Sharp, excerpt from
Four Seasons: The Story of a Business Philosophy

The First Four Seasons Hotel Opened in 1961 in Toronto
(source: Four Seasons)

The answer isn't obvious and some businesses clearly have to cut back on employees, service, and quality in order to survive. Such moves open up opportunities for others who can maintain their positioning and service. Whether you are a manager or an investor, it is worth thinking about the long-term implications of tightening the budget during economic weak periods. More importantly to investors, since nearly everyone reading this is, one may want to consider investing in companies that are able to maintain advertising, employee count, R&D, and product quality during tough times. As Surowiecki suggests, in some cases, it may be impossible for others to catch up once the economy reverses. This is likely to be true for growth industries that are relatively new (say some internet company or brand-new discretionary consumer product.)

The two referenced articles are well worth reading in my opinion:

Hanging Tough
by James Surowiecki. April 20, 2009, The New Yorker

A few bumps in the road, Part 2 of The Globe & Mail excerpt from Four Seasons: The Story of a Business Philosophy by Isadore Sharp


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