Globality: Harold L. Sirkin December 4, 2009, 2:10PM EST

Harold L. Sirkin: Recession Lessons: Read, React, Win

The key lesson from the recession: Managers can be whipsawed by a downturn or use it to gain a competitive advantage

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Journalists and economists will be writing the story of the Great Recession for decades to come. One of the most important stories, which we can start writing today, involves the lessons we can learn about managing through a severe downturn.

These lessons should be studied in B-schools and boardrooms everywhere, because recessions are inevitable. Whether executives need to apply the lessons as early as next year—due to a dreaded double-dip, or W-shaped downturn—or during some future cyclical recession is not important. What is important is that they understand that business as usual won't do and that simple cost-cutting and belt tightening are not the way to achieve a competitive advantage.

Some companies realized this early on. They behaved very differently during this recession than in previous downturns and are achieving promising results. They knew they had built up a layer of fat during the prior seven years—and knew they could use the recession to get down to fighting weight. But most important, they asked themselves fundamental questions: "What if our sales drop by 25% or even 40%? How do we prepare ourselves for the unthinkable?"

As they started answering these questions, they got scared. They realized their companies, no matter how strong, were ill-prepared to weather an economic storm of this magnitude. The good ones quickly recognized that if things got very bad and they did not act quickly, they might run out of cash and not have the access to capital when needed. Cash (not debt) would once again be king.

Future Returns

The good ones also knew that now was the time to invest in their futures because the returns would be at an all-time high. They needed to focus investments in customers and customer service, in getting lean and making their operations more effective, in drawing down inventories and managing capital more effectively, in restructuring their manufacturing and distribution assets, in new-product development, and in identifying areas in which they might want to make acquisitions so when prices fell or companies got distressed, they could do the deals fast.

A few forward-thinking companies hadn't waited until December 2008 (when the National Bureau of Economic Research finally confirmed that a recession had begun in December 2007). They decided six to nine months earlier that the recession was real and reacted quickly and decisively.

Consider the example of Milwaukee-based Brady Corp. (BRC). With about $1.2 billion in sales and operations in 26 countries, Brady is an international manufacturer and marketer of complete solutions that identify and protect premises, products, and people. Its products include high-performance labels and signs, safety devices, printing systems and software, and precision die-cut materials (primarily for mobile phones and hard-disk drives).

About 40% of the company's revenues come from the U.S., 35% from Europe, and 25% from Asia. With a reported 500,000 customers worldwide, Brady has been very successful, outperforming the Standard & Poor's 500-stock index by a factor of two during the past 25 years and the Russell 2000 by a factor of three. (Disclosure: Brady is a client of my employer, the Boston Consulting Group.)

Anticipating the Worst

In mid-2008, Brady, like other companies, began to see signs of a recession. Unlike many companies, whose management teams talked themselves into a "wait-and-see" attitude, Brady wasted little time. After a sleepless night, Chief Financial Officer Tom Felmer presented scenarios for sales declines of 10% and a once-unthinkable 25% to the Brady executive team. The projected impact of such declines on the company's profit, cash flow, and debt covenants was severe.

Everyone in the room knew that Brady wasn't ready for such a dramatic deterioration of business conditions and that the company would be in serious trouble if it didn't act. They also realized that "doing something" would create an opportunity to clean up inefficiencies that had developed during the past six high-growth years.