Fundamentals and expectations

Fundamentals and expectations
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First Published: Wed, Apr 08 2009. 01 15 AM IST

Updated: Wed, Apr 08 2009. 11 49 AM IST
Over the past two years, some businesses have been affected more than others because of the economic slowdown. The extent of the impact is a function of two variables: a change in the fundamental characteristics of these businesses, and a change in expectations on their performance.
We used Stern Stewart’s proprietary frameworks to segregate the impact into current operations value (COV), or the value estimate of the impact on existing profitability, and the future growth value (FGV), or the value estimate of the impact on future growth expectations. While the current performance of companies in the auto and auto ancillaries business has taken a harder hit than others, future expectations from companies in realty and allied industries have been affected most in comparison with others (graph 1).
Similarly, some industries are more affected from the indirect or the portfolio conduit, while others are more affected through their financing and business relations—or through the direct conduit (graph 1).
Also See Graph 1: The Shifting Sands (Graphic)
As these charts indicate, today, Indian companies are more affected by the indirect conduit. The deeper the impact of the “portfolio effect”, the greater is the fear and the greater are the chances of a longer downturn. Fear is contagious—it is easy to catch and difficult to get rid of. When people are fearful and apprehensive about the future, the impact is clearly visible in their economic decisions. In India, quite unfortunately, businesses that are “people-intensive”, or that employ a large number of people, seem to be affected more than others. The fear among employees in businesses such as IT, textiles, telecom, cement, and gems and jewellery is likely to contribute to the woes of other businesses such as auto, realty and consumer durables in terms of a decline in demand.
Illustration: Jayachandran / Mint
The two frameworks help us understand better the impact of the slowdown on various businesses and can be used by companies as a strategic input. However, the unique recipe for every business to get out of the tunnel is more a function of its ability to understand where exactly it stands, evaluate strengths, weaknesses, opportunities to prioritize responses and, finally, execute with clarity and alacrity. We have tried to analyse which businesses will come out of the slowdown soonest, and feel the least pain.
Industries which are likely to come out faster (graph 2), and with limited impact, need to think of actions to accelerate ahead, while others who are likely to be caught in the tunnel may have to worry about survival. The responses have to be tailored depending on specific business situations and the objectives.
Also See Graph 2:Varying Impact (Graphic)
For instance, the information technology sector with its significant dependence on other economies has seen a correction both in its recent fundamental performance and in future performance expectations. Around 67% of the respondents from this industry expect a downward revision in growth in FY09 and in FY10 as well. The industry has seen a substantial drop in valuations through growth expectations, and will continue to depend on external economies to a large extent in the near future. The “sun rise” industry of the recent past and flag bearer of the Indian growth story, now appears to be a “laggard” and needs to “adjust” itself to the new reality. While there is a clear need to focus on efficiency improvement, there is also a strong case to tap the substantial opportunities, including business and talent acquisition, particularly for companies with stronger and cleaner balance sheets. This is already evident in the international landscape—IBM, for instance, has not only focused on reducing employee costs and increasing productivity, but also pitched to acquire Sun Microsystems Inc. before finally deciding against it. The IT industry in India, too, is relatively better off in making judicious tradeoffs.
Companies in this business leave others far behind in terms of not just profitability, but also their readiness to execute the chosen strategy—the gap between its “intentions” and “actions” in this business is substantially low. While 67% of our respondents from the IT business see opportunities to acquire quality resources, and businesses, about 50% already have plans in place to do so. This contrasts sharply with companies in other sectors. Around 76% of all respondents agree that the number of strategic investment options open to them have increased, but only 37% plan to do something about this. And while 82% say that this is an opportunity to acquire quality human capital, only 48% are actually looking to do so (graph 3).
Also See Graph 3: Intentions Vs Actions (Graphic)
For at least 50% of the companies surveyed, the focus is on cutting costs, deferring capital expenditure and downsizing. Are these companies merely following an established pattern of preferred responses to a slowdown without looking at whether they need to do so? It is interesting that only one-third of these are likely to face cash flow and balance sheet risks. This should not come as a surprise. Time and again the economic cycles have provided the best backdrop to separate winners from others. It is only when the tide turns that one gets to see who is swimming naked!
Many business leaders assume that a strong market position is an insurance against trouble. That approach breeds overconfidence. Executives postpone taking precautions or reach for the same levers they pulled in the past. When the downturn hits hard, they usually overreact and focus on the short term. They slash costs and staff indiscriminately, cut capital expenditures, squeeze suppliers and avoid strategic acquisitions. Then when conditions improve, they must spend heavily to regain momentum.
Winners, by contrast, tend to make right short-term and long-term tradeoffs. During the up tide, they consistently manage costs and capital to focus on increasing their economic value added (EVA) and cash flow. Winning companies here have shown superior EVA improvement performance (see “Are Indian companies back to where it all began?” Mint, 23 February) while registering top-line trajectories similar to others’ in the recent years when high tides carried even the leaky boats (graph 4).
Also See Graph 4: Getting it Right (Graphic)
As the tide turns, winners tend to aggressively monitor the environment including competition, to get out of the tunnel ahead of others and clearly focus on the longer term. The farther one can see, the quicker one tends to move, and gain a larger winning margin. Today, when the downturn is at least two quarters old, the better companies are tending to ask: How should we accelerate out of the tunnel to take advantage of the opportunities, to capitalize on others mistakes? How can we acquire assets in distress to strengthen our long-term prospects? Can we hire great people who are now available? Around 30% of companies are striking a balance between their short-and long-term performance (graph 5).
Also See Graph 5: Striking a Balance (Graphic)
It is interesting that performance expectations in revenue growth and profit margins are not too different for businesses which are striking a balance and for those that are fighting fires. The choice that companies have to make would appear to have more to do with their perspective than the situation.
In the next part of this series, we will look at the reason why a slowdown is a good time for companies to change.
Sanjay Kulkarni is head of management consultant Stern Stewart’s Indian operations. Your comments are welcome at feedback@livemint.com
Graphics by Ahmed Raza Khan / Mint
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First Published: Wed, Apr 08 2009. 01 15 AM IST