Don Sull's blog

Recessions create buyers markets for rare, valuable, and difficult to imitate resources. Downturns also generate opportunities to enhance a firm’s existing resources, including brand and relationships, or build new ones from scratch.  Building resources when competitors are not investing confers three benefits–lower cost, more bang for the buck, and a head start when the economy turns up. McKinsey & Company studied US industrials that improved their relative performance during the early 1990′s recession, and reported in a 2002 study that these companies outspent their rivals on R&D, advertising and acquisitions during the downturn. Spending to build resources in a downturn is counter-intuitive, but below are three reasons why it can be a good idea.

1) Lowers cost of investment. Building resources requires inputs (e.g., scientists for R&D, advertising to build a brand). In a recession, demand for these inputs declines and so do their prices. Consider brand building. In a recent New Yorker piece, James Surowiecki described how Kellogg and Post led the market for ready-to-eat cereal prior to the Great Depression. As the economy tanked, the cost to advertise fell, and Kellogg seized the moment, doubling its marketing expenditure and advertising on the radio to build awareness of its new cereal Rice Krispies. Post, in contrast, reduced expenditure and lost market share. As public relations and marketing firms struggle with falling demand in the current downturn, Wal-Mart is increasing its public relations efforts to reinforce the retailer’s value-for-money message.

2) More bang for the buck. By investing when rivals are not, firms attain more impact for the same expenditure than they could in a boom when everyone is spending. Facing fewer adds competing for consumers’ attention, Kellogg could build more awareness per dollar of advertising invested. Long-term relationships, with customers or distributors for example, are another example rare, valuable, and inimitable resource. Downturns provide an ideal occassion to deepen them. The Great Depression wiped out many investment banks–many disappeared while most survivors focused on short-term profits. Goldman Sachs managing partner Sidney Weinberg, in contrast, spent years building relationships with government and business leaders that provided the foundation for the firm’s later growth. Partners remember what you did for them in tough times more than help provided in fair weather.

3) Headstart when the economy rebounds. Valuable resources require cumulative investment over time. These investments create a lag between initial investment and when value is realized.  Firms that invest in a downturn can build a valuable lead relative to rivals who do not. In a recent study of innovation during the Great Depression, Professors Malhar Nabar and Tom Nichols, found that companies in aggregate reduced investment in innovation (measured by patent applications). A few firms, such as Radio Corporation of America, Hewlett Packard, and Polaroid, invested aggressively in research and development. DuPont, for example, took advantage of oversupply of research scientists to accelerate new product development. By 1937, 40% of DuPont’s sales were from products–including rayon and cellulose film–that hadn’t existed before 1929. Once competitors recognized the value of DuPont’s new products, they needed time to close the technical gap, providing DuPont an opportunity to secure and extend their market position.

Up-front investment to build resources entails risk, and that risk does not disappear in a recession. Investing in a downturn can, however, cut cost, increase impact, and confer a lead relative to rivals. All of these can position a firm to create value once the economy rebounds. The next few posts will examin how firms can use a downturn to build human resource.