Why It's Time to Take a Risk

Business 2.0 By Erick Schonfeld, Gary Hamel, April 2003 Issue April 1, 2003  

Resources are cheap. The competition is paralyzed. The last thing you should do right now is play it safe.

R.J. Pittman is a classic business daredevil, a 33-year-old with a new technology and a taste for adventure. Larry Brilliant is a more established quantity, a four-time entrepreneur who co-founded the Well, the prototypical online community, in 1985. Though the two haven't met, the novice and the veteran are united in an act that, in this forbidding business environment, isn't just daring. It's practically unnatural. They are starting businesses.

Pittman is launching Groxis, which is built around software that makes Web searches more efficient. While some may question the appetite people have for such a product right now, Pittman thinks this is a far more auspicious time for entrepreneurs than, say, 1999. "Office space is cheap, and talent is available," he points out. "And the signal-to-noise ratio is much better now that all the junk dotcoms are out of the picture." Brilliant, for his part, recently founded Cometa Networks, a joint venture that is planning a nationwide system of wireless broadband Internet access spots. Building out yet another communications network may seem like the errand of someone who missed the memo about the telecom bust. But Brilliant dismisses any doubts. "The irrational exuberance of the 1990s has been replaced by an irrational lethargy," he says. He sees Wi-Fi as a huge opportunity, and he doesn't intend to let recession or war or corporate paralysis keep him from it.

This entrepreneurial bravado, so common just a few years ago, stands in marked contrast to the apprehension that seems to grip so many hearts in business today. Wherever you look, the forces of retrenchment are on the march. During the past two years, capital investment has declined about 11 percent -- more than during the 1990-91 recession and almost as much as during the recession of 1981-82. Billions of dollars are disappearing from balance sheets as companies write down the value of poorly conceived acquisitions, struggling venture divisions, and unsold inventory. The hiring slump is persisting, with more than 1.5 million jobs lost since the start of the 2001 recession. And among venture capitalists, 70 percent of current cash goes to fix problems at existing companies rather than to fund fresh ideas.

While retrenchment is a perfectly understandable reaction to an unexpected drop in revenues, at too many companies it threatens to become a habit. The trick in tough times is to downsize your cost base without downsizing your future. Even as your company sweats off fat, it needs to bulk up on some of the courage and faith in innovation shown by Pittman and Brilliant (tempered, of course, by a healthy dose of prudence). No company ever beat a bear market by starving itself.

You can't move forward when you're cutting back. Like a crash diet, retrenchment may help you look less like an inflated marshmallow, but the improvement will be temporary unless you commit yourself to better nutrition and a sustained exercise regime. "Denominator management" -- whacking away at head count, paring down inventory, and slashing capital budgets to buttress your financial ratios -- can take you only so far.

Retrenchment doesn't fundamentally transform a company's cost structure; it simply establishes a new, lower equilibrium between revenues and expenses. It doesn't create competitive advantage -- not unless you're taking costs out a lot faster than your competitors are and doing so in ways that don't imperil long-term success. In other words, retrenchment can buy you time, but it can't buy you a future.

At some point, in fact, it becomes retreat. Studies suggest that this point often comes sooner than most businesspeople expect. A Mercer Management study of 116 companies that aggressively cut costs in the 1990-91 recession, for instance, determined that only 29 percent of them grew profitably in the latter half of the decade. A more recent study by Strategos, the Chicago-based consultancy chaired by author Hamel, demonstrated the limits to a single-minded focus on cost cutting. It showed that while a company can grow earnings faster than revenues for a few years -- a sure sign of denominator management -- one that grows earnings more than five times faster than revenues for more than three years in succession is almost certain to see a subsequent collapse in growth. The point is simple: Retrenchment makes you smaller, not better. Story continued on next page Article Page: 1 2 3 | Next >

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