How to overcome the challenges of a crisis?

The current downturn in demand has shown how sensitively the economic system reacts and how thin the line is between a functioning and non-functioning company. In contrast to previous crises, such as after the Lehmann crisis in 2009, the forecasts indicate only slow recovery and that demand will develop at a lower level than before the crisis.

How can companies deal with this situation? It is helpful to take a closer look at the so-called operating point of a company. This operating point indicates how many resources are needed to generate a defined output. The operating point can also be regarded as “company efficiency.” Practical experience shows that companies cannot scale arbitrarily along the so-called “efficiency gradient” – a prerequisite would be total flexibility in resource use. Companies can usually handle a change in demand of only around 10% without significant efficiency loss.

There are three typical strategies, each of which is based on differently anticipated demand developments:

1. The scaling strategy: The downturn in demand is limited in time and number; the operating point shifts on the previous efficiency line (ƞ a) within a few per­centage points. A return to the original operating point is possible but unnecessary because the organisation also functions in the “new operating point”.

2. The bridging strategy: The demand recovers briefly, and this period is bridged with resource reduction or short-time work. During this bridging phase, the com­pany is willing to operate at a less favorable operating point. In the graph, this corresponds to operating point b on the efficiency line ƞ b.

3. Realignment strategy: The company expects no or a very long-term recovery in demand. The company temporarily creates its own breathing space and secures its operations by resource reduction and/or short-time work (operating point b). In contrast to the bridging strategy, the company imitates an improve­ment in efficiency through appropriate measures and transforms the company from operating point b to c and further in direction d.

Looking at the emerging far-reaching changes in the economy, such as a realignment of value chains, increased competition, and changed customer and supplier behavior, a realignment strategy currently offers the greatest opportunities for many companies. Because regardless of how quickly the demand recovers: These companies will be more sustainable and in a better position than those that simply wait and see.

"Companies can usually handle a change in demand of only around 10% without significant efficiency loss."

Written by

Stefan Zirhan, Partner

• Industrial and consumption cycle: The industrial cycle had already passed its peak in all major eco­nomic regions. The euphoric consumption in Europe and the USA was a typical sign indicating that the crash was not far off. In the last 50 years, there has always been a recession when retail sales and indus­trial production peaked together in the OECD, defined as the maximum deviation from long-term trend growth (see above chart)

• Falling order volumes in the industry: Especially early-cyclical industries, such as the semiconductor industry, have recorded a sharp decline in incoming orders as of late 2018. This is an important early indicator for other, more late-cyclical industries.

• Declining business confidence: The Business Confidence Index – also a reliable leading indicator for the industry – has been declining synchronously in the three major economic regions of Asia, Europe, and North America for several months.

• Inverse interest curve: On 13 May 2019, the Ameri­can interest rate curve turned negative. This means that US government bonds with a ten-year maturity bore lower interest rates than those with a three-month maturity. In recent decades, this has always been a reliable indicator of an imminent recession in the USA.

We already highlighted these points more than a year ago in the Economic Commentary for the 2nd quarter of 2019. The signs showed that a crisis was imminent; all that was missing was the trigger. It is probably impossible to predict precisely this. We had not expected a pandemic either. Our “favorites” for the trigger at that time were rather political events like an escalating trade war, a hard Brexit, or a military conflict in Iran.

The lockdowns and the resulting uncertainty further intensified the downturn. This is why we regard COVID-19 as the trigger and also as the catalyst for the downturn in the real economy that would have occurred in 2020 anyway.

What are the effects of the crisis on the industry?

The long-term driver of the real economy is consumption. It slumped dramatically in Asia, Europe, and North America during the lockdown in the first half of the year. The sharpest decline was observed in China, which also took the longest to recover compared to Western countries. In our opinion, the very dynamic consumption in Europe and the USA over the summer is strongly related to compensatory effects from the lockdown and is not sustainable.

When comparing consumption in the 12 months from September 2019 to August 2020 with the same period in the previous year, it is noticeable that consumption in the USA fell by 1.4%, in Europe by 3.6%, and in China by as much as 10.8%.

The development of industrial production shows a different picture. China’s lockdown-related downturn was only short-lived, and the industry’s momentum is already back above pre-crisis levels.

The downturn in Europe and the USA was comparable, although the recovery is much slower and the industry in the West is still well below pre-crisis levels. It also appears that the recovery process as a whole has come to a halt again, and the development is moving sideways at a low level (see next graph).

Comparing the industrial production of the last 12 months until August 2020 as a whole with the values of the same period of the previous year, we obtain the following results:

• Europe –6,2 %
• USA –5,2 %
• China –3,0 %

What will happen to the real economy?

The uncertainty remains high despite reports of success in the development of a vaccine against COVID-19. Unemployment is expected to increase in the coming months. Further lockdowns, such as those imposed in Europe this autumn, are also poison for the economy. The hpo model calculation continues to indicate a low level of dynamism for the coming year, although developments in individual sectors can be extremely volatile. As usual, the developments in the individual industrial sectors can vary greatly.

Written by Josua Burkart

and Benjamin Boksberger

The answer is clear: Do the one and do not let the other be. What does this mean?

Since the beginning of the Corona crisis in spring 2020, it has become clear that the demand for individual products and services will probably remain reduced in the long-term. For example, this includes many travel-related matters, primarily air travel and associated services such as limousine services or travel agency services. Also affected are numerous industrial goods such as those in the automotive supplier sector. At the same time, there are products and services that are experiencing a marked increase in demand. These include, for example, disinfectants, hygiene masks, general hospital equipment, but also offers for video conferencing, homeschooling, or the entire field of research related to the cure of or vaccination against the COVID-19 virus.

Most companies cannot stop or at least significantly reduce the production or provision of existing products and services overnight and switch to a product area that will continue to enjoy great demand for the foreseeable future. Existing know-how, infrastructure (e.g., production facilities), customer and supplier relationships – all these factors are aligned with the existing product or service range. A switch to a new field of activity with high demand usually requires the development of new skills, new infrastructure, new customer and supplier relationships, and often an entirely new business model. In most cases, there is still some demand on the market for the services previously provided. But how they can still be provided profitably in the future is changing compared to the past: Demand is lower, supply chains are changing, and so are customer needs. This is why the current situation must be questioned as a matter of principle:

• Do we still occupy the right stage of the value chain in our industry?

• Does our value proposition meet the needs of exist­ing (and potential) customers?
  

• Do we have the necessary high-performance busi­ness process model that efficiently generates our current products and services, even at reduced demand levels?

• And does our management structure correspond to this new way of providing services?

When questioning the current situation, it is inevitable that the question of new business areas with better prospects for demand arises – in extreme cases, this even leads to a significant shift away from existing business areas. Typical questions in this context are:

• What competencies do we have that can be applied in business areas with better growth opportunities?

• What does this mean for our value creation system?

• Are we set up to pursue innovations systematically?

• And how do we transform our organisation accordingly?
  

All these questions can be answered systematically and efficiently with strategic enterprise design.

Written by

Oliver Kohler, Managing Partner

A company’s design through strategic enterprise design is always based on a clear standpoint:

• Where does the company currently stand?
• Which services are provided for which customers?
• How great is the need for action? What is going well?
• Which areas are expected to have the greatest optimization levers?

Based on the standpoint analysis results, the enterprise design can be focused on specific parts of a company.

For example, if the assessment of the current situation shows that the strategic direction and the positioning are clear and meaningful, the company starts directly with the customer needs and the derived value proposition structure. Strategic enterprise design often first focuses on the area of service provision and addresses the area of innovation at a later stage. The approach of strategic enterprise design is very flexible. It can be adapted to a company’s situation, the urgency of changes, and the areas with the greatest leverage. What is fundamentally relevant in this respect is that all business-critical aspects are always kept in focus. This ensures that the effect on other elements is adequately considered when designing individual elements.

The design of a company’s service provision

(see upper half of chart: The core elements of strategic enterprise design)

1. The clarification of the positioning shows which value creation the company should generate or in which direction it should develop. For this purpose, we use the industry model, which precisely depicts all relevant market participants with the corresponding interfaces and enables complex relationships to be discussed in a boardroom-suitable presentation.

2. The value proposition and the range of services are structured based on necessary competencies and are 100% aligned with customer needs, eliminating services that do not add value. The value proposition is developed into a value proposition structure that shows where and with which connections differen­tiating customer benefits are generated—a kind of parts list of the value proposition.

3. End-to-end responsible processes are created to provide these partial services. These E2E processes are supplemented by the primary contact points between the processes. This leads to a macro-level business process model, which describes organi­sations’ activities and the requirement profiles for management positions. Depending on requirements, these E2E processes are then further optimized in detail at the micro-level in a further step, which describes the activities of individual persons and the use of aids. This can be used to derive requirement profiles for individual employees and specifications for ERP systems, robots, etc.

4. Based on this model, objectively and comprehensibly develop the future-oriented organisation, including the corresponding responsibilities and role profiles. The hpo design principles require that end-to-end responsible processes are designed indivisibly in one management area. In this process, we are guided by the question: Which processes have the greatest benefit if they are combined into a common, higher-level management area? Or in other words: “It is not bosses looking for management areas, but processes looking for common bosses.”:
   

"There is nothing quite so useless as doing with great efficiency something that should not be done at all." Peter Drucker

A successful transformation requires two things:

A clear vision of what a company should look like after a transformation and the path to achieving this vision until the vision is established or until the company “functions” as envisioned in the vision. However, these two subject areas cannot be viewed independently: How a target image “emerges” has a significant influence on whether a transformation succeeds (or fails). Yet, the target image alone is not sufficient for a successful transformation. The optimal timing of the individual transformation steps – tailored to the needs of the individual company – and meticulous implementation are crucial for the success of a corporate transformation.

To better assess the opportunities and risks of a transformation, it is necessary to consider the transformation phases. A transformation is usually initiated by a symptom that needs to be addressed (e.g., a decline in profitability), an external change (e.g., market consolidation), or some other critical situation. The goal of any transformation is to secure the future, assume social responsibility, and ensure the company’s attractiveness.

A distinction is typically made between three phases of transformation. Each has specific characteristics:

• Unfreeze: The existing is questioned and broken up (“unfreeze”). Employees should be involved in developing the desired target state to ensure broad support for the target image. A structured process and a transparent method support the management in this task.

• Change: The change from the current state to the target state. This phase inevitably results in a per­formance decline. It is management’s task to use suitable methods to keep the duration and severity of the decline in performance as minimal as possible. In this phase, the skeptics speak out, and there is a risk that the company will be “caught between two stools”.

• Stabilize: Most of the work is done, leadership qualities ensure stability in the target state and continue to develop the company.

Written by
Stefan Zirhan, Partner