June 14, 2019
July will mark the country’s longest economic expansion on record, “eclipsing the decade-long expansion of the 1990s.” All that growth is not met without growing concerns over slower global growth, however. Specifically, to close out 2018, the stock market turned in the worst December performance since the Great Depression, Brexit negotiations wage on, trade wars dominate headlines, interest rates fluctuate, and the budget and the trade balance remains in deficit. Adding to these headlines are a number of other factors in the tech sector that defy textbook financial red flags such as:
- Antitrust investigations across numerous household-name tech platforms
- >5x revenue valuations for unprofitable companies
- Quest for growth over profits
- Increasing valuations in unprofitable companies over consistently profitable companies
In 2018, unprofitable firms who went public had a median stock-price growth of 120% on an annualized basis compared to the IPO offering price. The median decline for stocks that were profitable was 57% during the same period. An example of this is DocuSign. DocuSign was mostly unprofitable both before and after its IPO. It’s currently trading at about $57, well above its $29 offer price. This trend is particularly prevalent in the high tech and software industries.
Is a Recession Near?
There is skepticism about the great economic expansion we are currently living in and plenty of concern that a recession is coming soon, or is already upon us. During a downturn, companies are at war with one another for market share – in addition to growing pressures for capital, people and partnerships. Successful companies know they have to prepare for a downturn while in an expansion because capital markets won’t give you money and people won’t want to work for you. Other companies won’t look to establish relationships with you if your firm does not seem like a success. Success, of course, is often measured by profit. When the next downturn inevitably occurs will you be able to turn a profit?
“In peace prepare for war, in war prepare for peace. The art of war is of vital importance to the state. It is matter of life and death, a road either to safety or to ruin. Hence under no circumstances can it be neglected.” -Sun Tzu, The Art of War
We have been living in relatively peaceful times, economically, and thus should be preparing for war. If you cannot turn a profit or control your pricing power now, then it begs the questions of long-term profitability and safety. McKinsey recently held a podcast on how companies can succeed through a recession. I’ll give you a sneak peek: the answer is by building resiliency.
If you like that content, read this McKinsey piece on their study analyzing the performance of 1,100 public companies during economic expansion, recession and recovery. The findings are quite revealing and prescribes a number of actions companies can take to build resiliency before any major downturn. One action to take is to invest in advanced analytics and technology.
In an economic downturn, your sales will become more volatile and to win deals, sales reps will turn to offering deeper discounts. This type of discounting obviously erodes margin, but it also erodes the brand associated values, which eventually leads to higher churn rates. No matter the economic situation, the strategic pricing capabilities should be deeply embedded in your organization and tied to long term strategy. In a recession, you must do more with less, sell more with a smaller budget, reach more prospects with fewer resources. Too often companies who did not prepare for war during peace time find themselves losing market share and profit quarter after quarter, even after the war is over.
Your Competitive Advantage
Controlling pricing and margin to prevent leakage with pricing software can be your competitive advantage during war. It’s an ROI story, plain and simple: the bottom line benefits will far exceed the price paid for the investment in the solution. This was the main selling point for SCM (supply chain management) and CRM (customer relationship management) software during the late 1990s and early 2000s. The best-in-class companies around the world will invest in technology even through an economic downturn especially if it is tied to profit. There is plenty of evidence to suggest this is a good idea. Here are two:
- Price management. In a new Forrester paper, Ten ways to prepare for the next recession, eight out of the ten ways to prepare for the next recession are related to software that delivers price management capabilities.
- Digitalization. Bain looked at a group of 3,500 companies worldwide, followed their performance before and after a recession and reported their findings in a December 2018 article in the Harvard Business Review. During expansion (peaceful) periods all companies seemed to have strong growth, but once a downturn occurred, performance diverged. The gap in performance widened during the recovery period and post-recession, the winners (prepared firms) were miles ahead of the rest of the pack, building EBIT at the rate of 17% CAGR vs 4% for those who did not prepare. Bain points out that CPQ solutions and advanced B2B pricing technologies are two digitalization efforts companies can make today to better succeed tomorrow.
No one can predict if or when a recession will actually begin. While we all recognize that every boom must have a bust, the specific causes for each downturn are different from those in the past. However, one strong signal of the end of a cycle has been the inversion of the yield curve, which happened in March 2019. Inversion typically happens 12-18 months ahead of the next downturn, and this was the case for the last eight US recessions. Ignoring a full yield curve inversion as a US recession indicator would require compelling counter evidence.
Now is the time to look at your commercial processes and build resiliency – especially those capacities that directly impact pricing profitability, rather than counting on cost-saving measures alone. We are currently in a period of “peace” but we could soon be in war times. It’s during those trying times that companies which are resilient and prepared will succeed while others fall into ruin. Think about the old adage: “don’t let a good crisis go to waste.” When tough times come, the battles won and lost for market share will decide the winners of the war.
If you would like more detail on how price optimization can help your organization boost profitability, get our whitepaper 5 Things Every CEO and CFO Must Know About Pricing.