Resilience in TMT: Winning in downturns
Economic downturns hold substantial opportunities for companies in the technology, media, and telecommunications (TMT) sector. By starting now to build an action plan and execute no-regret moves, companies can put themselves on a path to emerge resilient through the next slowdown.
The technology, media, and telecommunications (TMT) sector has enjoyed unprecedented growth over the past decade. Seven of the ten largest companies by market value are TMT companies. Incumbents such as Apple, Disney, and Verizon have been joined by a quickly scaling group of disruptive players such as Alibaba Group, Alphabet, Amazon, Facebook, Netflix, and Sales force, all of which have been buoyed by consumers and businesses growing appetite for technology products and services.
Yet the current growth outlook is uncertain. Business investment in the United States contracted in the second quarter of 2019, as did the GDPs of Germany and the United Kingdom, two of the largest economies in the world.
How the next downturn will affect individual TMT companies is also impossible to predict, but one thing is certain: the top tier of them, which we call “resilients,” will outperform the rest of the sector by a significant margin, according to our research examining the most recent two recessions. The research shows that how you manage through a slowdown largely determines how you come out the other side, not just in immediate recovery but for several years after. First and foremost, winning is about more than cost cutting. Resilients bested the majority of their competitors not only by battening down the hatches but by taking several key strategic actions, some of which were counterintuitive, and no-regret moves. These included increasing the productivity and amount of their sales and marketing investments, continuing to invest in their core product engine, creating capacity by reducing leverage going into the slowdown, and remaining active in M&A and divestments.
Of course, every downturn is different, and each company will play the next one differently. Any upcoming slowdown will be a significant opportunity for a company to set itself up on a long-term trajectory of outperformance. Well capitalized disruptors will likely go on the offense, using the slowdown as an opportunity to strengthen their long-term strategic positions. Incumbents many of whom have been using much of their cash flows to drive returns to shareholders through share buybacks and dividend increases will need to start making some hard choices on where to keep investing and put more emphasis on new digital and analytics tools to drive the next leg of efficiencies.
Regardless of their starting position, leaders of TMT companies need to start planning and taking action. Execution of strategic preparations will take time, as will securing critical buy-ins from management teams, boards, and shareholders. Successful strategic plans will need to take a long-term view and not give in to short-term impulses and pressures. In order to succeed, companies cannot afford to wait for the onset of a downturn to make no-regret moves.
Plan for next downturn, not the previous one
While TMT companies can learn from the previous downturns, we see three areas of fundamental difference to consider.
First, the market environment has changed significantly. Several key subsectors, such as software, IT services, and telecom services, are growing significantly slower than they were heading into the last cycle. E-commerce now makes up about 24 percent of the TMT sector’s revenues. Trade and geopolitical risks are creating significant uncertainty for global supply chains. And leading industry disruptors (for example, Amazon Web Services, Facebook, Netflix, Sales force) have achieved scale, while emerging disruptors (such as Airbnb and Uber) have raised a huge amount of capital.
Second, several financial factors have altered the landscape. Debt/EBITDA ratios are up across almost all subsectors (except e-commerce and media), while coverage ratios (EBITDA-to-interest expense) are stable or have deteriorated. The proliferation of subscription models (for example, software as a service) increases variability risk in revenue and it is unclear how that will play out during a slowdown. And shareholder activism in TMT is at all-time highs, with activists sitting on a large amount of capital to deploy.
Finally, productivity improvements have become more difficult to achieve, as simple cost-cutting measures are no longer sufficient. Instead, such gains require investments in digital, automation, and analytics, which will be difficult to make in a resource constrained environment such as a downturn.
What companies need to do now: Build a resilience action plan and start executing
Companies tend to put off preparing for slowdowns as they focus on the day to day tasks of increasing revenue and total shareholder returns. Continuing to wait, or wallowing in analysis paralysis, will be considered an egregious mistake in retrospect. Leaders must adopt a bias toward action and a steadfast mind-set that looks beyond any potential downturn and envisions the company’s path through the economic cycle toward sustained, stable growth regardless of market conditions.
The most critical aspect of such a proactive approach is building a formal resilience plan and gaining top leadership commitment to it. For each company, this plan needs to be grounded in an understanding of the impact a slowdown will have not only on the company but also on its ecosystem including customers, competitors, and suppliers. For example, IT hardware companies need to understand the stresses in their supply chain that may get introduced in certain scenarios. Software companies need to understand which customer segments are more likely to pull back and which ones are likely to stay stable or grow. Given the unique nature of TMT, in which players continuously make moves into new adjacencies, companies need to understand their competitive landscape and how it may evolve as new and existing players take actions in a slowdown. In addition, the plan must include a thorough assessment of the company’s own strengths and weaknesses (operational, organizational, and strategic) and a financial plan that incorporates scenarios based on these elements.