Strategy at an Inflection Point
In Only the Paranoid Survive, one of the best books on business strategy ever written, Intel CEO Andy Grove defined an inflection point as “a time in the life of a business when its fundamentals are about to change. That change can mean an opportunity to rise to new heights. But it may just as likely signal the beginning of the end.”
Today, it feels like we are at such an inflection point. Inflation is rising to the highest level in 40 years, there is war in Europe, with Russia hinting at the use of nuclear weapons. China’s leadership has announced that it intends to supplant the US as the leading technological and military power. Many believe that it is planning an invasion of Taiwan this year or the next. The war in Ukraine has made energy security a new top issue for security, just as pressures to deal with climate change are increasing. The millennial workforce exhibits demands, behavior, and beliefs that are a marked contrast to those of most traditional employees.
Causing this mixture of issues and events are a number of major tensions. Each is composed of two countervailing forces that have been fairly balanced in the recent past. But today, some forces are strengthening and others weakening. Like a tug-of-war when one side weakens, the flag marking the center of the rope begins to move. These tensions are among inflation, taxes, and spending, among a more hostile world, energy security, climate change, and globalization, and among traditional workplace norms and the newer migration of ideological struggles into education, workplaces, news media, and government.
Inflation, Spending, Recession
The current inflation in the US is primarily due to the federal government’s “helicopter drops” of $5 trillion in new money to prop up spending during the COVID-19 crisis. Economist John Cochrane says that, in the face of this stimulus, “The Fed being surprised by supply shocks is as excusable as the Army losing a battle because its leaders are surprised the enemy might attack.”
Inflation occurs when there is a disconnect between public spending and expected future tax collections. Inflation can be seen in two different ways. First, it follows as federal policies provide people with more disposable income that is not matched by increases in the supply of goods and services—therefore prices rise. Another way of looking at inflation is that modern money is a form of debt, whether it be paper, electronic accounts, or treasury bills. And, the value of such debt depends on the markets’ trust that these claims will eventually be made good, either by future taxes or by rolling it over to new equally valued debt. If that trust is lost, then these types of “money” become less valuable, buying fewer goods and services. Measured in money terms, prices appear to rise.
The problem for the economy is that the Federal Reserve cannot really fix this. Raising interest rates, its traditional response, is limited by the horrendous impact of higher rates on the payments the government must make on new and roll-over debt. The rise of secular inflation may also constrain political parties’ favorite way to buy votes—voting more spending for favored groups. And, if inflation continues, you can be sure that government employees and all other unionized workers will be demanding increases in pay, setting off new rounds of price increases.
The problem for businesses depends on where they stand in the food chains of supply and demand. The standard strategy advice to businesses is to engineer a position where the business’s value created is better than that of competitors. If the value provided is considered essential by buyers, this positioning can usually ride out inflation, and even profit from it, as long as management adjusts accordingly. But, this positioning doesn’t help much if inflation presses buyers to shift spending away from your “value” to substitutes or to simply not buy as much.
Thus, in inflationary times it is vital to look deeper than traditional measures of product performance and examine each product’s sensitivity to your buyer’s budget constraints. Inflation means that your buyers’ money does not go as far as it used to so they will be adjusting the mix of what they buy. Now is the time to trim back product lines that are both inessential and have the greatest price sensitivity to demand.
Now is also the time to trim back activities that add costs without adding much value—these are usually the leftovers of past initiatives that have aged past their sell-by date.
Now is also the time to look again at growth plans which imply adding new debt in the future. Interest rates will be rising, driving up the cost of capital.
There will also be the temptation to cut costs by adjusting supply chains and moving activities to less expensive locations. But, beware of issue #2, the pressures pushing back against the last thirty years of globalization.
Another concern is that this inflation may well lead to a recession that does not reverse inflation. This state of affairs is called “stagflation.” This was the situation for many years during the 1970s and early 1980s. Unemployment was high, inflation was high and economic growth was slow. The problem for policymakers is that more government spending will exacerbate the inflation and higher interest rates will further hurt broad categories of demand. The answer for a nation is to stop fiddling with financial tools and strip away the layers of law, regulation, and bureaucracy that prevent the country from being more productive.
For businesses, stagflation can be a trying environment. The basic pricing and product line responses to inflation must be continued, but there needs to be an increased emphasis on reducing both costs and expenses. Stagflation is the time to be especially careful about taking on debt and making less-than-critical acquisitions. For consumer goods, those bought by government employees and others insulated from cutbacks will continue to do well. Those who prosper in such periods tend to produce essentials for the many or luxury goods for the wealthy, with additional success going to those can dramatically improve product quality or productivity.
Energy, Security, and De-Globalization
The second nexus of forces creating a serious inflection point has been triggered by the war in the Ukraine and China’s plans to replace the United States as the world’s leading political and military power. This nexus of forces includes energy security, climate change, military preparedness, and the reversing of globalization.
The Ukraine war has revealed that Europe’s dependence on natural gas sold by a hostile competitor has been unwise. One response has been a re-examination of the need for energy security. This, of course, pits proponents of more oil and gas development, and even nuclear power, against climate change policies and a host of environmentalists. Some want to seek more windmills and solar power installations. But this growth trajectory depends on smooth relations with China which supplies 80 percent of the world’s lithium cells and much of its solar panels. With increased tensions between China and the US, this pattern of dependence is being called into question. The break will be sharp if, as many forecast, China invades and takes over Taiwan sometime in the next two years.
If these trends intensify, the world will see less globalization. Marc Zuckerberg’s Davos-Man statement “Companies over countries” exposes the inherent conflict between broad international companies and national interests. This would not be the first time the world moved from global capitalism to balkanization. By 1880, Singer was a global company, to be followed by Eastman Kodak, Standard Oil, Unilever, Westinghouse, General Electric, and more.
The worldwide depression beginning in 1929 triggered a number of new tariff policies which together with depressed demand, began to dramatically reduce world trade. Then, the shooting wars of the 1939-1945 period broke the planet into factions. Formerly global companies balkanized, creating foreign divisions whose only relationship to headquarters was a periodic financial report. Four examples are Shell, IBM, Unilever, and ITT.
One hopes that we shall not see a repeat of the foolish policies and huge wars of the 1929-1945 era. But if the US-China split intensifies, it is realistic to expect a dramatic upset in both trade patterns and the whole economy. Buying a growing quantity and range of consumer and industrial goods from China has cushioned the decline in US productivity growth and fairly stagnant real wages for non-supervisory employees. An average non-supervisory worker earning $17 an hour in 2022, only 6 percent more in real terms than thirty years earlier, can shop in Walmart and buy a jacket for $11 that would cost $30 or more if produced in the US, or a Sophia & William Chinese import patio dining set for $660 that would cost over $2000 from a US manufacturer. This political trade strategy has cushioned millions of US workers from stagnant wages and the loss of well-paying jobs in manufacturing. If this trade pattern is sharply reversed, the impact on prices, wages, and the US economy will be dramatic.
If there is an uncoupling from China, reshoring to the US is a very hard road. The engineering and manufacturing infrastructure required would have to be rebuilt over decades. It is much more likely that many will seek to build alternative sources of supply in India, South America, and South Asia. Now is the time to begin developing these connections and strategies.
A Changing Workforce
Many executives are working to adapt to a changing workforce. In part, the COVID-19 experience has accustomed many employees to the flexible work hours associated with working at home on a laptop. Returning to work, they are demanding more flexibility, child care, more vacation, and other amenities. In addition, many companies report that employees have become much more willing to jump ship—their sense of loyalty has diminished and the demand for people willing to work has mushroomed. Continuing high demand for educated employees will probably continue this trend. On the other hand, a recession will tilt the balance the other way. And, even without a recession, some companies are beginning to realize that employees who work at home might less costly if they lived in India.
On a larger scale, three other forces have combined to change many workplaces. First, the educational system and social media have drawn many young people into political and social activism. Whether the issue is climate change, racism, abortion, immigration, or LGBTQ+ issues, employees, especially the younger and college-educated, are more outspoken and, in many cases, less tolerant of countervailing opinions. Second, in many of the most influential settings, there are no longer any lower-middle or lower-class employees. In tech giants, almost everyone is college-educated, with many having advanced degrees. The same can be said for many newspapers, schools, and government agencies. This isolation from the norms and ideas of the majority of “ordinary” citizens can intensify the hothouse atmosphere. Third, social media has dramatically increased the ability of employees to communicate with one another and to shape the outside world’s view of the company and its actions.
In this changed situation, leaders are trying to decide whether they should adapt to the new norms, try to shape the working environment, or simply ignore it and wait for time to reduce the heat.
Recently, the discussion has sharpened because of the political rupture between Florida Gov. Ron DeSantis and the Walt Disney Co. The governor signed a bill banning Florida public schools from instructing kindergarteners to third graders on issues of gender identity or sexual orientation. Outspoken activist employees at Disney expressed “anger” and “fear” at this development and demanded that the CEO declare the company’s opposition to such a prohibition. He did and DeSantis responded by supporting and signing a bill that canceled Disney’s special tax district in Orlando. Adding additional complexity was a petition from conservative Disney employees who wrote that they “felt invisible” and uncomfortable with the company’s support of a progressive agenda. Would Disney’s support for an activist group of employees mean that other employees would leave the company?
Most CEOs don’t want to face such quandaries. As Cutter and Glazer report, “In private meetings and coaching sessions over the past few weeks, top business leaders have been asking . . . How can we avoid becoming the next Walt Disney?”
One simple answer is to not take corporate positions on social or cultural issues. Or, more directly, have the board of directors write such a prohibition into the bylaws.
Another simple answer is to help interested groups of employees to express and become active on various political and cultural issues but not take any overall corporate positions.
Some CEOs want to take social and cultural positions but are not willing to handle the kickback from customers, politicians, or shareholders. This is not a serious strategy.
The more nuanced approach is to work on shaping a corporate culture that supports tolerance for a diversity of opinions in addition to diversity based on race and gender. The insistence that the whole corporation support a particular activist position is, for example, intolerant of the opinions of others, possibly a majority, who do not agree.
One interesting step in this direction is Netflix’s new “artistic expression” clause to its corporate culture guidelines. The issue that caused heated internal debate was a group of employees demanding, along with a public protest, that Netflix drop comedian Dave Chappelle’s special “The Closer.” Chappelle had, they said made offensive remarks about transgender people. After months of discussion, leadership added this new section to the culture guidelines: “As employees we support the principle that Netflix offers a diversity of stories, even if we find some titles counter to our own personal values. Depending on your role, you may need to work on titles you perceive to be harmful. If you’d find it hard to support our content breadth, Netflix may not be the best place for you.”1
None of this is easy. For a large public corporation, it seems generally imprudent to let a single CEO or even a small but energetic group harness the company’s power to a divisive political or cultural issue. The issues of today will wane and new issues will arise.
On the other hand, if a company is to engage and motivate younger more idealistic employees, it should stand for something other than shareholder return. In this context, the job of leadership is to craft a set of values and actions that can become a long-term commitment, shaping the image of the company and affecting who will want to work there. It makes the most sense if such commitments have to do with the company’s products or processes or special customer characteristics. An oil company looks foolish trying to lecture the public on climate change. But, if it commits to safety, carbon capture, and bringing energy to the almost one billion people who have no electricity, then it can combine these values with its business.
Similarly, it seems hypocritical for a smartphone maker to make pronouncements on social justice when its batteries are made from cobalt mined by child labor in Central Africa. Or lecture on racism when the company’s footwear products come from Muslim Uyghur forced labor re-education camps in the Xinjiang autonomous region of China. For the longer term, it makes more sense to avoid such hypocrisy.