Managing in Business Cycles
Lorange, Peter, Ivey Business Journal Online
Knowledge of cycle management is more critical today than ever before. It implies making in-out decisions and long-short decisions. But how can leaders and managers do this effectively? The author, the former president of IMD, Lausanne, and the former owner of a not-so-small trans-ocean shipping company, has some excellent suggestions for managing through business cycles, both relatively stable and predictable ones, and volatile, almost-violent ones as well.
Virtually all businesses are cyclical and reflect the imbalances between supply and demand among the underlying activities of each given business. Perhaps some of the most extreme examples can be found in the shipping industry, in many commodities (metals, ores, agri-business), and in real estate and stock markets. In fact, cyclical businesses are everywhere. This is why good timing is especially critical for example, in deciding whether to get in or out of a particular market, to take a long or short position, or in judging the turning points. Still, we do not find much coverage of these issues in the typical business-school curriculum, or in business research or writing, for that matter.
In this article, I shall lay out what I see as the basic elements of effective management over business cycles. I shall draw heavily on examples from ocean shipping*. After all, which major industry might be more cyclical? For example, a modern Cape Max bulk carrier, say, of 140,000 tons d.w. size, would have, for instance, commanded a spot freight rate of approximately U.S. $140,000 per day in May 2008. Four months later, the same ship might have earned a mere U.S. $8,000 per day. So here, indeed, we are talking about violent cycles, much like we are experiencing today, and it appears, much like we will experience for the next while.
Much of what I shall be arguing seems to be generally valid when it comes to all businesses that are faced with cycles.
We do, of course, have general economic cycles. It should also be pointed out that there is a difference between cyclicality and volatility. The extremes I am referring to reflect the volatility that results from shocks, not only from cyclicality in its "pure" sense.
So, we know that most markets follow certain cyclical patterns. To achieve a meaningful return on capital, investors typically need to be present over long periods of relatively low earnings interspersed with shorter periods of stronger earnings. An alternative to this, of course, would be to go in/out during the peaks, totally avoiding the lean periods. While appealing, this is hard to pull off in practice. Figure 1 illustrates a typical market-development cycle over time.
An understanding of this type of cyclical pattern is critical for any sector in a given business. But for those firms who are exposed to this type of cyclical pattern, it would not necessarily be the best basis for making strategic decisions, because stability and predictability of earnings would typically be critical, above all for publicly listed firms. For many of these firms, a stable income stream, ideally portraying stable growth from an upward-moving market, would be essential to attract financing and capital.
When it comes to market cycles, one should remember that they tend to be relatively prominent in relatively mature industries, i.e. with the expectation that cyclical patterns of the past will continue into the future and be relatively "normal", such as depicted in Figure 2. What happens if this turns out not to be the case? For instance, what happens if the cycle does not flatten out as it approaches the top, but extends itself and climbs even higher? Or, alternatively, what if the bottom of the cycle does not lead to a flattening out and the market continues to decline? Figure 2 illustrates the potential of these developments, which are often deemed unlikely, according to conventional wisdom in the industry.
How might these discontinuities impact strategy? …