How to be a calm leader in volatile times

This article first appeared August 31, 2011.

Stock markets are gyrating, consumer and business confidence have tumbled, industries like retailing are being hit by seismic structural change of online and mobile shopping and there is political uncertainty about issues like the NBN and carbon tax.

Add to that the basket case otherwise known as the Eurozone and the likelihood of more bailouts and possible defaults, the US credit rating getting downgraded and the US economic fundamentals suggesting the world’s biggest economy could slide back into recession.

Future Fund chairman David Murray has told reporters that this level of volatility is likely to continue to continue for at least 20 years. The debt levels around the world will not be resolved in weeks, months, or even years.

So what can a business do? In times like this, it is tempting to sit tight and hoard cash. That is defensive and will not help, in fact it could hurt because there will be no growth. It is important to put this in some perspective. The only ones who are doing it really hard at the moment are self-funded retirees, many now living on less income.

Volatile times should force companies to think strategically about where they want to be five years from now. With the ground shifting constantly, they can adopt a SWOT (strengths, weaknesses, opportunities, threats) approach where they analyse where they are tracking and how they can improve.

RMIT economist Sinclair Davidson says part of the problem now is that while the fundamentals of the economy are good, it doesn’t feel that way. Our terms of trade are at historic highs, unemployment is relatively low, as is corporate indebtedness.

But the “sentimentals”, as he calls them, are down with uncertainty about public policy and falling consumer and business confidence are falling, and that adds to the volatility.

The businesses that get through this period, he says, will be the ones that are nimble and that can move quickly to take advantage of market opportunities.

“The way in which to do this properly would be to maximise flexibility, to make sure your business strategies are working well and that your business model is sound. Things can change so rapidly you need to have the flexibility not to be wedded to particular approaches,” Davidson says. “You need to react quickly and that means businesses need much more flexibility in how it copes with the market and at the same time with its inputs.”

“Firms with high overheads are certainly in a lot of trouble and certainly the extent to which you can vary your overheads quickly puts you in a much better position than businesses that can’t.”

One of the best examples of that is JB Hi-Fi. In the face of the worst retail downturn in 50 years, JB Hi-Fi has defied the doom merchants, posting a normalised $134.4 million after-tax profit, up 13.3% over 2010 after excluding a one-off hit announced back in February of $24.7 million relating to the closure of its Clive Anthonys electrical goods chain.

What’s JB secret? It’s remarkably simple. Unlike other retailers, JB Hi-Fi responds quickly to changes in the market. It is extremely flexible. If a strategy isn’t working, it will ditch it and adopt another.

Walk into a JB Hi-Fi store now and you will see less space for CDs and more space for hardware and electronic goods. Other retailers are complaining about the impact of online retailing but JB Hi-Fi has announced a new “JB Hi-Fi Now” digital music streaming service to be launched in the last quarter of the current calendar year in a staged rollout across Apple and PC formats. It will feature between six million and eight million tracks from 100,000 artists. JB plans to launch a “Now” app across all mobile platforms.

This is a massive decision. JB Hi-Fi is responding to market trends. Spotify, an online music streaming service available in Europe since 2008 has entered the US and The Wall Street Journal reports that it has already attracted 1.4 million users of which 175,000 (or 12.5%) have signed up for a “premium” service. Spotify has not indicated any plans for Australia but by the time that happens, it will be up against a strong incumbent running an established streaming service. More importantly, JB Hi-Fi, which according to the music industry sells four out of 10 CDs in Australia, has shown it is prepared to scrap an old strategy if necessary, a key lesson for businesses in volatile times.

Indeed, flexibility has always been part of JB Hi-Fi’s culture. When the company was set up in 1974, it specialised in hi fi equipment, records and then CDs. In an age of downloading, it expanded into televisions, home theatre, computers and gadgets, particularly anything that has an Apple brand on it – JB Hi-Fi is the biggest reseller of Apple products in Australia – digital cameras and games. Sales of mobile phones have grown significantly over the last 12 months and are now a big part of the business. JB Hi-Fi has shown an ability to respond quickly to volatile markets. Five years ago, they didn’t even sell computers. It is very much an evolving company that moves with the market.

To keep itself nimble, JB Hi-Fi has made sure it is not hamstrung by high overheads. Stringent cost controls are a key part of the business. Its latest accounts show that while other retailers are losing money furiously discounting, JB Hi-Fi’s EBIT margin is a healthy 6.6%, compared with 6.4% the year before and cost of doing business was flat at 14.5%. Gearing is low and the accounts show the company actually reduced debt levels last year. And to reduce high overheads, JB Hi-Fi has a policy of high variable compensation for its staff, giving them more incentives to sell and aligning their interests with that of the company.

The JB Hi-Fi story is a good example of a company that has focused on good strategy to deliver outcomes. It has developed these strategies in the face of volatility. It tells companies to look at experimenting with new business models, learning more about consumer needs and revisiting big inflexible projects and turning fixed costs into variable ones by, for example, bringing in contractors or introducing variable pay systems.

Another important step is not to be fazed by the volatility as you can’t control it. Boardroom veteran Charles Macek, a non executive director at Wesfarmers, says managers and directors shouldn’t waste their time worrying about things they can’t control. Instead, they need to focus on strategy and earnings.

“You focus on what you can control. You don’t ignore what’s going on in the markets,” Macek says. “It does impact on confidence and to an extent, that impacts on the financial system and the availability of credit.”

“But one has to divorce what’s going on in the market with what’s going on in the economy because unfortunately these days, markets are driven by machines and short-term traders. Two-thirds of the turnover is machine driven and doesn’t necessarily reflect what’s happening in terms of the fundamentals of what’s happening to the economy, it’s just people reacting to the latest news which is why you get this incredible day to day volatility in markets.

“From an investor’s point of view, you have to look through it and take a long-term view and look at the fundamental values. From a company management and board perspective, you manage the business as you need to.”

“I am sure the CEOs of the major Australian companies are not losing sleep over what’s going on in Europe and America. They understand they are not totally immune and are affected by it but it’s nothing they can control and in any event the impact is not likely to be as extreme in Australia as it is elsewhere so you do what you need to do.”

“So if you’re a retailer, for example, you watch your returns and sales. Retailing is at the forefront of structural change but even within retailing, there are pockets that are doing well.”

Macek believes the storm will pass. Which, he says, is all the better if the company has a conservative balance sheet because by the end of the year, there will be many bargains out there.

The lessons are clear. In volatile times, businesses need to maximise flexibility, hold their nerve, develop new strategies that respond to a changing market and focus only on what they can control.

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