ALL BUSINESS: Innovation needed even in recessions

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Associated Press

Posted on October 24, 2009 at 3:05 AM

NEW YORK (AP) — A theme is emerging from the flood of recent corporate earnings reports: Cost cuts are boosting profits.

Investors are cheering, but they shouldn't. Even in these tough times, more CEOs should be talking about how they are seeking out investments, developing new technologies and making acquisitions.

That's what will set their companies up for a stronger future.

Intel Corp.'s former CEO Gordon Moore had it right when he said years ago that "you can't save your way out of a recession." He meant that even in the toughest times, companies have to spend money on new ideas.

Recessions always end, Moore often said, and when they do, companies that embraced innovation during the downturn won't be stuck with obsolete products and services. Instead, they'll have new things to offer once demand picks up again.

"Customers don't come out of recessions spending the way they did before," said Chunka Mui, who has studied how companies can capitalize on opportunities during crises at his Chicago-based consulting firm, The Devil's Advocate Group. "They demand something different."

Surprisingly few companies are following Moore's advice of innovating during recessions.

Companies in the Standard & Poor's 500 index cut 25 percent on average from their capital expenditures expenses and 5 percent from research and development costs between the end of the third quarter last year and the second quarter this year, according to S&P.

Many have been crippled by the pullback in consumer and business spending as well as tight credit conditions, which is making it harder for companies to get loans to fund their operations. That's driven some to hoard cash and make drastic cost cuts. They're slashing jobs and wages and closing stores and factories.

The aggressive cuts have allowed companies to exceed Wall Street's expectations for their earnings. In fact, the "good" news has sent the Dow Jones industrial average above 10,000 for the first time in a year.

The problem is that too many companies are making widespread, not focused cuts. They're telling every division to cut 10 percent of their work force or slashing marketing dollars by the same amount companywide.

That is a quick way to rid a company of costs. But it doesn't help it get in a better position going forward, says Cesare Mainardi, managing director at the consulting firm Booz & Co. and co-author of the new book "Cut Costs, Grow Stronger."

"A downturn like this should force people's hand," he said.

At Intel, Moore's philosophy has been used consistently since he led the chipmaker starting in the late 1970s. Over the years, the Santa Clara, Calif., company's top executives continue to openly discuss the company's strategy of investing heavily in downturns.

During the 2001 recession, which hit tech companies particularly hard, Intel cut thousands of jobs and shut down unprofitable ventures. But it also ramped up spending on research and development on its core business of making computer microprocessors, even as its profits faltered. That helped the company diversify its product mix.

Apple Inc. had been struggling in the late 1990s as competition in the computer business intensified. But that didn't stop the Cupertino, Calif.-based company from boosting its spending by 30 percent on research and development from 1999 to 2002, even as revenues fell.

As a result, the iPod was launched during a downturn in October 2001. Apple also made headway on its iTunes music store at that time, enabling it to launch in 2003.

Southwest Airlines has also expanded during past recessions. The carrier, which is based in Dallas, was founded during a period of weak economic growth and soaring energy costs during the early 1970s. It boosted its fleet of aircraft and expanded its routes during the early 1990s and 2001 recessions, allowing it to steal market share from competitors.

To be sure, some companies are in fact heeding Moore's advice.

Intel announced plans to spend $7 billion over this year and next to build new manufacturing facilities so it can produce faster chips.

Walt Disney Co. is planning to give a high-tech makeover to its stores that will make them into mini-theme parks. Proctor & Gamble is overhauling its Gillette shaving operations in Boston.

Toys R Us Inc. has been buying up competitors, including high-end specialty chain FAO Schwarz. Cisco Systems Inc. has made five acquisitions this year, including two in the last month with a combined price tag of nearly $6 billion.

Google Inc. said it is ready to step up its hiring and plunge money into up and coming businesses, in areas like mobile technology.

"We now have the business confidence to invest heavily in the next phase of innovation, helping to invent the future as we see it," Google CEO Eric Schmidt told investors earlier this month.

It's a leap of faith — and the right time to do it.

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Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org

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