The new coronavirus is not only affecting people’s health, but it’s also affecting our global economy. Within a few days, the bright and flourishing economy for entrepreneurs has transformed into a dark landscape that many experts point to as an impending recession. The impact of this pandemic surprised most entrepreneurs and requires an inventive approach to keep their heads above water. But how would you go about that, innovating during a crisis? In this blog series we are looking for the answer in both scientific research and among entrepreneurs. We try to translate this into practical insights for SMEs and (regional) governments. This first blog looks back at previous crises and the effect of innovation vs. cost savings in times of crisis.
During a crisis, the first reaction that companies have is cutting back on investments and innovation. The main reason for this is that they must have sufficient (financial) resources available to absorb potential losses and thus guarantee their existence. The question is whether this strategy is also effective for the long term. Prof. Justin Jansen, academic director of Erasmus Centre for Entrepreneurship and fellow professor, Tom Mom, have previously investigated the effects of innovation and new business activities in times of crisis. Research into 600 activities of companies listed on the AEX and AMX (midcap) during the crisis in the years 2001-2002, shows that investing in innovation during times of crisis leads to frightening stock market reactions, resulting in a falling share price. The strategy of tightening the belt and cutting in operating costs appears to be a better option, provided that we can even trust the share price…
Short-term thinking in times of crisis
The research showed that from 2001-2002 “short-term thinking” not only dominated the stock market but also the boardrooms of listed companies. In the period 2001-2002, approximately 75% of the surveyed companies cut down heavily in personnel and business activities due to falling stock prices. Only 25% of companies deliberately invested in this time of crisis. The cutting was rewarded on the stock market, but only in the short term: the stock price of companies that invested fell much faster during the crisis than companies that did not invest. “It is precisely the Netherlands that profiles itself as a knowledge economy and encourages investments in innovation, thus renewal should be appealing to shareholders,” Mom explains. “But in times of crisis, shareholders tend to ignore these investing companies and reward companies that cut costs or divest activities,” Jansen continues.
Planned R&D investments and innovation projects are often critically scrutinized in times of crisis, as it is only later that they translate into better business performance. It is striking, however, that research shows how companies that invest in crisis times performed much better in the longer term. In the years after the crisis, the turnover, but also the share price of these companies, recovered much faster than companies that cut costs. What Mom and Jansen concluded from this is that the stock exchange initially seemed to prevent investment, but rewarded it in the longer term; in this case, with a sustained rate rise of more than 300% over the four years following the crisis. Companies that downsized during the crisis saw their share price rise by only 57% from 2003-2006.
Impact for SMEs and their business model
The research shows that for continued success in the medium and long term, companies will have to pursue an autonomous policy during times of crisis and will not be guided by short-term pressure from the stock market. But how do you do that as an SME entrepreneur, independent of company size and industry, given the current uncertain economic conditions?
SMEs in the Netherlands account for 99.8% of businesses (CBS, 2019). Economic recovery during and after the Corona crisis will therefore have to come from SMEs. However, it goes without saying that large companies have more resources at their disposal, which means they can invest more in innovation. Nonetheless, SMEs have previously shown that they are able to adapt quickly to changing circumstances.
Jansen: “In order to survive in the short term, entrepreneurs will initially have to come up with scenarios about the possible impact of the current lockdown and which aid measures could then be applicable. The costs will continue as normal, but income will fall (strongly) behind. You won’t last long as an entrepreneur.” Martin Luxemburg, director of the Erasmus Centre for Entrepreneurship, is enthusiastic about the examples we see in the news of SME entrepreneurs taking the first steps to adapt their business model by for example, offering online businesses to counteract a drop in turnover. However, this also raises some important questions. “Entrepreneurs should also ask themselves: what will happen when the economy starts recovering? Will they still be able to make it with their old business models in this new reality, in which there might not be an opportunity for continued innovation?” Entrepreneurs should use this time right now, especially together with their employees, to think more fundamentally about what changes in value creation and revenue models are necessary to survive not only this crisis but also the next 10 years. Martin says, “Our ScaleUp Dashboard shows that a relatively large group of SMEs (almost 40%) of the corporate sector continues to show a degree of contraction. These shrinking companies experience clear barriers to adapt to ever-changing market conditions. The leadership team often lacks the ability to actually apply new technologies and revenue models within its business processes and market propositions. These companies are now being hit the hardest.”
Curious to know more? Read about our research on entrepreneurship and innovation