In H1 of 2022, the S&P 500 saw the biggest drop since 1970 wiping out over $13 Trillion globally. Due to the hot war in Ukraine, energy and food prices are skyrocketing. Clogged supply chains around the world have contributed to the highest inflation rate since the mid-70s (8.6% in May 2022). The global economy isn’t thriving and chances of a recession are very high.
But there is hope. Recessions and down markets are breeding grounds for new disruptors. Startups that came out of the ashes of the last recession: Uber (2007), Netflix (pivoted to streaming in 2007), Airbnb (2008), DuckDuckgo (2008), Asana (2008), Whatsapp (2009), Venmo (2009), Square (2009), Pinterest (2010), and Instagram (2010).
For established companies, recessions provide a unique opportunity to gain significant market share - if they play it right! However, not much guidance exists for how tech companies can expand during recessions because “Tech” wasn’t really a thing back in 2008 (some people might disagree and that’s fine).
Whether a Tech startup or not, all companies are confronted with similar challenges in a recession that can be an opportunity at the same time. A crisis can be an opportunity.
Recessions are opportunities to gain market share
3 signals tell you whether a company is suited to weather the storm of a market downturn or not: free cash flow (profits), cash reserves (money in the bank), and burn rate (debt and expenses). Together, these factors decide how much runway a startup has, i.e. how long it can survive given the current revenue and expenses. The common recommendation is to have enough runway for at least 24 months.
The 3 indicators for recession proof companies also decide how aggressive a company can be in gaining market share or how hard it has to be in cutting costs. Even though the initial reaction should be cautious, not all companies should approach downturns the same way. Strong free cash flow and cash reserves paired with a manageable burn rate is an opportunity to gain market share and even pass incumbents - with the right strategy.
The long-term consequences for companies that cut R&D investments, scale back on sales and marketing, and lay off valuable talent are severe (see screenshot below). On the other hand, companies that reduce costs but reinvest them wisely gain significant market share.
In the HBR article “Roaring out of Recession”, the authors grouped 4,700 companies into four categories based on their performance during three recessions:
- Prevention-focused: hard cuts, no reinvestment
- Promotion-focused: minimal cuts and big investments
- Pragmatic: hard cuts and big investments
- Progressive: medium cuts, targeted investments
What they found is that progressive companies are 37% more likely to outperform their competitors, compared to 21% of prevention-focused companies. Progressive companies didn’t cut expenses more than their competitors and reinvested in R&D, sales & marketing, and tooling. [x]
How recessions affect startups
Recessions turn the startup world upside down. Dropping valuations lead to lower funding rounds or even down rounds. Cheap capital dries up, startups need to lay off parts of their workforce and drastically reduce costs.
Layoffs in the startup world picked up significantly in early 2022. As crude as it sounds, the biggest sin when letting people go is letting too few go. Death by 1,000 cuts is a serious problem that kills employee morale and causes “flee the ship” panic.
On the flipside, liquid companies can snap up talent that would otherwise be hard to get. Layoffs.fyi provides lists and names of employees that are looking for jobs.
The same applies to buying companies: dropping valuations and stock prices are excellent opportunities for M&A. Sometimes, the goal is to acquire unique technology (IP), sometimes an existing customer base, and other times acquihires for talent. As mentioned earlier, companies that take these opportunities tend to fare better. Market consolidation, as I predicted, is already happening.
How recessions affect customers
The deceiving thing about Recessions is that they don’t hit every economic sector at the same time. Usually, it starts with consumer goods, then expands into IT, and lastly energy. In the looming 2022 recession, however, it’s the energy sector that puts a heavy weight on the shoulders of consumers. [x]
The longer a recession takes, the more it changes consumer behavior. One to two years after the downturn, behavior typically comes back to normal levels. It’s critical to re-segment your target audience or customer groups since they’re unequally impacted by the downturn as well.
For consumer companies, HBR suggests four new categories for recessions [x]:
- Comfortably well-off
Similar categories might apply when selling to businesses, but every company has to figure it out for their specific situations. The key question is “for which customer segment is your product essential and for which not?”
Another part of changing consumer behavior is longer research and sales cycles. Consumers and companies spend less and do more research, making SEO a very important channel. Companies are advised to build out more content around common product/pricing questions and speed up the evaluation process.
As customer behavior changes, messaging has to adapt. Messaging, as a tool for product positioning, is an important anchor when customers evaluate your product/service. Recessions are not the best time to advertise scarcity and FOMO in your campaigns. Instead, replace them with safety and trust messaging.
Growth strategies for recessions
Cut costs and reinvest
During the Great Recession in 2009, average ad spend decreased by -12% in the US and -9% globally. The 2020 recession was one of the shortest in US history and a fire drill from which we can learn. In March, CPMs on Facebook dropped by -15-25% and on Instagram by -22% month-over-month. Youtube prices dropped by -15-20%. Advertisers reduced budgets, which means ads became cheaper across the board. Companies with enough capital and a good enough understanding of impactful channels can use this opportunity to double down. [x, x]
The worst approach is cutting costs equally across the board, e.g. -30% from search, social, display, and video. The best approach is cutting low-performing channels and reinvesting in strong ones. It doesn’t have to be a 1-to-1 investment. You can lower spending for poorly performing channels and reinvest half of that into strong performers. Most important is to cut your losses and bet on winners.
The best indicators for winners are:
- ROAS (return on ad spend): revenue do you make from advertising
- Payback period: time it takes to recoup advertising cost
- CLTV (customer lifetime value): revenue over a customer’s lifetime
Ideally, compare these metrics across all ad channels and redistribute your budget to the strongest ones.
Focus on retention and activation
Customer acquisition has been getting more expensive for a while, but recessions make it even more costly. As markets are shrinking, startups shouldn’t forget that gaining more market share can also mean making more out of the traffic and customers they already have.
#1 Instead of trying to convert traffic immediately, steering visitors to email conversions and building a large email list allows companies to nurture prospects longer and understand their behavior. If you can’t convert a subscriber, at least learn something about your product from them. Inboxes are intimate environments and attention is scarce. If you get into someone’s inbox, there is a chance you get at least cheap brand awareness.
#2 Even better are mobile apps because you can learn a lot more about user behavior and users are closer to the point of conversion. Experiments on native apps are much easier to run compared to newsletters. On top of that, app notifications - if not overdone - are more effective in engaging users than emails.
#3 A third way to improve retention is at the point of churn. Lead nurturing can improve conversion rates for traffic. Notifications can improve engagement. Churn optimization is the art of preventing customers from canceling their contracts. Ahrefs, for example, offered a free month when customers tried to cancel when companies cut costs in 2020. A bad way to approach this is making it harder for customers to churn, e.g., by forcing them to call a hotline to cancel.
If it’s a significant channel, double down on SEO
You’ll probably expect me to write that every company should invest more in SEO in a recession. But I don’t think so. Only if SEO has a significant impact on the business is it worth shifting budgets from paid to organic.
#1 Startups need to pay attention to dropping search volumes and conversion rates. As consumer behavior changes, so do the demand for certain topics/products and how well they convert traffic into customers. Track impressions for keywords with stable ranks over time. Monitor conversions by URL and if the top traffic-delivering keywords for them change in search volume.
#2 As conditions can change rapidly, startups should reforecast traffic for the next rolling 12 months every month to understand if they can hit their targets or not. Startups that are always aware of their vitals can react faster than their counterparts.
#3 When resources get tight and SEO is a viable Growth channel, startups should focus on optimizing the top 20% of keywords/pages that bring in 80% of revenue. The 80/20 rule applies in every corner of Growth and is an excellent tool for prioritization in crisis.
Weathering the storm
There is no perfect formula for thriving in a recession. The first priority for every startup is survival. If finances allow for it, Startups can redistribute budgets to performing channels and trim the fat. A higher investment in SEO can make sense but isn’t the solution for every company. Higher focus on retention, activation, and nurturing however seem to be almost always applicable during crises.
Companies making it out on the other end of a recession either come out stronger with a higher market share or weakened. The key differentiator is how well they invest their budgets and how well they understand how the market changes.