Headwinds

Business Strategies: How to Navigate Headwinds

The strategies employed by the management team can ultimately determine the business’s success or failure in navigating headwinds.

The capital allocation decisions and operating experience of the company’s management team become far more apparent when facing headwinds and receiving scrutiny from investors, stakeholders, and the public.

The leading global companies tend to pivot their focus on value creation, such as product development, even amid unfavorable market conditions.

Why? The board of directors and leadership team took measures to mitigate the material risks that could negatively affect their operating performance.

The critical point to understand here is the timing of the preparation, which occurred before the risks presented themselves rather than after. Therefore, a business run by competent management teams will have spent time strategically planning how to alleviate the risks via methods such as diversification.

If a company is publicly traded, management’s priorities often include protecting its near-term profitability (the “bottom line”), reporting earnings per share (EPS) on par with consensus estimates, and upholding the stock price.

Hence, underperforming companies anticipating challenging times or a strong headwind will engage in operational restructuring, including implementing cost-cutting initiatives.

In other instances, the surrounding circumstances can be more dire and require more “hands-on” adjustments to the entire business model because the estimated losses could be far more long-lasting to the business as a whole.

In the latter scenario, ensuring the negative effects are kept to a manageable level could, in fact, contribute to achieving more revenue growth and profitability over the long term.

Are Headwinds Positive or Negative in Business?

Headwinds represent negative implications on the company’s growth rate, margin profile, and operating performance, ranging from short-term underperformance with a swift recovery to normalcy to long-term performance far below historical periods, wherein the outcome is insolvency.

In short, a company’s business model—particularly at present, given the integration of technology within practically all industries—must be dynamic and capable of adjusting to unexpected “hurdles,” even if the occurrence is sudden.

The most common outcomes of facing headwinds are a decline in revenue, a slowdown in sales, increased competition in the market, and the incurrence of significant costs or expenditures.

From a more optimistic standpoint, headwinds present an opportunity to improve one’s business model (and adjust at a faster pace relative to the competition), whereas tailwinds are straightforward opportunities to capitalize on and profit from.

For instance, a company’s necessity to reduce its total spending to improve profitability could force management to prioritize the business’s core operating activities (and neglect the non-core activities that merely serve as distractions).

But to reiterate from earlier, the capacity to adapt to changes in the competitive landscape and consumer preferences is often the differentiating factor that determines the companies that establish a durable economic moat (i.e. the long-term protection of profits and market share).

The headwinds faced are seldom specific to only one company, barring extraordinary circumstances. Instead, headwinds tend to be industry or sector-specific, so the businesses most adept at adjusting to the risks posed can not only come out with limited damage but thrive thereafter.

The competitors at risk operating in the same (or an adjacent) market might suffer much more in comparison, so the effects should be analyzed on a relative basis.

Headwind Example: U.S. Fed Interest Rate Policy Changes

The Federal Reserve (Fed), or central government in the United States (U.S.), had an integral role in stabilizing the economic conditions and financial markets during the COVID-19 pandemic.

The Fed’s monetary policies served as a tailwind around the start of the pandemic but became a headwind in the post-pandemic era soon after once a state of normalcy was attained, namely in response to the widespread concern about rising inflation.

Once the market had reached a state of normalization, the Fed soon started increasing the federal funds rate from near zero, an initiative implemented around March 2022 to uphold the U.S. economy’s growth and reduce market volatility.

The pivotal shift of the central government to a risk-averse, restrictive stance on monetary policies (i.e. “fiscal tightening”) was intended to curb inflation.

In particular, the Fed’s decision to increase the interest rate—the cost of borrowing from the perspective of businesses—caused a slowdown in economic growth.

The Fed started to taper off its asset purchases and eventually resorted to selling off assets, which is a process formally referred to as “quantitative tightening,” which reduces the overall liquidity in the financial system at the risk of causing a reduction in economic activity (and that potential risk came to fruition).

The tightening of monetary policies reduced credit availability from the market interest rate since the cost of borrowing was higher. The increased cost of debt dampened investment and consumer spending, particularly in interest-sensitive sectors such as real estate and the automotive industry.

The Fed’s initiatives contributed to increased volatility in financial markets, which was a risk undertaken to avoid the material risk of rising inflation.

The trade-off in the Fed’s efforts to fend off inflation was an economic contraction in terms of growth, which is a challenging balance to strike. The Fed’s past fiscal policy measures, such as the unprecedented fiscal stimulus offered to support the economy, were offset by the Fed’s tightening measures, creating a new layer of complexity in the U.S. economy’s recovery process.

The Fed was the central headwind for businesses in the U.S. economy in the post-COVID period, primarily stemming from its continued efforts to control inflation via tightening monetary policy. The risk measures were deemed necessary to ensure the inflation risk was kept at a manageable level during a period in which the need to reduce inflation took precedence over an economic recovery.

In closing, the Fed’s initiatives to stabilize the risk of rising inflation (and prices) inadvertently created headwinds to the U.S. economy and businesses.

The efforts to reduce inflation in the U.S. highlight the role of the central government in an economic crisis, whereby government intervention must control material risks—such as inflation—to ensure the rate remains within the target range while continuing to support economic activity.

^{Key Policy Actions in Response to Post-COVID High Inflation (Source: Federal Reserve)}