DI INSIGHTS

Two Risk Axes — Which is Stronger?

During a recession, the best bulwarks are usually the assets with the least demand elasticity — they’re fundamentally woven into people’s daily lives, not to be unseated by mere strictures in disposable income or access to credit. Money aside, this novel pathogen presents an additional risk type: it challenges the way assets are used, the way supply lines are managed, and the way daily life is lived. As a result, money flows to projects that meet the dual challenges of recession risk and infection risk.

In evaluating projects at any scale, consider both kinds of risk and how they interact. Does economic slowdown reduce the overall demand for the project, as might be seen with a mall store? If so, the present crisis may affect its performance for years. Also examine its attendant safety issues: do its users face heightened infection risk? They do in malls, which could impact buyer behavior for as long as the pandemic persists and may continue to influence habits and norms for years afterward.

Infection risk also creates selective upsides — certain ventures gain value as people adjust their lifestyles — but the upside isn’t shared across entire categories. While the effect can be subtle in physical projects, it’s more observable with securities. For example, Data Center REITs have grown 17% year-to-date,²¹¹ partly driven by the demand for remote services to replace in-person modes of work and leisure. While self-storage properties also bear little infection risk to tenants, they saw no demand spike during lockdowns, growing only 8%.²¹² Clearly, safety isn’t the only way this virus impacts demand.

This observation is not a tip on which stocks to buy; rather, it’s an indicator of the risks facing any business endeavor. User needs are emerging as a much greater factor than whether economists would consider a good or service “elastic,” or whether governments would deem it “essential.” Thus, in designing for the new normal, the user still comes first.

Bet on the Future (to get here sooner)

Many elements of this crisis were anticipated within the next few decades. It’s been said that the virus hasn’t changed the future; it only brought the future closer. Already, U.S. healthcare systems were in a fragile state, with cost asymmetries mounting and bureaucracies bloating. Housing affordability was already top heavy, waiting to be tipped upside-down over a dragging labor market. The tech sector was already growing at more than twice the speed of global GDP, edging toward dominance. Climate change was already on our minds, and talks were progressing toward renewables. Bill Gates even warned of a global pandemic from the TED stage in 2015.²¹³

What few predicted was how soon it would all transpire. It’s time to update our “common sense” notions about the pace of transition. Rather than expecting automation to replace the workforce by 2035, consider how automated it could become by 2025 (now that we’ve experienced firsthand how the workplace can be a safety risk for humans). Instead of obeying the Paris Accord or other official benchmarks to phase legacy pollutants out of supply chains by 2030, imagine leading your industry competitors in a swifter embrace of local suppliers and renewable resources. Everything we thought would happen someday is happening today. Are we letting it happen, or making it happen?

To address these questions in your organization, consider updating your communication norms. As a team, are you willing to face one another’s disagreement when new, untested ideas are brought to the table? If not, how can you change the incentives and expectations to allow for more open discussion? More importantly, do you have a shared sense of your common goals and values? What would collective success mean for everyone in the room? Is your current set of habits and norms the best way to approach that collective win?

What about the world beyond your walls? When you survey the business landscape, does your team see the same patterns? Do you readily admit the limitations of your predictive models? Do you embrace cognitive diversity, seeking to coordinate between differing viewpoints? Do you openly discuss risks and how to manage them?

These discussions will begin the process of sense-making. Only when clarity of conversation emerges can there be a meaningful confrontation with the future. Once you’re speaking a common language, using shared values and meanings, you can begin to see the road ahead with depth perception.

Engineering and Architecture: Expansion vs. Reinvention

Note the building types that are seeing steady growth in demand during this recession: industrial, mission critical, life science labs, and cell towers. These types have a few things in common — they pose little infection risk to users, they benefit directly from the growth of the technology sector, and they raise the demand for engineering. Even if the pandemic lingers for many months or years, there will be plenty of engineering contracts to go around. “Expansion logic” will prevail in the engineering race, as track record and turnaround time will draw the most business from well-funded clients with short deadlines. Expect to see engineering firms with stalwart reputations and deep rosters gain even more market share.

In contrast, the building types that make the most comprehensive use of the architect’s expertise — education, healthcare, hospitality, retail, civic, and office — are now suffering the lowest demand for growth. But as we see it, this lag in growth doesn’t mean there’s low demand for architecture. In fact, what these buildings and their inhabitants need are retrofits that return a sense of safety, togetherness, and productivity to our most communal spaces. But what will govern these building types is a kind of “recession logic” that favors creativity, cleverness, and courage instead of basic firepower. Those who win the contracts will be the ones who create them — who make a value offer so unique, they convince the buyer to shop. This is good news for small teams with big brains.

The opportunity for architecture is far different from the one for engineering, and much harder to attain: it demands complete reinvention. It will involve securing new business in proactive ways through unfamiliar channels; it will require a pivot toward interior design as an integrated, central practice; it will even challenge billing structures, performance evaluation models, and (due to importing/exporting shifts) whole new supply chain agreements.

The most agile, perceptive, imaginative teams will have the greatest advantage, able to sense subtler opportunities and deliver designs that solve unprecedented problems. Meanwhile, those committed to business as usual will be committed to the trash bin.

M&A: Scope Over Scale

In merger and acquisition parlance, a scale deal is when one company seeks out another within the same vertical market (a hotel chain buys another hotel chain), aiming to increase market share, control more real estate with the same zoning, acquire similar talent, or bulk up their brand family. In short, they scale up. During an economic expansion, a scale deal can be a powerful way to leverage risk and improve bottom-line earnings with relatively little overhead. In recessions, interest rates are better, but all buys bear higher risk, and vertical market share may be overvalued. Scaling isn’t always best.

Scope deals move horizontally rather than vertically, bridging distinct but related markets (e.g. a theme park chain buys a hotel chain), thereby growing the scope of the company’s capabilities. Instead of simply packing on the pounds, a horizontal deal finds complementary ingredients — intellectual property, talent, corporate culture, or other assets — and strategically integrates the two brands into a single, stronger entity with the best aspects of both.

Whether the economy is expanding or receding, scope deals can spark innovations, bolster resilience, and beat market trends. Scope deals require more intensive research and due diligence, deeper intuition for soft skills and cultural fit, and a refined sense of strategic partnership. As a result, they can take more time and capital, but can pay off more in the long run.

If you’re in the position to acquire or to be acquired, know that the intel needed for a scope deal is both broader and “softer.” Specialists from both companies with diverse expertise will have to discuss immeasurable goods (corporate culture, brand story, vision) and complex measurables (profit and loss, structure of benefits, intellectual property). They will need a years-long strategic plan that involves collaborative leadership on both sides. With myriad experts who speak their own private languages, these talks can become a quagmire that slows or halts the acquisition.

If you’re committed to a merger that will bear fruit, it will be worth your while to engage a third party with experience in mediating talks and mitigating complexities. Consider the cost of the right consulting firm as a small price of admission to a wide realm of opportunity.

M&A: Distressed Assets 

This euphemism could be replaced by the familiar real estate term, “fixer-uppers.” The market has more distressed assets now than ever, and the number only seems to be growing. This could present a major opportunity for savvy fixers. It could also present a minefield of risk, in which appearances are deceptive: what’s bad looks good, and what’s good could look positively dead.

A distressed asset comes disguised as a liability: it needs work, but it also harbors potential. Left unchanged, it won’t be favored in the market. To realize gains, the asset must undergo thorough transformation. Buying a distressed asset is therefore a commitment to see it through that change; it takes vision and patience. 

If you’re thinking of acquiring a company in distress, what’s your vision for restoring its true value? If you’re planning to revitalize a property in your city, how will you change its future? Have you already secured the resources to complete the transition you know is possible? Have you brought your vision to any experts to have them “stress test” the idea? Again, a detached third party may be your best advisor when it comes to assessing these risks and opportunities.

2021: The Year of the Redesign

We’ve said it before, but it still warrants deep consideration: many buildings, if not most, need retrofitting, inside and out. From office to healthcare, education to hospitality, airports to apartments, the ways we work and live in these structures have been wholly redefined. Now, the spaces themselves need to adapt. The phrase of the year — perhaps the decade — is “adaptive reuse.”

Needs range from interior to exterior, and from human to environmental. From the ways people use entrances, exits, lobbies, and elevators to the way workspaces are arranged or windows permit airflow, every assumption of building design has been called into question. Many offices won’t even reopen until the spaces within can guarantee safe distance and clean air for their workers. Similarly, hotels and airports won’t see travelers return until safety has been made central to the experience.

But this moment of change is also an opportunity to demonstrate the power of environmental resilience and health — preparing our structures for the next crisis, not simply reacting to previous ones. In a world of accelerating change, shocks and pivots are inevitable, making adaptive buildings essential for humans to thrive.

Designers have seen these needs from afar — but finally, business owners and property holders can see them, too. They know their buildings won’t bring back inhabitants without serious overhauls. What they don’t know is what they need or how to ask for it; they’re simply aware that something’s broken, waiting for a change. They haven’t set finite budgets or validated them. They haven’t developed program requirements. They haven’t begun to envision what would work or considered what could work. All they know is that this doesn’t work.

When the buyer is aware but not informed, the seller’s challenge is to initiate, educate, and inspire. Owners need you to call on them like never before. They need to see research-driven, data-supported, user-centric designs they can understand. They need to be able to gauge risks — not just the risk of change, but the risk of doing nothing while others change. Above all, they need to remember why they entered into business in the first place: to be leaders in their industry, seeing differently than others see. Re-inspire them to lead with courage and competence, and they’ll jump at the chance to return to their entrepreneurial roots.

If you’re confident it’s time for reinvention, but unclear on how to actualize the change within your firm, a consultation with DesignIntelligence may be your next right step. Our strategic advisors have the experience and creativity to come alongside your team and catalyze a transformation — one that starts with discovering your authentic core values and applies them to every corner of your business.