What is optionality and how can it help companies during a recession?

2023 isn’t the first layoffs we’ve seen. We can point to plenty of times when cutting staff was the probable option, if not the popular one. To dig into what’s happening and what we can do differently Quartz at Work turned to Tim Sanders, VP of client strategy at Upwork, former chief solutions officer at Yahoo, and New York Times bestselling author.

The recurring theme I hear from leaders announcing layoffs is that “we overhired.” That speaks to the artisanal nature of talent acquisition. When headcount is funded, there are few, if any, metrics required to “open a requisition” with a recruiter. It’s a matter of the hiring manager’s stated need and approved budget.

However, companies that are more scientific about adding talent—those employing a fractional to full-time model—will have fewer layoffs because much of their talent will be on demand with scale-up and scale-down capabilities. With recruiting, all you can do to cut expenses is lay off people.

Generally, good and bad economic times are part of a normal business cycle. Layoffs aren’t always the solution to prepare for a downturn. It’s important to remember that businesses can cut costs without cutting capacity. Research shows companies that emerged the strongest from an economic downswing relied more on operational improvements than layoffs to cut costs. This is where it’s beneficial to master the balance sheet.

The biggest risk for some companies is that they will either be leapfrogged by a more innovative and opportunistic competitor or they will miss a once-in-a-cycle opportunity to make a big leap in their market.

Each company needs to balance the risk of standing still against the risk of running out of cash. In some industries, like food manufacturing, this might lead to a wait-and-see approach to new products, marketing, and expansion. But for winners-to-take-all or high-velocity industries like cybersecurity, the risk of standing still is far greater than running out of cash.

Notably, research from McKinsey and Harvard Business School underline resilient companies that have created gains lasting through and long after an economic crisis. These companies viewed long-term growth as more important than achieving short-term cost efficiencies.

The dot-com crash and the Great Recession created unique opportunities for challenger companies to leapfrog their competition. Apple launched the iPod in October of 2001 and shut out Sony over the coming years in personal music devices. Netflix leveraged the 2008 recession to launch video-on-demand, shutting the door on Blockbuster’s resurgence.

When Bain and McKinsey studied the 2008 recession, they determined that the winners were the companies that treated the recession not as a storm but as a curve in a racetrack to power out of. These companies didn’t just do well from 2009 through 2010. They outperformed the S&P 500 for almost a decade. These companies seized the opportunity to fuel growth and innovation—through optionality or structural flexibility.

In its most basic form, optionality means building flexibility throughout the value chain. Optionality is especially important when a situation is uncertain or risky, such as during a recession, because options give you control.

You build optionality through buying decisions and contracts. For example, you seek a variable versus fixed cost structure. You purchase services on-demand versus acquiring and installing them. Cloud computing is an example—this is why the cloud had a surge of adoption post-2008 as companies moved to it to build more optionality into their P&Ls.

The more optionality you build in, the more financial and operational flexibility you gain. Having financial and operational flexibility enables you to cut costs, not capacity. Then, when demand returns, profits can grow faster as incumbents struggle with higher costs and a smaller workforce.

One of the most significant fixed costs for any company is payroll. There aren’t many options when trying to reduce that expense item, so that’s why layoffs are so common. But if you leverage on-demand independent talent through a work marketplace like Upwork, you have endless options to scale up or down billings without losing access to the talent later.

Modern organizations understand that it is their workforce that fuels growth and innovation. To maintain talent and scale workforces during uncertain times, you could contract independent professionals on-demand rather than hire full-time employees who you may not have enough work for later. Then you can ramp teams up and down quickly and contract specialists with the skills to meet your changing needs.

Additionally, you could automate more tasks to gain efficiency and save more jobs. Building in the right automation allows you to move employees to work on more critical projects that are core to your business and to respond faster to changing circumstances. This is why researchers at Bain and McKinsey determined that digital was a massive accelerator for challenger companies.

In the late 1920s, Kellogg’s and Post were neck and neck, each owning similar shares of the ready-to-eat cereal market. During the Great Depression, Post did the predictable thing: it cut expenditures and waited for better times. Meanwhile, Kellogg’s increased advertising and launched a new product: Rice Krispies. This strategy put Kellogg’s in the lead, which they’ve maintained ever since.

When the dot-com bubble ruptured in 2001, Apple, to outward appearances, was confined to making personal computers but had less than 3% of the PC market. Sony was riding its 20-year reign as king of the personal audio market—a product category Sony founded with their Walkman franchise. The early 2000s didn’t seem a good time for premium products. But that’s precisely when Apple decided to release iTunes and, a few months later, the iPod. Apple had spent the early part of the dot-com bust re-imagining what the personal audio market looked like. They revolutionized the music industry, and Sony never recovered. iTunes and the iPod enabled Apple to build an ecosystem that locks users into Apple’s entire product line.

As most retailers pulled back spending and hunkered down during the 2000 recession, Target increased its marketing efforts, opened hundreds of new locations, reconfigured its stores to include more food, grew its online sales, and partnered with well-known designers to introduce new products. It also cut costs by improving its productivity and increasing efficiencies within its supply chain operations. The company grew sales by 40% and profits by 50% throughout the recession. Target became a hybrid retail leader (online and offline), second only to Walmart, where it remains today.