It has become clear that Britain’s vote to leave the European Union (EU) is a major disruption to global business plans, and its consequences clearly rise to the board level. Ongoing political chaos in the United Kingdom (UK) is having seismic economic effects and has already amplified downside political risks across Europe.
“Wait and see” is a dangerous response to a highly uncertain situation. Proactive board leaders can undertake several immediate initiatives that will minimize the damage to 2016 results in Europe and improve the resiliency of your company’s plans for 2017 and beyond.
What we know today: The UK’s economy will contract next year. Frontier Strategy Group’s (FSG) Europe, the Middle East, and Africa (EMEA) Team forecasts a sharp slowdown in UK growth in the second half of 2016, deepening into a recession of -0.5 percent in 2017. Regardless of the pace and the aim of its exit negotiations with the EU, deep splits within the UK’s major political parties and energized independence movements in Scotland and Northern Ireland guarantee governmental dysfunction and depressed sentiment among consumers and businesses.
Beyond the UK, certain economies are especially vulnerable. Ireland, Norway, and the Netherlands will be hurt quickly as UK demand shrinks. Around the world, UK and European economic woes are likely to hit Poland, South Africa, Algeria, Azerbaijan, Bangladesh, and Costa Rica especially hard in their respective regions.
What we won’t know anytime soon: As of yet, it is impossible to predict (1) whether the European Union will change fundamentally or lose additional members, (2) the political and economic effects of energized populist parties in many European countries, (3) the downside risk to the UK from regional separatism, or (4) the new destinations for foreign investment that may leave the UK. Scenarios and contingency plans are essential tools to manage risk and identify targeted opportunities in this environment.
Bolster Commercial Execution in the Second Half of 2016
Boards should expect to receive a rapid-response sales strategy review from UK executives and risk assessments for Europe overall. Is management being sufficiently proactive in managing new risks?
Prioritize risks to 2016 sales targets—In the UK, business investment is most likely to see near-term declines as companies worried about growth move to limit expenditures (hiring is sharply down in London), while consumer sentiment will be dragged down by housing-price shocks. Sterling and euro depreciation will hit specific customer segments hard. Expect management to proactively engage customers about changes to their expected spending, and redeploy sales and marketing resources to the least vulnerable territories.
Target contingency plans on talent and finance—Uncertainty about visa requirements for Europeans in the UK (and for non-UK citizens generally) is a serious engagement and retention risk. Currency effects are wiping out margins for some UK subsidiaries and should force a near-term rethink of hedging and payment terms. Expect management to document contingency plans with signposts and priority actions by function, especially for finance and human resources (HR).
Track leading indicators of changes in demand—Volatility in currency markets and commodities markets will have global ripple effects on business and consumer sentiment, and on government finances—especially in emerging markets. Ask if European management teams are adjusting their dashboards and monthly/quarterly agendas accordingly.
Stress-Test Strategic Plans for 2017 and Beyond
The next planning cycle will be more demanding than usual. Updating forecast data is a small part of the needed response. So much will remain uncertain that plans for Europe (and for markets with links to Europe) should be stress-tested for resiliency against downside scenarios. Contingency plans should be put in place for big bets.
Use scenarios to model UK and EU demand—FSG’s benchmarking found that simple scenarios are key to organizational alignment and resilience; the companies that do this best grow market share 2.1 times faster than their competition in volatile markets. My pre-Brexit vote NACD post highlights a range of risks worthy of incorporating into scenario plans.
Evaluate risk exposure in European operations and the supply chain—Profitability and pricing power for imported products will diminish if barriers to trade with the UK increase and European currencies weaken further. Scenario analysis can help evaluate potentially improved returns from localized production and supply-chain structure.
Rethink Europe/EMEA hub locations—Potential changes that affect HR, legal, regulatory, and finance teams may tip the scales in favor of revisiting the UK as a hub for EMEA, Europe, or Western Europe leadership and operations. Balance financial and political/reputational considerations along with change-management costs. Retention of European nationals currently based in the UK is becoming a factor as well.
Reassess global market-portfolio prioritization—Long-term investment plans for Europe must be rebalanced given the likelihood of a UK recession in 2017 and ripple effects varying among other European countries. Moreover, investment cases for Europe are likely to face sharply skeptical review even as EMEA leaders strive to make up the gap that UK underperformance will create. At the global level, Asia-Pacific and Latin America leaders have an opportunity to put forward more aggressive plans for 2017 and beyond. India in particular is a substantial market that remains under-penetrated by foreign companies; higher-risk big bets there may be more warmly received when Europe looks so uncertain.
When uncertainty is high, boards have a valuable role in helping management bring focus to the most important decisions rather than falling victim to firefighting and analysis paralysis. Companies that set a proactive agenda now for a mid-year course correction and forward planning will be well positioned despite market volatility in the year ahead.
Joel Whitaker is Senior Vice President of Global Research at Frontier Strategy Group (FSG), an information and advisory services firm supporting senior executives in emerging markets.
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Companies continue to face significant global economic uncertainty. Although U.S. economic prospects have improved in recent years, structural weaknesses in other regions pose significant challenges for multinational companies. To ensure their organizations thrive in this volatile environment, boards and senior executive teams must pay close attention to regional trends and international politics and how these affect the growing interdependence of markets worldwide. During a presentation at the 2015 NACD Global Board Leaders’ Summit, Kaushik Basu, chief economist and senior vice president of the World Bank Group, identified four major market conditions that will influence the growth prospects for many businesses.
The shape of the post-crisis recovery continues to change. In recent years economists have been hard-pressed to forecast how global markets will behave. After the 2008 financial crisis in the United States, economists initially anticipated a V-shaped recovery, in which the market hits bottom and then recovers. As it became clear that the recession would continue, they altered their predictions, asserting that the recovery would be U-shaped instead. When the European debt crisis occurred, economists then foretold a W-shaped recovery. The lesson seems to be that economic cycles have become less predictable and no longer adhere to historical patterns. In response to this increased uncertainty, directors and management teams must now expand their strategic planning process to incorporate a range of possible economic scenarios.
The economic fortunes of emerging economies are not uniform. Brazil, India, and China are often touted as emerging centers of economic power; however, . In the past year only India and China saw growth in their gross domestic products, while Brazil—which has endured corruption scandals, tax increases, and spending cuts—has experienced virtually no economic growth. When discussing potential investments in these foreign markets, boards should require management to provide forward-looking country assessments in order to responsibly evaluate the potential risk and rewards.
Economies are porous. Directors need to be aware that local economies are inextricably intertwined, and that deteriorating economic conditions in one country can therefore spread quickly to other nations. For example, the ramifications of slowing growth in China are significant because so many countries are increasingly dependent on continued Chinese investments and consumption. Africa, Latin America, and Germany are likely to suffer most as major exporters to China. Conversely, India’s economic growth has recently accelerated, due in part to structural tax reforms that have created a more welcoming investment climate, resulting in a rapid surge of foreign direct investment in 2014.
Increasingly disparate monetary policies among the developed nations will have global economic ramifications. Directors will be expected to understand the consequences of divergent policies—especially those of developed countries—for the world’s biggest economic blocks. For example, the Federal Reserve is debating a possible rise in interest rates after seven consecutive years of record-low borrowing costs. While a rate hike would ostensibly strengthen the U.S. dollar by encouraging investments in this country, it could also raise the prices on U.S. exports and undercut the economic viability of U.S. products in foreign markets. In the Eurozone, the European Central Bank (ECB) has in recent years maintained loose fiscal policies, increasing the supply of money flowing through international markets in hopes of facilitating economic recovery. A U.S. interest-rate hike would result in a weaker euro, which in turn could lead to a boost for Eurozone economies because buying trends would begin to favor domestic products. On the other hand, tighter U.S. fiscal policies could readily be undone by the European Central Bank injecting even more liquidity into the markets to keep euro values low and maintain the viability of Europe’s export market. Emerging markets, too, might experience a negative impact from these proposed policy changes. Because they have been borrowing money in U.S. dollars at near-zero rates, these countries will almost certainly see an increase in debt and decreased economic growth if U.S. interest rates rise.
Now in its third year, NACD’s Directorship 2020® takes an investigative look at the trends and disruptors that will shape boardrooms agendas of the future. This initiative is designed to raise directors’ awareness of these complex emerging issues and enable them to provide effective guidance to management teams as they navigate the associated risks and opportunities. The inaugural 2015 session was held on March 3 at the Grand Hyatt Hotel in New York City, where subject-matter experts from Broadridge, KPMG, Marsh & McLennan Cos., and PwC and corporate leaders explored the boardroom implications of geopolitical and economic disruption.
Illustrating the boardroom perspective on the impacts of economic and geopolitical disruption on corporate strategy.
In his remarks on economic disruption, Peterson Institute for International Economics Visiting Fellow and International Capital Strategies Executive Chair Douglas Rediker examined the changing face of global competitive markets. Governments around the world are increasingly involved in market activities and are more likely to champion domestic businesses or businesses based in countries with which they have trade agreements. This situation creates a business environment in which companies seeking to expand must assess a foreign country’s protected business sectors in order to fully evaluate the endemic risks and opportunities.
Taking a geopolitical perspective, UBS Executive Director and Head of U.S. Country Risk Dan A. Alamariu considered the ripple effects of government regulation, using a case example of the sanctions recently imposed by the US and EU on Russia. Though these measures did diminish the buying power of the ruble, the sanctions also hurt Western companies operating in Russia because consumers could no longer afford to purchase foreign goods. He cited other examples as well. In its efforts to recover from the financial crisis, the Chinese government has recently implemented a number of economic reforms. While these reforms may succeed in re-establishing China as an “engine of growth,” the infighting that they have triggered among political elites could ultimately dampen growth and set the country on an uncertain course. Closer to home, persistent gridlock in the US government is preventing needed progress on issues critical to the business community, such as tax policy and infrastructure.
Both speakers alluded to the fact that as countries become more divided and inwardly focused—both internally and with respect to international relations—developing collective approaches to major transnational issues such as climate change and cyberattacks will become more challenging. Companies will therefore need to devise their own strategies for addressing these challenges.
Economic and geopolitical disruptors are inextricably linked, and the three main takeaways from both sessions are as follows:
Embrace risk—you may discover opportunities. Directors need to start thinking like emerging markets investors. In other words, they should get comfortable working in a business environment that is volatile and unpredictable. This breed of investor has historically been focused on domestic, regional, and international political and economic risks. Because technology has created a world that is deeply interconnected, investors must proactively cultivate an understanding of geo-economic risks. By extension, it is also important to recognize technology as a major disruptive force that will continue to impact companies across all sectors. For example, tablet devices have completely changed not only how people communicate and access multimedia content but also how companies conduct business. By embracing disruptive technology, companies can in turn create the caliber of differentiated products that will transform the marketplace.
Be prepared. This ageless scouting motto is especially relevant to anyone managing or overseeing a company. Businesses the world over are more interconnected than ever before, which forces companies to compete across national borders and exposes them to international political and economic risks. Boards need to consider the ultimate “black swan” events that could affect their companies. By extension, directors need to be mathematically literate—if they are not already. Black-swan events include natural disasters, such as Hurricane Sandy, which incapacitated businesses in our nation’s financial epicenter; political events, such as the outbreak of war; economic unpredictability; and technological innovation, which we have seen from the automobile to the iPad. Having a by-the-numbers plan for how the company could behave in specific scenarios will create a comprehensive understanding of the risks the business faces. Because it’s impossible to completely protect a company, it is essential to create resiliency. The board must therefore ensure that incident response plans are in place and must routinely test those response plans to confirm that they meet the company’s evolving needs.
Beware of “herd mentality.” Directors need to periodically review the current board composition; and if there are gaps in the board’s collective knowledge that may prevent it from assessing areas of risk, it may be in the board’s best interests to bring in a third-party expert to help inform boardroom discussions. This is especially true of cyber risk. Many boards are still struggling to comprehend the depth and breadth of these threats, and because it’s neither possible nor desirable for every board to have a cyber expert in their ranks, it is imperative to bring in outside sources to inform and educate directors and management.
Look for full coverage of this NACD Directorship 2020 session in the May/June 2015 issue of NACD Directorship magazine. For information on future events and recaps of past events, visit the NACD Directorship 2020 microsite.