The Leading Edge: A Fresh Approach to Uncertainty in Latin America
By Bernardo S. Sichel
Director, Latin America, DSI
The Federal Reserve's announcement on May 10th that interest rates would most likely go up in the near future sent shockwaves through Latin America's stock exchanges. This confirmed the assessment of the World Bank and the International Monetary Fund (IMF) who concluded at their meeting in Washington a month before that while short-term prospects for the region are promising, companies need to be cautious about such upcoming turbulence [1]. Benefiting from historically-high commodity prices and extremely low interest rates, the region is expected to achieve 3.9% growth in 2004, according to IMF forecasts. However, as the past has shown, Latin America is highly uncertain and volatile (see Figure 1).
Yet, most companies in Latin America continue to conduct their strategic planning processes in the same old fashion (formal planning conducted once a year with very little flexibility on its update and revision) and with the same traditional tools (e.g., demand forecasts, discounted cash flows, sensitivity analysis). Not surprisingly, the ability of Latin American companies to achieve competitive advantage in global markets and sustained financial returns to their shareholders has been less than stellar [2].
How can companies better prepare to succeed in such a whipsawing economic environment? When the tide turns, the companies that are best able to respond with flexible, agile strategies in Latin America will win, while companies unable to change their course will be crippled. At a recent high-level conference in Buenos Aires, we examined how scenario-based planning can help build this agility.
Figure 1
As past experience has shown, Latin American economies, and the companies that operate in them, are extremely vulnerable to external shocks and volatility (see Figure 2 for the evolution of Latin America's sovereign bond spread vs. US treasuries).
Figure 2
Scenarios for the Future
What might lie ahead for the region? We explored this question at a recent meeting we conducted at the World Business Forum in Buenos Aires - where DSI's Chairman and CEO Paul Schoemaker shared the stage with world figures Bill Clinton, Rudy Giuliani and Jack Welch. During this event, we worked with conference participants to identify key trends and uncertainties and developed high-level scenarios for Argentina.
There are many sources of uncertainty looming on the horizon that could
wreak havoc in the region. Among them:
- How will international interest rates change? What will be the impact
on the region's cost of capital and financial stability?
- How will international commodity prices change? What will be the impact
on the region's trade balance and fiscal health?
- Will populism continue to rise in the region, as in Venezuela? What
will be the impact on economic agents and overall stability in the region?
- How much outsourcing will occur from the region to lower-cost destinations
in Asia, notably China? What will be the combined impact on the region's
manufacturing sectors?
- Will much anticipated institutional reforms take place? What impact
will such reforms have on foreign direct investment into the region?
- Will economic integration continue, and, if so, will it be the FTAA
(ALCA) or other types of bilateral and multilateral agreements? What
will be the impact on the level of trade and economic stability in Latin
American countries?
With all these reports about increasing complexity and uncertainty in
Latin America, how should multinationals and "multilatinas"
prepare for the future?
Discerning the Patterns
Beneath the wild fluctuations of the economy, there are some broader patterns that can be discerned, as shown in Figure 3. Argentina has moved from a closed economy in the 1970s and 1980s, to growth and prosperity in the 1990s, a major financial crisis in 2001-2002 and correction in 2003. Given these patterns, what will the economy look like going forward?
Figure 3
During the conference in Buenos Aires, we identified several key trends and uncertainties that were expected to drive future scenarios, as shown in Figure 4. We then used two of these - social attitudes and the economic situation - as a framework for the four scenarios shown in Figure 5.
Figure 4
We then asked some 450 Argentinean executives to assess the probability of the four resulting macro scenarios and their company's level of preparedness to succeed in each one of them, with 10 being fully prepared and 1 being totally unprepared (see Figures 5 and 6 for the scenario's probabilities and level of preparedness and the scenario blueprint, respectively).
Figure 5
Figure 6
As Figure 5 indicates, the results were staggering but not necessarily
surprising: Although various scenarios were highly likely, executives
felt only prepared to confront the scenario with the highest probability
("Wild South") and the one that most resembled the past ("Back
to the Future"). While the scenario of social fatalism and economic
chaos was given a 17 percent probability, participants felt they were
relatively unprepared to meet it. What this suggests is that these companies
(similar to other results we have obtained around the region) are not
preparing for multiple futures through their planning exercises. In an
environment that is so uncertain, shouldn't companies be preparing to
meet multiple futures?
This ability to address the shifting environment is crucial to competitive
advantage and profitability for the companies in the region. A recent
study conducted for Brazil's retail sector determined that the financial
performance of two of the most prominent Brazilian retail companies had
less to do with the effect of their distinct business models than with
overall economic conditions [3]. Returns were overwhelmingly
correlated to the overall conditions of the country. The insight that
this result suggests is that competitive advantage in emerging markets
does not depend as much on typical factors such as industry structure
or even execution. It comes from somewhere else.
A New Approach
While the environment is clearly very important in influencing returns to Latin American firms, isn't it out of the control of companies in the region? Many firms see the economic uncertainty as a part of the environment that they can do little about.
In his most recent book, Profiting from Uncertainty: Succeeding No
Matter What the Future Brings, Paul Schoemaker suggests that there
are four different sources of superior profits. Specifically, structural
advantage (superior hand of cards), operational excellence (superior ability
to play a hand of cards), business reinvention (changing the game) and
profiting from uncertainty (continuous quantum change). We believe that
winning in Latin America, and in emerging markets for that matter, is
best achieved by focusing on the last source. Higher levels of uncertainty
offer superior opportunities for above average returns. However, they
also require a new and different approach, one with a fresh mind-set and
updated processes and tools.
Changing the mind-set to profit from uncertainty requires overcoming
two ubiquitous decision-making traps in emerging markets: gut reliance
and decision paralysis. The former is dangerous because it could lead
to ruin (past experience is no guarantee in a changing environment). Decision
paralysis is equally hazardous because it limits the ability to capture
upside returns associated with uncertainty (which defeats the purpose
of competing on an uncertain environment).
Adapting the processes and tools to profit from uncertainty requires a change in the strategic process' focus, moving from a traditional inside-out approach to an outside-in one. To help companies in this transition, scenario planning and options thinking are two of the most effective concepts/tools available. The former allows the company to learn about and prepare for multiple futures, including the possibility of external shocks, while the latter enables the firm to build a portfolio of strategic options that balances "no regret" moves with call options and focused bets. This reduces the company's risk of going out of business during external shocks while capturing the upside in more prosperous times.
Latin America is a region with great profit potential for multinational and "multilatina" companies alike. No matter which scenario transpires in the region, there will be value created and destroyed across many sectors and countries, resulting in new winners and losers. Companies can improve their chances of being one of the winners by adopting a fresh strategic planning approach to navigate through the fog of uncertainty.
If you would like to comment on the contents of this article or learn more about how to prepare your company to profit from uncertainty in Latin America, contact us at: sichel@thinkdsi.com or (610) 717-1000.
Footnotes:
[1] Nejamkis, Guido (Reuters). World Bank and IMF: Latin
America must prepare for a turbulent future. (April 25, 2004).
[2] America Economía (Dow Jones). Competitive,
but global?. Number 273 (April 2004). According to the analysis, only
Cemex (cement), Embraer (regional and business jets) and Techint (specialty
pipes) are truly global. This discussion came right after Brazilean AmBev's
"merger" with Belgium's Interbrew, casting doubt about the region
companies' capacity to overcome structural barriers to become global players.
[3] Journal of Retailing and Consumer Services. "The effectiveness of strategic planning: competitiveness in the Brazilian supermarket sector". Volume 11, No. 1 (January 2004).
