Are You Ready for Global Turmoil?

By Paul J.H. Schoemaker, Ph.D.
Executive Chairman, DSI

Many managers are deeply unhappy with the linear and often misguided projections produced by traditional forecasting and budgeting systems. The world they operate in has not only become more risky, it has become more uncertain. Recent newspaper headlines about Citigroup’s layoffs, Iceland’s sudden downturn, worldwide food shortages, and so on, remind us that we may be in for some serious global turmoil.

For example, the price of corn has increased by more than 50 percent in 12 months. Whereas in the past food shortages were mostly local or regional problems, they are becoming increasingly global. The large-scale shifts toward bio-fuels, continued ill-effects of climate change, and national security concerns about access to food and water make our world increasingly interconnected. Subsidies, import restrictions, and starving populations are making food supply a global problem.

Food supply is just one of many global challenges facing us. The World Economic Forum’s report “Global Risks 2008” identifies many significant risks our world economy faces.¹

Economic: Rising food, water, and energy prices; sustainability of growth in China, India, etc.; insufficient funding for pensions and healthcare in developed countries; economic bubbles in credit, housing, and other asset markets; weakness in capital markets to finance growth; weak insurance regimes to protect against catastrophes
Geopolitical: Continued terrorism; spread of nuclear weapons; regional conflicts and failed or failing states (Taiwan, Middle East, Iran, Pakistan, North Korea; Horn of Africa, fragile countries in Latin America); expansion of organized crime (drugs, weapons); backlash against globalization; human rights violations; clash of civilizations
Environmental: Extreme weather (cyclones, flood, droughts); ecosystem degradation (water shortages, deforestation, infectious diseases); natural catastrophes (earthquakes, seaquakes, inland flooding, category-5 hurricanes hitting major cities, global-warming fallout)
Societal: Global pandemics; infectious diseases (HIV/AIDS, TB, malaria); rising obesity, diabetes, cardiovascular disease in developed countries; spread of U.S.-style liability regimes; under-investment in growth; wealth polarization; overpopulation; transportation constraints (airports, highways, harbors, public systems)
Technological: Failures of critical infrastructures (energy grids, Internet, emergency management); health effects of nano-particle exposure (in paint, cosmetics, healthcare) or cell phones (brain tumors); ethical lapses in use of biosciences (cloning, stem cells, genetic engineering); cyber terrorism; nuclear terrorism; bio-warfare

This wide range of challenges suggests that, continuing a trend of many decades, we shall experience increased volatility in our business and financial environments, as shown in the chart below. In this chart, I measure how much volatility the NASDAQ has exhibited each year by simply taking the high and low for a given year and dividing that range by the mean level for the year (so as to get a relative measure). The 70-year trend line covering 1937 through 2007 shows a positive slope, meaning that the amount of unanticipated change has steadily increased over time. The slope is even steeper for more recent decades, suggesting that considerably more uncertainty lies ahead.

It is important to distinguish between sources of variance that are anticipated (such as normal business cycles that can be predicted easily and are reflected in the stock price) versus variance that the market did not see coming, and hence did not reflect appropriately in asset prices (such as the collapse of the dotcom era in 2000 or the recent housing bubble). The chart below suggests that the number of surprises and their magnitude have increased over time, reflecting our increased global interdependence, the accelerating march of technology, as well as heightened geopolitical tensions. It is our belief at DSI that this will continue and we fear that many companies are not ready for the turmoil ahead.

Figure 1 - Increasing Volatility (NASDAQ 1938-2006)
[click image to enlarge]

Although our global system can probably handle any one of the challenges identified in the World Economic Forum report in isolation, a significantly deeper problem is that we may face several of these major challenges at once. Policy makers and business leaders are justly concerned about the fragility of our financial and economic systems, since crises can spread overnight and companies can lose much value in a single weekend (as Bear Stearns recently learned the hard way).

How robust our circuit breakers and intervention mechanisms are remains an open question, especially since market psychology and mass hysteria can play a major role in eroding confidence. Many of the risks described above are interconnected, and it is not clear that our financial and economic systems can easily handle the confluence of stresses they may impose on our fragile regulatory systems.

For example, the recent sub-prime mortgage problems, the increase in energy and food costs, and the weakening economy are very much interlinked, without a single entity understanding or controlling all the underlying issues. Positively correlated risks will bring about greater market swings and more fragile fault lines. As a consequence, all companies, but especially those with overseas business, need to be prepared for a roller-coaster environment.

Unfortunately, many are not prepared. Below we examine some key questions we were recently asked by the Harvard Business Review online and offer some brief recommendations.²

Q1. If you haven’t already prepared for higher levels of turmoil, is there still time?

Yes, there is still time for those companies that did not over commit. The key to dealing with turmoil is to have flexibility in your strategy. In addition, you need to detect the changes soon and respond accordingly. This requires good peripheral vision, i.e., the ability to pick up weak signals outside your area of focus. Few companies do this well and often they get blindsided unnecessarily, as documented in our recent book Peripheral Vision.³ If your company did stick its neck out dangerously far, as some of the smartest financial firms did by over-betting on subprime mortgages, then you may wish to unwind some of these commitments or pursue hedging strategies that will mitigate your downside exposure. All companies should stress test their strategies by putting them into the wind tunnel of wide-ranging future turmoil to see how robust they are. As Darwin observed, it is not the strongest or smartest who survive, but those who are most adaptive to change. Don’t box yourself in.

Q2. Should companies that have engaged in scenario planning go back and revise some of their assumptions?

Ideally such revisions should happen as part of an on-going monitoring and scanning activity. It was easy for Shell’s scenario experts to recognize that they needed to rethink their conceptual frameworks after the Berlin Wall came down since a new geo-political world order was about to emerge. The challenge is to do so ahead of time, when the signals are weaker. Cognitive science shows that managers often overreact to changes in symptoms or surface features, such as a spike in sales revenue or a drop in interest rates, but under-react to more fundamental regime change, which often happens more gradually (and thus can sneak up). By designing scenario-based monitoring systems and executive dashboards, as we do at Strategic Radar Inc. (www.strategicradar.com), leaders can track which scenarios have become more or less likely. And as importantly, they can track signals that are emerging that do not fit any of the scenarios. If this parking lot of aberrant signals gets crowded, it is time to go back to the drawing board. Don’t ignore the warning signs or run through red lights.

Q3. What are some best practices that companies should follow?

Here is my favorite list in a nutshell, with some best practice companies listed as well (as based on my book Profiting from Uncertainty).⁴ Ideally, these practices operate as a highly integrated system with numerous cross synergies.

Use scenario planning to improve your organization’s insight and foresight about the future (Shell, Sprint, and the World Bank excel at this).
Devise adaptive strategies that have sufficient flexibility built in to deal with the unexpected, including future-proofing your plans using real-options thinking (BP and Google have been strong at “optionality” thinking).
Design a dynamic monitoring system to track the external world in real time, as well as to gauge internal progress of executing strategies and plans (P&G, IBM, and NASA do this well).
Improve your organization’s agility in terms of structure, processes, norms, and rewards to cope better with the unknown (WL Gore and Microsoft come to mind).
Enhance your information and decision-making procedures to remain vigilant through external networks and by properly balancing traditional and newer tools (Samsung and Apple are strong here).
Foster strong leadership at multiple levels in the organization to deal better with crises and other unexpected circumstances (GE and McKinsey excel here).

It appears we may be entering a period of increased upheaval and global turmoil. This will place special challenges on managers who have to deliver reliable results and make the numbers. Only a prepared mind which knows how to adapt can do so well. Just as sea captains have to deliver their cargo without sinking the ship, even when facing violent storms, pirates, and tough currents, senior leaders must do likewise. This requires good navigating equipment, well-crafted maps, a well-trained crew, and the ability to change mid-course if circumstances dictate it is necessary. The invention and use of the compass allowed Venice to become a larger city than Paris circa 1400. Using this instrument, Venetian ships sailed the Mediterranean and other seas farther from shore than most dared in search of land and treasure. Likewise, companies with superior navigational ability can succeed where others will fail. And in times of turmoil, the spoils can be great.

Notes

¹“Global Risk 2008: A Global Risk Network Report” World Economic Forum: Switzerland. January 2008.

²You can join the online discussion at the article's Harvard Business Publishing blog site.

³Day, George S. and Schoemaker, Paul J. H. Peripheral Vision Detecting the Weak Signals That Will Make or Break Your Company. Harvard Business School Press. 2006.

⁴Schoemaker, Paul J. H. Profiting from Uncertainty, Strategies for Succeeding No Matter What the Future Brings. The Free Press. 2002.

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