In June 2001 we co-authored The Mind of a Fox. In it we said that much of the future is uncertain and beyond our control. The only way to handle it is play different scenarios, examine their probability and impact and look at the options to seize the opportunities offered in each scenario and counter the threats.
Before the Great Financial Crash of 2008 the majority of companies preferred to base their strategy on a single, expertly-driven forecast. Now they are not so sure, and are much more willing to interrogate their vision and strategy by measuring the resilience of both against a variety of scenarios. In particular, they are prepared to change the direction of the business should a case be made for doing so.
The selection of the axes
As we said in Scenarios, Flags and Probabilities, the best way to present a range of scenarios is to devise a gameboard with two principal driving forces as its axes. In this case, we have chosen globalisation - or the absence of it - as the vertical force. Will the world act in concert and continue to open up global trade, thereby experiencing broadly the same fate of either recovery or continued recession (above the horizontal)? Or will the world become increasingly divided geopolitically and form regional trading blocs with different economic growth prospects (below the horizontal)?
The principal force on the horizontal axis is whether the policy of quantitative easing undertaken by the US Federal Reserve, the European Central Bank and the Bank of Japan is successful in promoting a broad V-like bounce-back economic recovery in 2014 (to the right of the vertical)? Or whether when the tapering of the programme does begin and interest rates rise, we will continue with a long drawn-out U-shaped recession, or, worse still, suffer a relapse into a depression (to the left of the vertical)?
These two forces produce four possible scenarios, the first two of which we regard as our mainstream favourites up to 2020, and the last two as our outsiders with lower odds of materialising in the period of interest.
This is a flat-line future of minimal economic growth for the world as a whole. It is not a serious double-dip but more a series of low corrugations with minor improvements and deteriorations. We believe this scenario is a credible one for two reasons. First, the world had a long boom between 1982 and 2007, but the problem was that the second half of the boom was propelled by credit and was therefore artificial. Individuals, companies and governments overextended themselves and now we are paying the price of having to revert to reasonable debt ratios, which is having a braking effect on the world economy.
Second, an important influence on the medium-term economic prospects of any country is its demographics. One of the reasons that the Japanese economy has failed to recover properly since the crash of early 1990 is that it has an ageing population. This not only affects consumer spending in key sectors, it also impacts on innovation. Europe right now has even worse demographic trends than Japan faced in 1990. Apart from ageing, a country like Italy has a naturally declining population. The US is better off with a younger population and continued growth in the 35-45 year old segment, which is critical for consumer spending.
Hence, in this scenario, with the possible exception of Germany, Europe and Japan will be stuck in a 0-1% economic growth range, while the US might return to the 2-3% range. Nevertheless, it remains very tough over a prolonged period, meaning that companies with intelligent strategies will continue to grow, but companies with mediocre strategies will go to the wall.
In particular, we have come across three responses which work in Hard Times: maintaining a perpetual spirit of innovation in the company so that new products creating new markets are regularly offered; living the brand as opposed to just clever advertising to convince customers that you really do offer value for money; and being the cheaper alternative (which obviously runs the risk of triggering a price war).
The second mainline scenario we offer envisages a U+V world where the Old World economies with ageing demographics go through the 7-year 'U', while the New World economies with much younger populations experience a 'V'-like recovery, and grow at least three times faster that their Old World counterparts.
In other words, we live in a two-speed 'UV' world where the principal strategy for multinational companies is to chase the 'V'. For many US and European companies it is their favourite scenario. Accordingly they are doing everything they can to establish a presence in Asia, India, Africa and South America, either in terms of expanding their sales coverage or establishing new production facilities, or both.
Our principal flag for choosing between Hard Times and Ultraviolet is China's future economic growth rate. If it remains in the range of 8 to 10% p.a. then all the countries supplying China with resources will continue to do well in China's slipstream. If, however, China has the kind of wobble that Japan had at the end of 1989, then everybody is condemned to Hard Times. We have gone more negative on China for several reasons: exports constitute a significant percentage of China's GDP, and exporting into a flat Europe does China's growth prospects no good. In major cities outside of Beijing and Shanghai there are growing numbers of unoccupied suburbs where municipalities have borrowed the money to build them from Chinese banks, and people are not moving in like they used to. Furthermore, China faces a demographic cliff of note as the result of their one-child policy instituted in 1978; and as China becomes a more expensive economy, it will have to make the same shift as Japan did in the 1970s from cheap replication to innovation - a much more challenging game.
Accordingly we give a 40% subjective probability to Hard Times during the next 5 years, and 30% to Ultraviolet. Like two racehorses leading the field but with not much distance between them, they are jockeying for prime position. Watching the data coming out of China on its economy is thus a continuous activity. Of course, a company can bet on both scenarios; for example by offering value for money and chasing the 'V' at the same time.
New Balls Please
We would not be good futurists if we did not explore the outer limits of the cone of uncertainty that opens up into the future. We have two scenarios which we call 'outsiders', but for which Malcolm Gladwell would prefer the term 'outliers'. The first is an extremely positive one where US Federal Reserve Chairman Ben Bernanke's policy of almost zero interest rates works for the US - the world's largest economy. It fully recovers and lifts the whole world up with it in a full-scale 'V'. The title of this scenario - New Balls Please - is a Wimbledon expression to signify the players are getting new tennis balls to replace the old ones.
We feel the recovery will usher in a completely different game for which new balls are needed in two important respects. The East will be the economic equivalent to the West, thereby overturning several centuries of Western supremacy. Marketing strategies of companies will need to accommodate this. In addition, the world is finally running out of resources, and there is no Planet B. With rising population numbers and a widespread economic recovery, resource prices will go through the roof, and new ways of extracting them will be found (fracking for oil being an example). However, one statistic says it all: if China, with its mammoth population, ever mirrors US standards of living, we would need to draw on the resources of four Earth-like planets (which we obviously haven't got).
Thus technologies that improve the efficiency of resource consumption, particularly oil and metals, will be the most sought after, as will substitutes like solar energy. More efficient supply chains that reduce the freight cost element in the final price of a product will also be a precondition for competitiveness. Our lifestyle will probably change where shopping at local neighbourhood stores will be preferable to travelling to distant malls. Localisation will replace globalisation.
At the moment we only assign a 15% probability to this scenario as the two main flags that would indicate it is in play are down, namely a drop in the US unemployment rate to 6,5%; and a levelling-off or reduction in the national-debt-to-GDP ratios of the Old World Economies to indicate that governments are finally getting their financial affairs in order. On the other hand, another flag of note would be a sustained rise in US property values to give consumers the confidence to spend again. This flag is beginning to rise, but is not yet fluttering in the wind.
The last scenario we put forward is the one we most fear: a double-dip where the worst is yet to come. We call it Forked Lightning, and there is a parallel: 1932. Everyone talks of the Wall Street Crash of 1929. In actual fact, the market went down in 1929, recovered in 1930 and 1931, and then crashed to 11% of its 1929 peak in 1932. The equivalent today would be the Dow Jones Industrial Average free-falling from its current level of around 15 500 to 1 500, which would be a catastrophe.
We have two flags for this scenario. The first is a sudden jump in the interest rate on US 10-year treasury bonds to above 5%. The would indicate a loss of faith in the way the US is handling its budget deficit. Right now the flag is down, but the interest rate is rising. The second flag is a default by either Spain or Italy on their national debt, as such an event would have much bigger repercussions for European banks and pension funds than a Greek default. The financial numbers are much larger and the markets would probably freeze like they did in 2008.
We give this Black Swan scenario a 15% probability in light of the present Eurozone recovery. However, the odds are still high enough for the flags to require extremely close monitoring, particularly given the risk of contagion in Europe. Remember: you can do nothing once the lightning starts, except go indoors! Hence the best option is to make sure your financial situation remains fairly conservative, so that you can survive the storm if it hits, like many companies did in 2008.
You will notice that we give equal odds to the two outside scenarios because we simply cannot anticipate what will happen to the patient we call the world economy when the drip called 'zero interest rates' is removed and tapering begins in earnest. Will the patient return to full, independent health, or will there be a sudden relapse?
There you have it. Don't bet on a single future. Rather keep all four of our possible futures in mind, watch the flags go up and down, adjust the probabilities, and adapt your strategies and tactics as you go along. More and more companies are agreeing with the greater flexibility inherent in our approach when faced with these volatile times. Our scenarios are not designed to capture each and every precise detail of what actually happens. Their purpose is to give those who use them the eyes, instinct, reaction time - and the mind - of a fox.