Surviving in a hostile environment

With the first earnings season of 2016 well under way and 1Q readings on the major economies published, it is a good time to take the temperature of the market. Tepid is probably the answer. But, what we see in both cases is that growth will be hard to come by and is by no means certain.

This low growth backdrop, coupled with the price-sensitivity that low inflation brings, is creating a very tough environment for companies to operate in. Layer on the pace of disruption coming from technology, digital and changing consumer behaviours, and this becomes a very hostile environment in which to manoeuvre.

Luckily, EY has just published its 14th Global Capital Confidence Barometer. This gives us an insight into the concerns of the C-suite (over 1,700 executives from 45 countries and across 18 sectors) and some guidance on how they plan to negotiate this difficult terrain over the coming year.

Top tips for surviving in a hostile environment:

1. Create your own tailwinds as the global economy will not be providing any

The expectation of executives for the global economy is, well, more of the same. Nearly half (48%) see growth exactly the same as in 2015, with some seeing possibly a little more upside and some less. Very few executives (2%) see any great potential for change in the global outlook.

While they view the global economy as stable, it is stability with persistent low growth for the foreseeable future. As such, management teams are more determined than ever to identify new avenues for growth.

This is backed up by 1Q GDP readings. The US came in at 0.5%, versus an expectation by analysts and economists of 0.7% – the UK slipped to 0.4%, China came in at an expected 6.7%, and the EU surprised on the upside with a healthy(ish) 0.5%.

However, as in the corporate world, growth is difficult. Many of the readings in the first months of 2016 have been contradictory. Strong employment figures in the US are coupled with low growth in wages. Serious concerns about industrial output are competing against raised confidence in industrial surveys and increasing investment. And, on top of this, there is no clear trajectory for central bank policy. Anywhere.

2. Costs and margins are coming under sustained pressure

Executives have already firmly established control of costs and margins as a top corporate priority. Their acceptance of prolonged low economic growth has elevated this discipline even further. When asked what has risen up your boardroom agenda during the past six months, 44% said reducing costs and improving margins. This is quite amazing as it comes after seven years of focus on operational efficiencies. This really is the central issue companies’ face in this new environment.

Another factor feeding into this cost-control mentality is the price sensitivity caused by the shift to operating in a digital environment. Customers and consumers now have the ability to access many suppliers and, more importantly, compare pricing and reviews instantaneously.

We see this clearly in 1Q reporting. While revenues have taken a hit against 2015, it is earnings that have tumbled most. While there have been more upside surprises compared to previous quarters, this is off a very low bar. There is also no clear picture emerging out of any sectors either. But one thing is clear: a vigorous focus on controlling costs and improving margins is central to how companies now operate. It is part of the modern corporate DNA.

3. Dealmaking and alliances provide some navigational tools to traverse an uncertain landscape

Disruptive forces affecting companies’ core business models was another strong message coming from the C-Suite.

Digital technology is changing the way companies across all sectors interact with their customers. The influence of digital is facilitating changes in customer behaviours and expectations, causing measurable core business disruption. Additionally, increased sector convergence and cross-industry innovation are increasing the number of competitors companies face.

While these developments pose a major challenge, they also provide opportunities as companies seek to carve out new markets to boost their own revenues and earnings. Those companies taking a proactive attitude to perpetual change and challenges to their core business will be best positioned to take advantage of new market opportunities.

This is why global M&A prospects remain positive, with 50% of companies planning transactions this year, according to the CCB. The survey finds a continued appetite for buying and bonding (dealmaking and alliances) and a fiercely competitive M&A landscape in which almost a third (28%) of executives surveyed expect to see more unsolicited bids in the next 12 months. Underlining the strong focus on inorganic growth, 40% of respondents are seeking to forge alliances with other businesses.

With the evolutionary path of many sectors so uncertain, companies will do deals where they see the long term value rationale or certainty of sector trajectory. In other areas of their operations they will look to alliances to provide a future path.

The more informal nature of alliances also enables an environment where collaboration efforts can quickly respond to changes in the external market. They can provide the ideal opportunity for larger industry players to quickly engage with start-ups, especially those with emergent or disruptive technologies. For the start-ups, alliances allow them to leverage the expertise of established companies, giving access to experts and infrastructure.

Such deals are often structured in a way that partners can bring specific portions of their operations to the deal, narrowly defining the parameters in ways that insulate their other areas of business. Ideally, these arrangements accelerate innovation by enabling greater collaboration while reducing deal-making risk. New business models need new ways of partnering for success.

We do see this continuing desire to transact in the global M&A analysis through to 30 April. Although the YTD deal value and volume were lower by 23% and 11%, against the same period last year, the shortfall in value was largely driven by a lack of big ticket deals, and the drop in volume was primarily due to lower activity in lower-value bands (under US$50m or undisclosed).

Looking at just core deals (US$100m – US$10b) we see a similar picture to 2014 and 2015. This suggests that M&A market is likely to remain sustainable, at least at the global level.

We will look at UK CCB results in detail next week.

 


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