How quickly conventional wisdom can change. Forty years ago, a world dominated by two polarised economic and political systems looked set to endure indefinitely. By the end of the century, the Cold War had given way to a seemingly mono-polar world, with a technologically pre-eminent America at its economic summit.
The world we see today is, for many, quite new and possibly bewildering. While economic growth in mature developed markets is slowing, SAAAME markets are surging ahead. SAAAME doesn’t include Japan, as this is a large G7 developed economy. Mexico is excluded, as it trades mainly within the North American Free Trade Agreement zone and less with SAAAME. For now, Russia and the Commonwealth of Independent States (CIS) are also excluded from SAAAME, as trade is largely internal or with Europe.
Many commentators are focusing their attention on what are considered to be the largest and fastest-growing BRIC markets (Brazil, Russia, India and China). But the broader regional economies that surround these countries are also undergoing an economic renaissance.
So what are the defining features of a global economic order with SAAAME at its apex? First and foremost, what we’re seeing is nothing new. Western economic dominance is a relatively recent phenomenon and today’s developments are essentially a rebalancing of the global economies.
Collectively, SAAAME makes up the lion’s share of the global population and land mass. SAAAME also has substantial manufacturing capabilities and access to the labour to support this, large and growing consumer markets, and a sizeable pool of both educational establishments and well-educated professionals (Figure 1 shows how both the number and quality of university graduates within many SAAAME markets have risen on the back of the rapid economic expansion in recent years).
But we believe the real issue is not so much the speed of economic growth within the SAAAME markets, but how interconnected the trade flows between them have become. Trade between the SAAAME markets is growing much faster than the developed-to-developed and developed-to-emerging market flows (see Figure 2). At present, these intra-SAAAME flows are dominated by commodities. A telling example of the impact is the fact that China is the fastest-growing customer for Saudi Arabian oil and now vies with the US as the kingdom’s biggest oil market.1
As affluence continues to expand (see Figure 3), the pattern of trade will be increasingly focused on manufactured goods. The trading relationship between China and Brazil exemplifies the growing interconnectivity of SAAAME. China has now overtaken the US as Brazil’s biggest trading partner, with trade growing exponentially in recent years (see Figure 4). In turn, SAAAME corporations are becoming leading multinational players as they expand across SAAAME and non-SAAAME markets.
So what opportunities does this changing order open up, what are the potential threats to today’s dominant global businesses and what kind of enterprises are going to come through stronger?
Our analysis of the strategic implications of the rise and interconnectivity of SAAAME markets has centred on how this will affect financial services organisations, the main focus of this article. But we’ve also been looking at the implications for their corporate clients, and many of the challenges and opportunities are common to all sectors.
Businesses from around the world are naturally looking at how to strengthen their presence within fast-growth markets and tap into the evolving patterns of trade. Financial institutions that can develop the geographical reach and service capabilities needed to follow their clients into new markets will be in the strongest position to attract and retain customers and develop new sources of revenue. While some institutions are looking to exit from ‘peripheral’ markets that do not meet their immediate return objectives, others are seeking to extend their international coverage in recognition of its importance in sustaining client relationships and enhancing performance.
The kind of support financial institutions might be looking to offer includes finance to help clients set up manufacturing facilities and then support for the infrastructure and other developments needed to build demand in local markets. A typical example would be an electronics company setting up a factory in one of the frontier African markets. Smart businesses and their financial services partners are not just looking at the potential for low labour costs, but also how to make the most of the untapped market on their doorstep.
The snag is that foreign entrants are locked out from many parts of the larger and more developed of the SAAAME markets. The difficulties of gaining entry are especially pronounced within financial services. There may be restrictions on licences or foreign ownership. India and China are examples of this. Even if not, some of the acquisition prices are prohibitive. Brazil is an example of this. So a lot of forward-looking financial institutions are going to be looking at the smaller and less saturated markets. For example, trade flows into and from Africa are growing rapidly. This suggests that participating in some key African markets early could provide an important foundation for future growth.
For SAAAME financial services (FS) groups, simply relying on domestic growth is not enough. They also need to find ways to follow their customers and tap into the most valuable trade flows. Some are extending their reach into other emerging markets. But most are taking a fairly cautious approach to international expansion. When you think how big many SAAAME FS groups have become in terms of assets, this is rarely reflected in their international presence. If they stand still, they could quickly lose out to more ambitious competitors. There is a transformational window of opportunity here, but it may be short-lived.
The bulk of the cross-border acquisition and expansion of SAAAME financial institutions has so far been within their home regions. But if SAAAME institutions do become more ambitious in their international expansion plans, their Western counterparts could become targets for acquisition. Western businesses could be especially attractive to SAAAME giants that are looking to acquire the technology, product expertise or management experience that would allow them to compete on the global stage. Takeover prices in some developed markets are generally favourable for now, especially within the mid-market, but may not be so for long.
The rise and interconnectivity of SAAAME also opens up a new and possibly unfamiliar set of risks. The direct risks posed by the increasingly interconnected global economy were highlighted by the $12 billion of losses from the Thai floods of 2011,2 which were concentrated in an area that had seen a rapid rise in international component production in recent years. The losses are not only telling in their overall scale, but also the significant impact of supply chain and business interruption claims coming from other countries, notably Japan.
Beyond the immediate loss potential is a longer-term risk of marginalisation for corporations and financial institutions that fail to keep pace. As more and more commerce flows between the world’s fastest-growing economies, a significant amount of trade is bypassing the West. Western businesses need to find ways to tap into this intra-SAAAME commerce or risk being cut out of the loop. While SAAAME enterprises, financial and otherwise, are nearer to the focus of global growth, they too could lose out if they fail to follow the most valuable commercial flows. In the case of banks, if they can’t offer the trade finance, acquisition support and other services clients need to develop their business internationally, their customers will switch to institutions that can.
As a result, both Western and SAAAME businesses are going to be extending their reach into new and unfamiliar markets where they will need to contend with varied and possibly limited risk data, legal systems and regulatory frameworks, along with the potential for political instability and very different business practices. Businesses may also face licensing or ownership restrictions, requiring them to operate with an ever-growing array of local partners (both within the financial sector and beyond). Getting on top of these risks is one of the biggest considerations for organisations looking to expand within SAAAME.
The underlying risks are organisational as companies seek to develop the governance systems and flexible capabilities needed to operate across more extended lines of command. They will also need to secure enough talent to meet their objectives in markets where qualified people may already be in short supply.
Strategies and risk management systems developed in the West may no longer be relevant in these rapidly changing market conditions. Equally, domestically focused SAAAME institutions may lack the international experience to deal with the complexities and ambiguities of these new market demands.
The rapidly changing global environment necessitates a longer-term and more proactive approach to strategic planning. While it’s vital to consider the risks and opportunities in the short term, it’s equally important to develop a clear articulation of how markets and customers are changing and how the business can turn these changes to its advantage. Organisations that merely react to market changes and risks as they arise will perhaps face the greatest risk of all—of being no longer relevant to their customers.
Companies will need to explain to investors how their risk profile and risk appetite are likely to change. More comprehensive and effective risk evaluation and pricing will allow investors to target particular risk and reward profiles with greater precision and differentiation. Relations with government, the media and society as a whole are becoming more important as the state plays a central role in economies and the reputation of the institution comes to underpin its shareholder value and licence to operate.
A key priority is determining how these evolving risks are likely to interact and therefore assessing the impact on existing business models. The corresponding priority is how to price the risk, with the guiding principle likely to be ‘every risk is an opportunity as long as it’s priced correctly’. For example, moving into a new frontier market would provide an important foundation for future growth as intra-SAAAME trade flows continue to expand. As a relatively under-developed market, the acquisition costs and opportunities to build market share may be more favourable than in a more prominent SAAAME market such as India or Brazil. For financial institutions, the corollary of this limited development is that there may be scant risk data upon which to price insurance, credit and acquisitions. As a result, new qualitative pricing approaches are likely to emerge to augment quantitative evaluation. In these markets, financial institutions are also going to need new approaches to collateral and recovery in the absence of enforceable legal redress. Within inter-state relations we’ve already seen deals in which infrastructure investment is dependent on the delivery of materials. While this may be at the extreme end of what a company could enforce, there may be opportunities to enhance the links between investment and repayment.
Across all markets, ‘big data’ analysis offers opportunities to price risks and target customers with greater precision. Big data refers to all the huge and increasing amounts of information that are exchanged every day, most of which go unused. Openings for differentiation include new techniques being developed to extract risk and customer profiling data from the unstructured purchasing, social media and other digital trails people leave.
New risk identification, pricing and mitigating mechanisms will lay the foundations for a very different risk value chain from the financial risk focus seen at present, changing how risk is perceived, how the market is segmented and the kind of opportunities businesses are prepared to pursue.
As the global economy evolves, a sharper —and more strategically focused—risk value chain is going to be crucial in both managing the dangers and capitalising on the opportunities that competitors may miss or be reluctant to pursue. In future editions of Resilience and as part of our Project Blue series, we will be looking at specific aspects of the new risk landscape, the implications for particular businesses and the openings they present.