Nowhere to run, nowhere to hide

2007 was a tough year for America’s microbrewers, firms such as Boston Beer Company, that brew speciality beers. The price of malting barley, used to color and sweeten beer,  nearly doubled after barley farmers in the U.S. planted more fields with corn to take advantage of government subsidies for corn-based ethanol.  The government introduced the subsidies to decrease American reliance on Middle Eastern oil, at a time when crude prices were rising and geopolitical forces threatened to disrupt supplies. That same year, poor weather in Europe severely limited yields of hops, which provide beer with a bitter tang, driving up the prices. Hops prices jumped just as the euro strengthened against the dollar, further jacking up the prices paid by brewers. That same year, SAB Miller and Molson Coors Brewing, the second and third largest brewers in the U.S., merged, creating a behemoth to further pressure profits of small brewers.

Microbrewing might seem like the kind of business that could escape market turbulence–the production technology hasn’t changed in centuries, demand is local, and the business is simple.  Yet even in this industry, profits were influenced by a wide range of forces, including government regulation, oil prices, exchange rates, industry consolidation, and European weather.

Brewers faced turbulence because they were linked into the densely interconnected global markets. Greater integration of the global economy intertwines the fates of companies with far-flung economies and exposes them to a much wider range of possible changes, many arising outside their line of sight. The integration of formerly communist countries into the global market economy is a dramatic example, but it is part of a bigger trend toward closer integration in markets for raw materials, finished goods and services, capital, and labor. According to research by Peter Lindert and Jeffrey Williamson, since the end of the second World War, capital markets have grown 60% more integrated while gaps in commodity prices have fallen more than 90%. The Internet weaves together strands of information from around the world into a dense tapestry.

Integration into the global economy brings benefits. A start-up founded in Boston might license technology from Germany, outsource coding to Indian workers, imitate a low-cost business model from Brazil, and target the Chinese market. Integration also exposes a firm to greater turbulence, which I define as the frequency of unpredictable changes that influence a firm’s ability to create and sustain value. Firms face turbulence when the variables that influence their ability create value are dynamic, complex, and aggravated by competitive pressure.

Dynamism describes the frequency and magnitude of change in an individual variable. A few variables, primarily demographic shifts proceed in a smooth line. Most variables, however, are susceptible to sudden shifts. Many economic variables have grown more volatile in recent decades. Since the Bretton Woods system of fixed exchange rates collapsed in 1971, currencies have fluctuated more wildly against one another. My colleague Andrew Scott estimates there were nearly 250 currency crises between 1978 and 2003,  for instance, while prices for a wide range of commodities also displayed greater volatility in recent decades. Non-linear changes, such as home prices falling off a cliff or consumer acceptance hitting a tipping point, further increase dynamism.

Complexity refers to the number of and interactions among forces that influence value creation. While waiting for a flight in the Copenhagen airport, I used the The Economist, Financial Times, and Wall Street Journal, to generated the following list of factors that could shape the opportunities and threats a firm faces.
National government (nationalization, privatization, intellectual property regime, fiscal stimulus, demand stimulus, bailouts, banking regulation, tax policy, trade agreements)
Technology (alternative energy, stem cells, cloud computing, open source, nantotechnology)
Competition (industry consolidation, emerging market competitors, industrial clusters, government-owned enterprises, industrial ecosystems)
Global finance (currency crises, non-bank banks, sovereign wealth funds, microfinance, repatriation of funds, financial innovations, Basel III)
Macroeconomics (cycles, stagflation, hyperinflation, exchange rates, interest rates, hot money)
Labor (emerging market workers, immigration, urbanization, outsourcing, regional labor markets, unions, aging population)
Energy and raw materials (price volatility, security concerns, underwater sources, genetically modified food, reclamation and recycling)
Geo-politics (terrorism, war, nuclear weapons, regional zones, WTO, supranational legal agreements)
Physical environment (climate change, water shortages and reclamation, pandemics, urbanization)
Normative shifts (sustainability, rethinking capitalism, God is back, corporate social responsibility, Internet privacy concerns)

Two things to note about this list: It is long, and it is incomplete. The more variables that matter, the more vulnerable a firm is to changes from an unexpected direction. It is not only the sheer number of forces influencing a firm’s performance, but the interactions among them that increase complexity. It was not hop prices, competitive consolidation, or barley supplies in isolation that pressured brewers’ profits, but their combination into a perfect storm at the same time.

Leading in turbulent times

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Don Sull is professor of management practice in strategic and international management, and faculty director of executive education at London Business School. This blog is dedicated to helping entrepreneurs, managers, and outside directors to lead more effectively in a turbulent world.

Over the past decade, Prof Sull has studied volatile industries including telecommunications, airlines, fast fashion, and information technology, as well as turbulent countries including Brazil and China, and found specific behaviours that consistently differentiate more, and less, successful firms. His conclusion is that actions, not an individual’s traits, increase the odds of success in turbulent markets, and these actions can be learned.