The Financial Executives Institute will be holding the Ayala- Finex Finance Summit on August 1, 2016 at the Fairmont Hotel in Makati. Among the speakers are: SurajMoraje of McKinsey, MayureshOke of Google, SheelMajundar of Microsoft, James Lafferty of British American Tobacco, Ed Morato of Bayan Academy, ChitoOreta of Manila Water and Riza Mantaring of Sunlife. The Program title is: The CFO in a VUCA World.
So what is VUCA?
VUCA is short for volatility, uncertainly, complexity and ambiguity. It is a catch all for everything that is going crazy out in the world. The notion of VUCA was introduced by the US Army War College to describe the volatile, uncertain, complex and ambiguous world that resulted from the end of the cold war.
VUCA consolidates four distinct types of challenges that demand four types of responses. It discusses systemic failures and behavioral failures, which are characteristic of organizational failure.
We start with Volatility. The characteristic of a volatile environment is that the challenge is unexpected or unstable and could be of unknown duration. It is not necessarily hard to understand, and information about the situation is often available. A clear example of this is that every time the oil supply chain is disrupted or when the fuel prices fluctuate there is a geopolitical event in the Middle East. The approach is to build in slack and devote resources to prepare for any possible scenario. For instance, one could stock up inventory or build a pool of talents to act as a buffer or as replacements. However, building a buffer stock or a reserve of employees involves costs and the investment should match the risk.
Second is Uncertainty. This is the situation where despite a lack of specific information, the event’s basic course and effects are known. Change is possible but not a given. For example, an automotive competitor’s oncoming product launch could muddle the future of the market and the business. We could deal with the uncertainty by investing in information. We need to collect, interpret and share this information with our organization. This works best in conjunction with structural changes such as adding information analysis networks or big data filters that can reduce uncertainty.
Third is Complexity. The situation has many interconnected parts and variables. The challenge is to connect the dots to make it comprehensible. Some information is available or can be predicted, but the volume or the nature of it can be overwhelming to process. Again, the value of processing big data comes to fore. An example of this is doing business in various markets in different segments. The approach is to re-structure and to bring in or develop specialists who would understand the different situations. We also need to build up other resources to address the complexity.
The fourth is Ambiguity. This is characterized by causal relationships being completely unclear. No precedents or similar cases exist. One simply faces the “unknown unknowns”. An example of this is when one decides to launch a new business. The approach is to experiment, run pilot projects and to fail quickly. Yes, failing quickly and deciding to cut bait at the first confirmation of a fatal flaw in the business model would reduce cost exposures, the emotional trauma as well as optimize the learning experience. Understanding cause and effect requires generating hypotheses and testing them. One needs to design experiments (or pilot projects) so that lessons learned can be used as a guide and broadly applied.
One of the challenges in a VUCA world was discussed in the recent economic forum hosted by First Metro Investment Corp. This relates to the theoretical framework of devaluation. One of the speakers presented statistics showing that our more developed Asian neighbors had to go through a period of weak currencies or devaluation before entering a path to progress. What is the underlying concept behind this thesis?
First, let us define devaluation. It is an administrative reduction in the exchange rate of a currency against other currencies under a fixed exchange rate system. A good example of this is the recent lowering of the UK pound after Brexit. This particular example was market driven. Governments or central banks could resort to devaluation as a means to deal with balance of payments deficit.
Devaluation can give domestically produced export goods a competitive edge while making imports relatively expensive. So, whether or not the devaluation can help achieve balance of payments equilibrium will depend on a number of factors. These include, foreign demand for locally produced goods and local need for imports, how price changes brought about by devaluation impact on imports and exports, the availability of resources to increase exports as well as to reduce imports and, over the long term, controlling inflation to ensure that domestic price increases are kept in line with, or below other countries’ inflation rates.
Devaluation can also affect the business climate in a number of ways. In particular, it could provide manufacturers and exporters the opportunity to expand sales and boost profits. Devaluation increases import prices and make imported goods less competitive against domestic products, thus encouraging local consumers to switch to locally produced substitutes. On the other hand, devaluation lowers export prices, thus helping to become price competitive in foreign markets and gain market demand. If the UK pound, in the example above, is devalued by one third, then this would allow British exporters to reduce their prices by a similar amount thus improving their price competitiveness in the export market. Alternatively, they may choose to maintain their prices by the full amount of the devaluation in order to increase unit profit margins and provide funds for sales promotions and marketing support.
In my previous experience as a CFO of our group’s export manufacturing company, a devaluation would trigger an initial spike in currency profits as described in the economic model that I just mentioned. This would not last long, however, as the other inputs to production that are foreign exchange linked like power (think imported coal), imported capital equipment for production, imported raw materials would catch up as well. The constant that usually remains the same would be labor costs but even this would have to be adjusted because of inflationary pressure.
Another major item is the depreciation of existing facilities. I remember that our export customers would also ask for their share of windfall profits by way of price discounts. In our experience, devaluation does not really benefit us in the long run, possibly because of the low local value content that goes into production. I suspect that even the BPO industry despite the large skill-based labor component, would not benefit from devaluation because of the imported inputs (consider IT equipment). The only segment that clearly benefits would be our overseas workers whose families can collect a larger amount of pesos for the remittances made in foreign currency.
We have always espoused stability in foreign exchange rates. It will allow us to plan and to price our services in a consistent and regular manner. There are of course, tools that would help us stabilize this particular risk. We utilized forex derivatives that allowed us to lock in future rates not just for our exports but also for our imported components. In all cases, we avoided speculative positions and recommended plain vanilla positions to keep rates stable and our position square. The goal was always to reduce volatility in exchange rates, uncertain cash flows, complexity and an ambiguous outlook. Truly, exciting in the business world could be a curse.
We invite everyone to attend the Ayala-Finex “The CFO in a VUCA World” to understand how you can navigate through the turmoil and changing winds of our business environment. We are certain that you will have a better understanding of how to face the changing times.
Ronald S. Goseco is currently the EVP of the Financial Executives Institute and COO of IDI-Volkswagen, an Ayala company.