Brand Building, Beyond Marketing

Consumers are becoming more suspicious of traditional branding. Here are five steps to regain their trust.

strategy-business.com
by Nicholas Ind and Majken Schultz
Not so long ago, brands were … seemingly powerful, and virtuous. Any inconvenient truths were hidden by glossy packaging and one-way, big-bang marketing campaigns. Now, …  people can see behind the marketing facade and are questioning what they are told. … This has created a challenge for many brand owners, because they are ill equipped to cope with greater openness. But the most innovative companies are recognizing the way perceptions are changing, and are adapting their branding strategies accordingly — in some cases, reinventing them entirely.
… More broadly, many enlightened organizations are moving branding entirely away from communications and toward connecting strategy, culture, and a wider stakeholder involvement. … These organizations have understood that brand building (even if the terminology of branding is not used) is a participative process involving the whole organization and is the responsibility of all employees. The Netherlands-based finance group Rabobank, for example, … recognizes that its strength is rooted in its closeness to customers, that its brand is built primarily in the everyday contacts that people inside the bank have with members. It is in this continuous dialogue between customers and employees — both online and offline — that the company’s brand is always evolving. …
Similarly, the Danish toy company Lego Group, … has recognized that its brand is not created by the marketing department, but instead by the larger organization in its interactions with customers and other stakeholders who have become part of its community. Like many other organizations, Lego built its business through a controlled approach to intellectual property. … However, as computer games grew in popularity, the company feverishly tried to adapt to new trends and opportunities in the marketplace. The result was that the brand became increasingly irrelevant, as people lost track of what it stood for and confused employees struggled to deliver a trusted Lego experience.
…[A] new CEO, Jørgen Vig Knudstorp, who took office in 2004 … realized that customers, who were using and adapting  … the Lego Group’s intellectual property, were not threatening the brand, but were actually redefining it. (See “The Promise (and Perils) of Open Collaboration,” by Andrea Gabor, s+b, Autumn 2009.) One of the secrets of Lego’s ability to engage its stakeholders with the brand is that it took advantage of the small opportunities that emerged along the way: from giving consumers the “right to hack,” to inviting small groups of passionate consumers to headquarters to work with the designers on new ideas, to the new CEO accepting the invitation to talk to the brand community on their turf. … By opening itself up to an active involvement with these enthusiasts, the company has been able to tap into a rich vein of innovative thinking and has been able to once again make the brand relevant.

A New Role for Branding

The Lego Group is an interesting example of open innovation … . It indicates a significant shift in the way we think about brands and points to a future that will be radically different — … where managers will have to give up the idea of control over a brand and accept instead a fluid, uncertain world where a brand evolves in dialogue with others. This in turn will require both openness and trust.
Although we might argue that the very essence of brands is about trust — in the sense that consumers should be able to trust the promise that a brand name makes — in reality trust has often been missing. Organizations have trusted neither their customers nor their employees. …
A similar situation exists with regard to consumers. Rather than being open and participative with consumers, many organizations assume that the people buying their products and services can’t be trusted. …
How, then, can trust be engendered? Trust has to be earned over time through the experience of promises delivered, which means less of a focus on telling people about how great your brand is and more on building relevant content. … [The] Dutch insurance company Interpolis, … decided that instead of asking customers to provide receipts and questioning their claims, it would trust them. Former Interpolis executive board chairman Piet van Schijndel (now a member of the board of directors of Rabobank) said in a speech that the company “had to let go of the old-fashioned concept of an organization built on mistrust and rules. Instead, we started focusing on trust between people; between ourselves and our customers and between the management and the staff.” The result was not only greater operational efficiency, but also a decline in the number of claims.
We would suggest that brand executives, … should … work to trust those around them and become active participants in nurturing brand dialogue … .

Five Imperatives to Regain Trust

As the shift from a marketing communications–driven approach to brand building toward an organization-wide, participative approach gathers pace, managers will have to become aware of some new imperatives — but also some new dilemmas and challenges.
1. Content not communication. It is what you produce and how you deliver it that matters if you want to build a relationship with customers. …
2. Mind your language. Be aware that the language of branding is a turnoff inside many organizations, and that the hyperbole of marketing communications is increasingly ineffectual. …
3. Let go. … It is employees and increasingly customers who self-manage brands. …
4. Open up. There is a greater requirement to make the brand open to the influence of others. …The most important mental shift here is to stop seeing users as an object and to start seeing them as a source of creativity and value creation.
5. Just do it. … [Accept] that there will be successes and failures. Learn from open source practices, and experiment. …

Opportunities and Dilemmas

… This brand new world is one of freedom, yet managers have to confront a number of challenges: greater transparency increases the volume of stakeholder interactions, co-creativity provides input but also resistance from the conservatism of many brand enthusiasts, and more dialogue can undermine the coherence of the brand.
There are no easy solutions to these challenges, but we should pay attention to [the 2009 Spanish, European, and World soccer club champions, FC Barcelona’s Chief Executive] Joan Oliver i Fontanet’s argument that brand building (perhaps like soccer) is an art that requires intuition and a willingness to adapt to ever-changing circumstances. … This new freedom has the potential to inject dynamism into brands, so that they become continuously innovative and create real value.

Author Profiles:

• Nicholas Ind is the author of 10 books, including The Corporate Brand (NYU Press, 1997), Living the Brand: How to Transform Every Member of Your Organization into a Brand Champion (3rd ed., Kogan Page, 2007), and Branding Governance: A Participatory Approach to the Brand Building Process (with Rune Bjerke; Wiley, 2007). He is an associate professor at Oslo School of Management.
• Majken Schultz is a professor of management at Copenhagen Business School and a partner in Reputation Institute, a private advisory and research firm. She has published widely in the field of management and branding and serves on several corporate boards. See http://www.majkenschultz.com/.

It Makes Sense to Adjust

Business transformation is now a continuous process that most companies haven’t mastered. Here’s a formula for managing ongoing change.

strategy+business magazine
by Vinay Couto, Frank Ribeiro, and Andrew Tipping
It used to be that a business transformation was a once-in-a-lifetime event, the sort of fundamental reset prompted by a rare, short-lived disruption such as a new technology, a devastating scandal, or a dramatic shift in costs. But if the recent economic upheaval reveals anything, it is that companies of all sizes, in all industries, are operating in a more volatile, less predictable environment, and that change has become a way of life. To navigate such a rocky landscape, companies must be ready to repeatedly transform themselves — indeed, to institutionalize the capacity to alter strategies again and again — as business conditions require….
The problem is that most companies don’t have an adequately proactive road map for transformation.  … [If] an organization prepares for transformation (perhaps when it is not occurring), steering through it is far less difficult.
Each company’s strategy for approaching transformation falls into one of three categories. These categories in turn determine the level of transformation — the timing and the magnitude — that the company can support.
1. Reactive. This is the default transformation strategy; it is minimal, and has become second nature to most seasoned executives. A change in circumstances provokes a short-term response, generally an abrupt shift that requires little cross-company coordination or follow-up. … Problems arise when executives try to apply this approach to situations that call for more sweeping and highly detailed transformation. …
2. Programmatic. This strategy is more comprehensive and is appropriate when major change is required and a company has sufficient lead time. In such circumstances, the company launches a widespread change initiative across the lines of business that are most affected. A cross-functional program office is set up, tactics are identified, milestones are established, executives are assigned to oversight, a communications program is launched, and progress is tracked.
These programs can be effective in dealing with a contained event or threat, such as a new competitor or a new product from a rival, and their potential reward is greater than that of the reactive approach because they are more forward-looking. But as the name of this category implies, the transformation is a program — a systematic, planned sequence of activities designed to achieve specific goals within a specific period of time — and, thus, the outcome takes longer than a reactive transformation.
3. Sense-and-adjust. This is the most long-term and sustainable strategy, but only a few companies have successfully implemented it. Unlike the first two approaches, sense-and-adjust is dynamic, constantly and consistently smoothing out volatility in areas of business subject to swift and dramatic change, such as research and development or frontline operations like manufacturing and logistics.
Sensing is an ongoing effort to gather and analyze data on current and future business conditions and, more important, translate it into likely outcomes. The sensing process should leverage baseline planning information — what’s captured in strategic and operating plans — and synthesize it with key performance data to form a single “dashboard” of actionable information that can be used by business unit heads or corporate leaders in functions like IT, HR, or marketing….
Adjusting is the process of altering business strategies on the basis of sensed outcomes. In this phase, which is done in tandem with sensing, business unit or department heads assess the data to determine possible resource and capability trade-offs. …
As adjustments are made, the sensing capability picks up and continues the cycle, both scanning the horizon for market shifts and monitoring the execution of these strategic responses. Sensing does little good in the absence of adjusting, and vice versa.
The sense-and-adjust approach to change is not the traditional stutter-step strategic planning process in which business units are summoned every six or 12 months to present their take on the market and their performance expectations. The sense-and-adjust process is continuous, incorporating new information and forecasting outcomes and expectations constantly. Companies that have mastered the skills to handle the programmatic approach and have an organization that is reasonably resilient — flexible and anticipatory — are the best candidates for this sustainable strategy. …
For some companies, particularly those without the mature planning processes and deep leadership bench necessary to implement a full-fledged sense-and-adjust strategy, a programmatic transformation can offer a clear path toward that goal. …
If nothing else, all companies must recognize that the pace and magnitude of change is far faster and greater now than ever before and that transforming their business is no longer something they can avoid, defer, or out-manage. Even small moves to increase an organization’s sense-and-adjust skills will reap significant and sustainable rewards.

Author Profiles:

• Vinay Couto is a partner with Booz & Company in Chicago. He focuses on global organization restructuring and turnaround programs in the automotive, industrials, and consumer packaged goods industries.
• Frank Ribeiro is a partner with Booz & Company in New York. He focuses on overall corporate transformation and associated capability-building programs to increase an organization’s effectiveness and efficiency.
• Andrew Tipping is a partner with Booz & Company in Chicago. He focuses on large-scale organizational transformation to increase the effectiveness and efficiency with which companies meet customer needs.
• Also contributing to this article were Booz & Company Senior Associate Matthew Siegel and Principal Curt Mueller.

Unlocking the elusive potential of social networks

To realize the marketing potential of virtual activities, you have to make them truly useful for consumers.

McKinsey Quarterly

JUNE 2010 • Michael Zeisser

There is much hype about social networks and their potential impact on marketing, so many companies are diligently establishing presences on Facebook, Twitter, and other platforms. Yet the true value of social networks remains unclear, and while common wisdom suggests that they should be tremendous enablers and amplifiers of word of mouth, few consumer companies have unlocked this potential. At Liberty Interactive, which comprises many specialty e-commerce companies, we wrestle daily with the question of how to realize the promise of social networks.

… When you think of word of mouth as media, it becomes a form of content, and businesses can apply tried-and-true content-management practices and metrics to it. In addition, word of mouth generated by social networks is a form of marketing that must be earned—unlike traditional advertising, which can be purchased. We therefore concluded that we could succeed only by being genuinely useful to the individuals who initiate or sustain virtual world-of-mouth conversations.

So what does it mean to be useful in a world of virtual conversations enabled by social networks? … We have … learned a few lessons that can be encapsulated in two primary insights. First, a powerful way for a brand to be useful in the virtual world is to confer social importance on its users. Second, “virtual items” are critical to stimulating social interactions that may in turn generate word of mouth.

The power of importance

An effective way for a brand to be useful in the context of social networks is to make people who originate a word-of-mouth conversation seem important within their own social environment. Recognition by peers is a powerful motivator, and brands that allow users to gain it deliver real perceived value. When users publicize that recognition, it translates into word of mouth. Companies can confer this kind of importance—for example, by issuing achievement “badges” that users can post to their Facebook profiles or by deploying leader boards or achievement scores of all types. As Web sites evolve to become increasingly dynamic experiences that let people interact in real time, the value to core users of being recognized for their prominence in a community will only increase.

We’ve also learned never to underestimate the value consumers place on opportunities to brag online about their achievements. That’s made significantly easier through the clever integration of a Web site with Facebook and Twitter. We see this phenomenon daily—for example, on the forums of our Bodybuilding.com site. When members boast of reaching their target weight or other goals with help from Bodybuilding.com workouts, we receive authentic and credible word-of-mouth endorsements at almost no cost. In fact, if recent behavioral research is accurate, these experiences can create “contagions” in which the behavior of users is mirrored by their networks of friends, amplifying the word-of-mouth effect and reflecting well on the underlying brands.

The allure of virtual items

It’s our strong intuition that virtual items play an important role in facilitating virtual word of mouth. … While the notion of virtual goods—nonphysical objects used in online communities and games—still puzzles many executives, it’s quite apparent that consumers love them. People acquire or compete for virtual items obsessively on Foursquare, Zynga, and many other sites. …

So why do consumers pay real money for online objects that don’t actually exist? Their motives reinforce our notion that users seek online importance: they purchase virtual goods primarily for self-expression (such as virtual houses or virtual gifts) and for recognition (such as virtual badges for becoming, say, the “mayor” of a bar on Foursquare). … Brands should actively experiment with ways to use virtual goods as catalysts of word-of-mouth media.

Virtual gifting is becoming an important consumer activity among Facebook members. Today, much of this activity is free, but Facebook is introducing a virtual-currency “credit” system that will allow sellers to get real dollars for their gifts and other items. In the context of a social network, it is not a stretch to conceive of virtual gifts as important objects, especially as their availability can be strictly limited. …

We’ve also found that basic laws of consumer behavior still apply: consumers love a bargain, and companies should take full advantage of social networks as powerful notification tools. Users can be alerted to sales or to the expiration of a promotion, but companies must be mindful that these feeds and tweets are designed as catalysts to generate virtual word-of-mouth media. They are not social-media junk mail, but legitimate content objects—actual pieces of media that we want the initial recipients to distribute to their friends.

One final recommendation: no gimmicks. Forget dancing monkeys, artificial contests, or stupid tricks; they add no value and waste people’s time. A commitment to being useful in social-media activities means a commitment to creating only high-quality interactions. Again, regarding word of mouth as a media product makes it easier to define what quality means for your particular activities. There are clearly many ways for brands to make themselves useful to consumers, so managing virtual word of mouth goes well beyond maintaining a Facebook page or a Twitter account. Exactly how far remains to be seen, and companies should apply an experimental mind-set, while being careful not to overinvest.

Word-of-mouth marketing through social networks could emerge as an important tool in the marketer’s arsenal. That will depend on whether marketers can tame the fundamentally unpredictable and serendipitous nature of word of mouth without losing what makes it so valuable in the first place—its authenticity.

About the Author

Michael Zeisser, an alumnus of Mckinsey’s New York office, is a senior vice president at Liberty Media.

When It Comes To Retirement, 67 Is The New 55

NPR

by Alan Greenblatt

June 18, 2010

Looking forward to retirement? You may have to wait a bit longer. Financial pressures are pushing up retirement ages all over.

iStockphoto.com

William Reichenstein, who teaches finance at Baylor University, tells his students that they will have to save a lot more of their working income if they hope to retire as comfortably as their parents and grandparents, simply because they're going to live longer.

On Wednesday, … California's Republican Gov. Arnold Schwarzenegger announced a deal with four state public employee unions to raise the retirement age by five years for newly hired workers.

These moves follow several recent age increases across Europe and among U.S. states. Faced with one of the worst pension shortfalls in the country, Illinois in March lifted the retirement age for new state workers from as low as 55 all the way to 67.

The increases also anticipate the coming debate among members of the White House deficit commission over raising the eligibility age for Social Security benefits. …

The motivations driving all these various governments are similar. People are living longer and, therefore, are drawing retirement benefits for longer periods. …

Retirement Ages Around The World

View a sampling of official retirement ages around the world, according to a 2009 report from the Organization for Economic Cooperation and Development, based on data from 2002-07. France is among the countries listed that have already announced plans to raise their retirement ages in the coming years.

Adrienne Wollman/NPR

"If their parents are going to retire at 65 after working 40 years, they need to plan for about a 20-year [retirement]," [Reichenstein] says. "For my students' generation, with life expectancy going up about a month a year, in their cases they have maybe 25 years in retirement they have to plan for."

Another result of longer lifespans in the United States is that the ratio of people paying into Social Security, compared with those drawing benefits, is shrinking rapidly. "We know that in 2017, Social Security will begin paying out for the foreseeable future more in benefits than it collects in taxes," says Richard W. Johnson, director of the Urban Institute's retirement policy program.

The Social Security trust fund will be able to make up the shortfall for 20 to 25 years. "But that trust fund is now being used to offset other parts of the deficit," Johnson says. "Once we can no longer use that trust fund to fund other services, the deficit really balloons."

How Old Is Fair?

That's why President Obama's deficit commission is seriously considering raising the retirement age. … The full retirement age is set to rise to 67 for people born after 1960.

Raising the full retirement age by 2020, rather than 2027, would save $92 billion, according to the Congressional Budget Office.

"We have this huge problem we really have to address," says Steven Sass, director of the Center for Financial Literacy at Boston College. "We either have to cut benefits or increase revenues."

Sass points out, however, that raising Social Security's retirement age will disproportionately affect low- and moderate-income workers. People who work longer into old age tend to hold less physically demanding office jobs and are better educated. Those who are less educated or work in manual labor make up a greater share of people who are opting for the lower-paying early retirement benefits. Their numbers are increasing with the recession.

Because Social Security benefits are paid out on a sliding scale — you lose about 7 percent for every year you retire early — raising the full retirement age amounts to a de facto cut for those who are forced to retire early. "It's a terrible way to cut benefits," says Eric Kingson, a professor of social work at Syracuse University and co-director of Social Security Works, a coalition of unions and other groups that lobbies against benefit cuts.

"Life expectancy has improved, but not for all the groups," he says.

Enlarge Manu Fernandez/AP

People in Barcelona protest Feb. 23 against the Spanish government's plans to raise the retirement age. The marches were sparked by Prime Minister Jose Luis Rodriguez Zapatero's proposal that Spaniards delay retirement from 65 to 67 to ensure the long-term stability of the country's pensions.

Political Fallout Across Europe

There are fierce arguments looming over whether taxes should be raised or Social Security benefits should be cut, either outright or through an increase in the retirement age. These kinds of debates are already happening across Europe.

Greece, until recently, allowed workers in more than 580 job categories considered hazardous to retire with full pensions as early as age 50 for women or 55 for men. In response to its fiscal crisis, that country has raised the retirement age to 65 for most workers.

In Ireland, the government has proposed gradually raising the retirement age from 65 to 68. Hungary raised its retirement age in 2008 from 62 to 65 — one big reason why the ruling Socialists got trounced in parliamentary elections in April.

French President Nicolas Sarkozy is bound to experience blowback on his new plan, too — even though it won't erase even half the nation's projected pension funding gap.

Reichenstein, … says there is no other option. "The governments have promised more than they can meet," he says. "The reality is that they have to cut back."

More States Are Cutting

Reichenstein notes that things aren't quite so drastic — yet — in this country. For one thing, the U.S. federal debt — although climbing rapidly — is not yet as great as a share of GDP as debt in many European nations. Our median age is lower, too, thanks in part to immigration. The median age in the U.S. is just under 37, while it's right around 44 in Germany, Italy and Japan. And there are still some years left to find fixes for Social Security.

But state systems may be another matter. A study from the Pew Center on the States in February found that state pension systems were collectively running a $1 trillion deficit — and that was based on figures compiled before the 2008 stock market crash.

The California Public Employees' Retirement System announced Wednesday that the state needs to increase its pension contributions by $600 million a year.

Schwarzenegger's new agreement raises the retirement age for state workers by five years and requires current workers to contribute more of their salaries into their own retirement accounts. …

Several states have already done so, creating two-tiered systems that are much less generous for new hires.

"It's a correction long overdue," says Dowell Myers, a demographer at the University of Southern California. "Not only are people living longer but they're living way longer than they were when these programs were set up, and we have less money than we used to."

Globalization’s critical imbalances

Future financial crises could accelerate the rebalancing of global economic activity from developed to emerging markets.

McKinsey Quarterly

JUNE 2010 • Lowell Bryan

• Exhibit 1: The job losses of the Great Recession follow a pattern different from that of previous recessions and may reflect structural, rather than cyclical, causes.
• Exhibit 2: Food prices have been extremely volatile since 2006 and are on the rise again.

To some extent, the rebalancing of global economic activity from developed to emerging markets simply reflects economic laws of gravity. In a world where ideas can flow freely and countries are at different stages in adopting modern modes of production, communication, and distribution, less developed nations should grow more rapidly than their counterparts in the West as they catch up.

But it’s also important to understand that emerging-market economies have a structural advantage that is grounded in the operation of the global economy. …[It’s] roots run … all the way down to the fundamental issue that labor can’t be freely traded on a single global market, while capital and commodities can. Any company sourcing its production or service operations in a lower-wage emerging-market country therefore can save enormously on labor costs. That’s painful for displaced Western workers, but it’s good for the company’s profits, good for consumers in developed markets, and good for the newly minted citizens of the global economy who are working in emerging-market factories and call centers. This is a dynamic we take so much for granted that it’s easy to imagine it as a semi-permanent condition that will underpin global economic development for the foreseeable future.

… I believe senior executives need to prepare now for a world that—as China’s recent decision to relax its informal peg of the yuan to the US dollar underscores—will be coming to grips with an unsustainable set of economic relationships. Their unwinding will have serious long-term implications for those executives’ strategic priorities, including where they locate operations and what customers they serve in which markets. Equally important is the need for preparedness in case the unwinding process is sudden and abrupt. While we surely seem to be headed toward a new global equilibrium, the transition to that future world may not be smooth and gradual.

Adam Smith meets the global economy

We usually think of the global economy in terms of outputs such as cars and packaged goods. Yet the real integration of the world’s economy begins with factors of production. Of those, commodities, capital, and labor are the most important for understanding our structural economic issues. The test of whether a market has fully formed is whether all customers get the same items at the same price, allowing for transaction and transportation costs. (This condition, called the law of one price, was originally advanced by Adam Smith.) Such market conditions have long existed at a global level for natural commodities, such as crude oil, bauxite, and iron ore, as well as for manufactured commodities, such as petroleum, aluminum, and steel. The law of one price also exists for freely traded foreign exchange and most instruments traded in the capital market. It does not exist for labor, however—which is the fundamental structural issue the global economy faces.

To understand labor’s role, of course, you need to understand arbitrage. … In the real economy, such arbitrage focuses on capturing differences in the cost of production across geographies. As markets have opened and transaction and transportation costs fallen over the past quarter century, arbitrage opportunities in global financial markets and commodities have been quickly exhausted, so they easily meet the global law-of-one-price test. Yet there are still enormous arbitrage opportunities available in labor rates: the cost of performing the same job in different nations can vary significantly. As a result, multinational corporations that are able to source their production in emerging markets can enjoy large labor cost savings.

Until recently, labor arbitrage across countries was hard to capture because high-quality, highly productive labor was scarce in emerging markets. In the past decade, however, it has become relatively easy for companies to capture such opportunities, thanks to the combination of urbanization, education, infrastructure investments, new technology, the spread of advanced production techniques, and the evolution of digital standards. Even today, the cost of labor in China or India is still only a fraction (often less than a third) of the equivalent labor in the developed world. Yet the productivity of Chinese and Indian labor is rising rapidly and, in specialized areas (such as high-tech assembly in China or software development in India), may equal or exceed the productivity of workers in wealthier nations. Given such differences, more and more companies around the world are locating production in emerging markets.

Labor costs and currencies

The structural issue facing developed-world nations is that the amount of high-quality, high-productivity labor that will be mobilized over the next decade in Brazil, China, and India (not to mention Mexico, the Philippines, and Thailand) is likely to be measured in the hundreds of millions of people. By comparison, the entire US labor force comprises 150 million people. This is a wonderful trend for humankind and would be a boon for everyone in the world if emerging-market employment were directed largely toward production for domestic consumption. The challenge for developed-world governments and citizens seeking jobs, however, is that a significant fraction of this emerging-world labor displaces jobs that would otherwise be created in Europe, Japan, and the United States. This may be the underlying reason why unemployment in Europe, Japan, and the United States is becoming more structural rather than cyclical and may get worse over time no matter how much public stimulus is provided. Certainly, the job losses of the Great Recession look quite different from those of past recessions (Exhibit 1).¹

In a completely open global capital market, foreign-exchange rates would adjust until labor markets in the developed world began to be competitive again, even if it took a major currency revaluation to achieve competitive parity. However, exchange rates in countries such as India and China have often been subject to foreign-exchange controls and interventions of various kinds. The result is that exchange rates haven’t adjusted freely, leading to the shifting of developed-world service jobs offshore (particularly to India) and the migration of manufacturing jobs (particularly to China).

Assume, for the moment, that Europe, Japan, and the United States continue to run structural fiscal deficits and relatively loose monetary policies and to struggle with job creation. Also assume that China’s recent announcement of a return to the “managed floating exchange rate” that prevailed from 2005 to 2008 does not mark the end of currency market interventions by emerging-market nations. Both scenarios are likely, so tensions between developed-world currencies and emerging-market currencies will probably continue to build. In particular, as more and more emerging-market citizens capture job opportunities associated with production and services for developed-world nations, the structural pressures on advanced countries will continue to increase. For example, it’s hard to see how the United States can resume the rapid GDP growth necessary to reduce its fiscal deficit—which requires increased tax revenue and lower government spending—when almost 20 percent of its working population is unemployed or underemployed.

As the GDP growth of emerging-market nations continues to outstrip that of the developed world, the pressure on currency values will continue to build. Eventually, the tension must be released, and currency values will readjust. For all of us, the speed of that adjustment makes a big difference. The dollar and euro would need to be devalued by between 30 and 50 percent for financial foreign-exchange rates to reflect the purchasing-power-parity (PPP) exchange rates of emerging-market currencies more closely (and, therefore, for labor of equal quality and productivity to be priced relatively equally across geographies). An adjustment of this magnitude that took just a few weeks, rather than a few years, would obviously jolt the global economy.

Commodity complications

Commodities are a further complication. Ramping up production in China, India, and other countries to capture the economic returns from the increasing supply of high-quality, productive labor requires more commodities to produce more output. Since the global law of one price applies to commodities, this means that, with all else held equal, producers in China and India end up paying more than they would if those countries’ currencies were stronger. Simply put, commodity prices are too high in emerging-market countries and too low in developed-world countries.

As a result, developed-world consumers are using more commodities than they should, while emerging-market consumers are using fewer than they otherwise would. That’s distorting pricing feedback to customers and suppliers. What’s more, some of the returns that companies theoretically should be earning by taking advantage of low-cost, high-quality, productive labor in emerging markets is instead transferred to commodity-exporting nations. The resulting surpluses often then wind up in sovereign-wealth funds for deployment in the global capital market.

The fact that commodity prices, to a greater extent than currency values, are set in truly global markets where nations have little power over prices suggests that financial tensions will build earlier, and with greater volatility, in commodity than in currency markets. Some argue, in fact, that the last crisis was precipitated by the unbelievably rapid commodity price rise, in mid-2008, that saw oil jump to $140 a barrel, from $60 in early 2007, and coal increase to $170 a metric ton, from $50, over the same period. There are already signs that commodity prices are coming under pressure, even though developed-world growth remains relatively stagnant. Most commodity prices have doubled from their 2009 lows. Perhaps most disquieting, food prices have risen rapidly (Exhibit 2). It seems quite plausible that we could have a repeat of the commodity price movements of 2008 in late 2010 and 2011, even if developed-world GDP growth is only modest.

A dramatic increase in commodity prices could stall global economic recovery and also be the catalyst for emerging markets to revalue their currencies upward against the dollar and euro to reduce the high cost of imported commodities. Even the prospect of such a revaluation could cause large dollar and euro asset holders, such as sovereign-wealth funds, to accelerate the diversification of their holdings away from those currencies into foreign direct investment in emerging markets. That, in turn, could help trigger a currency crisis.

Adjustment uncertainty

It is very difficult to say how these issues will play out. The global rebalancing that is needed is obvious: developed-world countries need to save more, consume less, become more fiscally disciplined, and run current-account surpluses (or at least be neutral). Emerging-world countries need to let their currencies rise until PPP rates are closer to financial-exchange rates. They need to consume more, save less, run current-account deficits (or at least be neutral), and continue investing, with some of the capital provided by outsiders. If major national governments work proactively together to rebalance and coordinate their fiscal, monetary, trade, and foreign-exchange policies, the adjustment process could be gradual.

But such a policy adjustment is easier said than done. Developed-world politicians must respond to the demands of voters who don’t understand how the global economy works or what has changed in recent years and who mostly want policies that are fiscally unbalanced. They generally want governments to spend more money on social programs—in the United States, for example, on Social Security and Medicare—without increasing taxes to pay for that additional spending. The usual response by developed-world governments to such dilemmas is to run bigger fiscal deficits and to borrow more money. Yet most developed-world governments have been rapidly exhausting their debt capacity, and some nations, such as Greece, Portugal, and Spain, are already experiencing fiscal crises. At some point, the International Monetary Fund and major nations could become unable, or unwilling, to bail out overly indebted governments, at which point defaults and debt restructurings would become inevitable.

Emerging-market leaders have different challenges. In general, they have been “virtuous”: most have low debt-to-GDP ratios, maintain large currency reserves, continue to run current-account surpluses, and provide more capital to the developed world than they receive. Their economies are based upon undervalued currencies, low-cost labor, high savings rates, exports, and investment in infrastructure. These countries are wary of growing too rapidly or allowing too great a volume of capital inflows, particularly since, with undervalued currencies, they don’t want to sell their assets cheaply. They also are wary of anything that would derail their growth, given the rising expectations of their populations.

Both sides, of course, need to give way. In the longer term, the capital markets will discipline governments if the imbalances—particularly the fiscal imbalances of developed-world governments—continue to grow. But in the short term, the powerful market states involved (for instance, the United States, the eurozone countries, Japan, China, India, Brazil, and major commodity-exporting nations) are so large and can pull so many levers that they exercise significant power in the global capital market, resisting its discipline. If that’s the path they choose, it’s likely that the tensions created by unbalanced and divergent policies will build until they cause rapid currency shifts, massive changes in commodity prices, and punitive interest rate increases (or even defaults) for overly indebted sovereign borrowers.

The corporate agenda

Companies have much more freedom in the global economy than governments do. They can more easily capture the opportunities created by divergent, unbalanced government policies. They can position themselves to capture profits from both cross-geographic labor arbitrage and the consumption growth that results from rising incomes in emerging markets. They also have significant opportunities to serve the changing needs of aging populations in the developed world.² The underlying global economic processes under way are very powerful, and the profit opportunities will be enormous as four billion people in emerging markets triple or quadruple their incomes and wealth over the next 20 years.

That said, business leaders should not be sanguine about what lies in store. Although it’s impossible to know in advance the speed or intensity of the needed adjustment, turmoil probably lies ahead. Here are four suggestions for executives hoping to get out in front of it:

• For starters, as companies plot their global footprints, executives should not assume that the prevailing reality of globalization will continue. Labor arbitrage opportunities won’t disappear, of course, but strategies predicated on them could become less remunerative—maybe gradually or perhaps all at once.
• Second, it would be wise to be prepared for the high probability of future financial shocks. To do so, most companies need to become more adept at risk management and to err on the side of being overcapitalized, overliquid, and overprepared.
• Third, companies should engage in serious scenario planning around “unthinkables.” These might include the potential for significant, rapid shifts in currency values (for example, a 30 percent decline of the dollar versus emerging-market currencies); an exit from the euro by some nations; dramatic, rapid changes in commodity prices (for example, oil prices spiking to $200 a barrel); or defaults on debt by major nations.
• Finally, multinational-company executives who set strategy in emerging markets need to stop saying that those markets may someday be at least as important as drivers of consumption as they are platforms for low-cost manufacturing or services—and to start acting as if that day was near. … China’s scale makes its potential to transform the competitive balance of industries, and thus its importance, somewhat unique. But as currency adjustments bring purchasing power closer to parity around the world, the importance of emerging-market consumption will be reinforced everywhere. …

These suggestions represent specific applications of the more dynamic management approach I have urged companies to adopt in the past. The hallmarks of that approach—heightened awareness, greater resilience, more flexibility, and the timely alignment of leadership around needed adjustments—will be invaluable for companies as they navigate the choppy waters of global economic rebalancing. This process will continue and perhaps even accelerate in the years ahead, not despite, but because of the structural adjustments that are needed to put the global economy on a more sustainable trajectory.

About the Author

Lowell Bryan is a director in McKinsey’s New York office.

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Notes

¹ For a perspective on the relationship between offshoring and employment from 2000 to 2003, see Martin Neil Baily and Robert Z. Lawrence, “Don’t blame trade for US job losses,” mckinseyquarterly.com, February 2005.

² See David Court, “Serving aging baby boomers,” mckinseyquarterly.com, November 2007.