On Wednesday, November 9th, just a few hours after Donald Trump had been officially elected as the United States’ 45th president, FSG hosted a networking breakfast with a group of Latin America general managers from top multinationals in which we presented our view on how a Trump administration will affect the business environment in the region. Here are some of the initial reactions of the executives in the room.
Too late for target revisions
Although there is the case to be made to renegotiate top-line and bottom-line targets in the region, namely in Mexico, only 17% of FSG clients are considering revising their 2017 targets for Latin America. This does not mean that regional managers would not like to renegotiate targets with corporate. Rather, it suggests that they feel it is too late in the game for them to make any major changes to strategic plans that have been already been submitted and approved by corporate, in most cases.
FX volatility and changes to trade policy, major concerns
Trump’s election led to renewed FX volatility in the region and uncertainty about his trade, immigration as well as domestic and foreign policy agendas is likely to trigger ongoing volatility throughout 2017. This will make it even harder for multinationals to maintain or grow market share, while at the same time protecting operating margins, especially for those companies with limited local production capacity in the region. As a matter of fact, FX volatility was selected as the top concern for 67% of FSG clients, with 44% of companies planning to expand local production in Latin America as they try to create a natural hedge against currency depreciation.
Ongoing currency depreciation since 2014 had already prompted many multinationals to increase their manufacturing footprint in Latin America. What is different this time is that changes to trade policy – in particular to NAFTA – could force many companies to reassess the optimal location of production facilities across the region, adding an additional layer of complexity to supply chain decisions. Indeed, 33% of executives pointed to the need to revisit their plans for local production following Trump’s victory.
M&A, the only way to grow market share while protecting profits?
Currency depreciation will once again outweigh inflation in most LATAM markets in 2017, providing a competitive edge to local players. Those companies that choose not to expand local production will find themselves in a difficult position to justify additional price increases, unless they implement noticeable changes to their product mix, positioning or the provision of value-added services. This will leave many companies with an almost inevitable choice. In the first case, if they choose to pass on FX depreciation to customers or partners, then they will lose market share; if they instead choose to absorb higher import costs to maintain prices steady, they will see margins erode. When confronted with this dilemma, 56% of FSG clients reported that their pricing bias in 2017 would be somewhat skewed towards profitability, 33% somewhat skewed towards gaining market share, and 11% totally skewed towards market share growth.
But not everything is lost for companies focused on the bottom-line. M&A will continue to offer very interesting inorganic growth opportunities for multinationals given even weaker currencies in 2017, falling corporate valuations in local currency, and the fact that many local companies are in dire need of capital as access to credit becomes more stringent in the region. 75% of the executives present in the room actually expect to gain market share versus local competitors in 2017, which suggests that strategic acquisitions will be a key growth lever for multinationals in Latin America.
Brazil could compensate for Mexico’s underperformance. But wait, are we talking about top-line or bottom-line?
Following Trump’s victory, FSG has revised Mexico’s economic growth forecast from 2.2% to 1.5% in 2017. The major forecast revision driver is investment, which we now expect to grow by 1.0% and not by 3.0% had Hillary Clinton become the US president. Our investment revision is solely based on heightened uncertainty about Trump’s trade and immigration policy agenda, which will paralyze many Capex investments in Mexico in the first few months of 2017. A weaker peso will force Banxico to increase interest rates at a faster pace, cooling down consumption, and in order to preserve macro stability the Mexican government will most likely resort to additional budget cuts next year.
All the factors above point to lower demand for companies in Mexico, whether they compete in the B2C, B2B or B2G segments. Our base case economic forecasts for Mexico do not account for overly disruptive changes to trade or immigration policy (we believe, for instance that NAFTA will be renegotiated but not cancelled); however, should Trump’s administration adopt more radical protectionist measures, the Mexican economy could easily fall into recession already in 2017.
According to a client survey that FSG conducted in July, Mexico was the top market for corporate investment for 31% of multinationals, tied with Brazil for the first place with also 31% of companies reporting Brazil as their top market for investment. However, following Trump’s victory, Mexico’s privileged position in multinationals’ portfolios is likely to change. As a matter of fact, 86% of FSG clients now believe that they should reassess their priority markets and segments in the region.
What is more, 83% of FSG clients believe that Brazil is best positioned to compensate for potential underperformance in Mexico given new market dynamics. Although it is true that Brazil (and Argentina) have very limited exposure to the US in terms of trade exchange and immigration flows, and that its 200 million person market could easily compensate for lower sales in Mexico if Brazil’s economy regains steam, the reality is that Brazil still lags behind most LATAM markets in terms of average operating margins as a result of the infamous Custo Brasil, or high cost of doing business. As a client put it, “we’re going to have a very hard time finding new sources of profitability in the region if Mexico stumbles; we’ve come to terms with lower profitability levels in Brazil, and that is not going to change in the near future.”
How should companies adapt their strategy to a post-Trump world?
FSG has been advising clients to conduct rigorous scenario and contingency planning ahead of the US elections, advice that we took to heart as we created our own economic scenarios and implications for Latin America. Had we not done our homework, it would have been impossible for us to confidently present our view on Latin America to a group of clients only a few hours after results were called declaring Trump’s victory. Although we now know the results of the US election, it is still not too late for your company to create scenarios for your business, given the high degree of uncertainty regarding Trump’s administration policy agenda.
Beyond scenario planning and market monitoring, FSG recommends that companies implement three sets of actions to protect their business in LATAM: (i) revisit your fundamental market assumptions, whether about priority markets, exchange rates, pricing strategy and your value proposition; (ii) build underdeveloped capabilities, especially around channel management; and (iii) reset your local operations for profitable growth, leveraging momentum to create a cost-conscious corporate culture.
Last but not least, LATAM executives should pay special attention to the importance of staying aligned with corporate and with local teams, given the high likelihood of market disruption over the next few months. As a matter of fact, organizations that exhibit high alignment and resilience are more likely to exceed expectations for profitability and market share, with a 99% confidence level.