Today, borders among countries no longer stand for unconquerable restriction. Geopolitics as a notion has become extremely important and crucial to all kinds of business. In January 2016, the World Economic Forum pointed out those multinational enterprises’ concerned by categorizing geopolitical risks into those resulting from geography, economy, and the environment. Indeed, unrest in the Middle East, territorial disputes in the South China sea and the refugee and fiscal crises that shroud Europe in gloom have caused tremendous ups and downs to global business.
Here is the question: Are executives prepared to consider geopolitical risks as one of the major factors in their decision making, and identify ad-hoc solutions for investors?
Geopolitical risks can cause sudden yet fatal harm to firms’ core business. From a micro perspective, unstable interstate environments drive away foreign direct investments and increase the likelihood of capital flight, they also build high entry barriers for companies. High volatility usually affects traditional industries such as oil and gas and may lead to irreversible consequences. From a macro perspective, while emerging markets become ever more important, they are also the countries that are putting up obstacles in light of increasing global tension. Rising nationalism makes governments in emerging markets set stricter regulations thus companies have to absorb extra costs in order to enter those markets, losing economies of scale. The trend could affect all kinds of industries. Take Pan American Airways as a notable example: it faced overwhelming fixed costs stemming from the 1973 oil crisis due to a severe decline of customers. The phenomenon, accompanied by the Pan Am Flight 103 terrorist attack in 1988, were the key reasons that led to its bankruptcy in 1991.
Executives with keen business minds have certainly noticed the importance of identifying geostrategic risks. A recent survey conducted by McKinsey indicates that 49% of executives have identified geopolitical instability ‘very important’ when assessing impact on global business, double the figure of 2015 (23%). More than half of the executives in financial industry responded that uncertain regulatory environment and political instability would affect their organizations’ profitability. Leveraging knowledge of geopolitics has rapidly gained in importance.
However the same survey also reveals that only 13% of executives have taken steps to address geopolitical risks, suggesting one core issue: Companies have not yet developed the capabilities to manage global uncertainties.
Geopolitical instability is a challenge, yet it is also an opportunity to grow: Adopting comprehensive research in the operating countries and including geostrategic risks into strategic-planning process not only mitigate the hazard of an asset bubble, but doing so may put companies in the blue ocean thus enjoy a greater first-comer advantages such as abundant resources or prompt information. With rising uncertainty in every corner in the world, what doesn’t change is that knowledge is power.
This is part of our series articles in the International Corporate Finance Report.