A record year, but not without challenges
2013 was another record year for your Company. In some respects it was easier than 2012, with faster like-for-like revenue growth, 3.5% versus 2.9%. We reached our margin targets on a constant currency basis and did even better like-for-like. But following a major strengthening of sterling against most of the faster-growth markets’ currencies, we missed our margin target in reportable sterling terms. Encouragingly, having budgeted around 3% like-for-like revenue growth at the beginning of 2013, our forecast for full year growth became progressively stronger, and we finished the year with like-for-like growth of 3.5%. This, combined with intelligent control of headcount and discretionary spend, improved profitability and replenished bonus pools. However, pressures within the industry are becoming more and more intense, with clients understandably continuing to demand more for less and consolidating competitors discounting their pricing heavily, particularly in Media Investment Management.
So why was 2013, although another record year, still difficult? Clients were certainly in better shape with profits at an all-time high as a proportion of GDP, margins generally stronger, share prices rising as institutional investors rotated out of government securities and with clients sitting on, in the case of US-based multinationals, over £4 trillion in cash with relatively unleveraged balance sheets. But, whilst clients are now certainly in stronger shape than post-Lehman in September 2008, they still lack the necessary confidence given that global GDP growth remains sub-trend and the ‘grey swans’, or known unknowns remain – although most, if not all, of the latter are whiter. Black swans are, by definition, the unknown unknowns.
There are at least four or five grey swans, perhaps even six now in the case of the UK.
- Firstly, the potential fragility of the Eurozone, certainly better since one of the Super Marios, Mario Draghi, took over as the President of the European Central Bank, but still subject to potential shocks, for example, from the implementation of banking stress tests during this year and the still socially and politically unacceptable levels of unemployment and youth unemployment, for example in Spain. The Eurozone has also been aided by others stressing the need to reduce unemployment and surrendering the inflation rate constraint, for example, by both the former and new Chairpersons of the Federal Reserve Bank in the US, the re-elected Prime Minister Abe in Japan and Mark Carney, the new Governor of the Bank of England in the UK. This has certainly helped equity securities too.
- Second, the prospects for the Middle East, are probably now, if anything, better than a year ago. Although Syria remains a mess and there remain challenges in Libya and between Israel and Palestine, the Russian-led intervention on the chemical weapons issue in Syria and President Rouhani’s initiatives from Tehran have improved the political climate. Perhaps, the next election in Egypt will also bring more stability, although the region remains generally fragile to say the least.
- Third, a China or BRICs hard or soft landing. Most, if not all of these markets have suffered a slowdown in 2013 and, following the tapering noises from the US, significant currency weakness, with the exception of China. However, they still remain faster growth markets than the slower growth mature markets of the West.
We reached our margin targets on a constant currency basis and did even better like-for-like
We remain bullish on China. The new leadership has immediately addressed issues of corruption and the Third Plenum document reinforced the strategic directions of the 12th Five Year Plan, with an emphasis on lower quantum, higher quality GDP growth, a switch to consumption from savings, a healthcare and social security safety net and a strengthening of the service sector.
While we are traditionally bullish on Russia, and the Sochi Winter Olympics were an undoubted success, the crisis in Ukraine means that everyone is watching carefully to see how events unfold. Brazil and India both face elections shortly and politics and the economies are dominated by electoral considerations. It looks likely that President Dilma Rousseff will be re-elected, particularly if Brazil wins the 2014 FIFA World Cup. It should be a great tournament, despite infrastructure issues and social unrest, which will continue. After the election, growth should resume on towards the Rio Olympics in 2016. India may be a different kettle of fish. The election may not deliver a clear-cut result and although the BJP party looks stronger, there will be a coalition, which may result in continued stasis.
However, the continued increase of the hundreds of millions in the new middle classes in all these countries seems to be the real economic motive force, particularly for fast-moving consumer goods. On its 25th anniversary, CNBC, together with PricewaterhouseCoopers, took a look at the world in 25 more years. China was projected as the world’s biggest economy with GDP of $34 trillion versus $8 trillion now, the US second at $28 trillion (but still with markedly higher GDP per capita) versus $16 trillion now, and India third. India would be the most populous nation with 1.6 billion people and China second with 1.4 billion. We continue to significantly focus our future on the growth of these markets.
- Fourth, dealing with the US deficit and a record level of £16 trillion of debt in the most effective way. Despite the sequester, which slowed growth in the US in the first half of 2013 by 100 basis points or so and the Congressional agreement to kick the can down the road further than usual, these issues remain to be resolved. In addition, we have to come off the post-Lehman cheap money drug at some time and the scale and speed of tapering remains the key issue for the strength of equity and currency markets. This remains the elephant in the room, as the US is still currently twice the size of the Chinese economy.
- Fifth, and more parochially, the decisions to launch referenda for Scottish independence and Britain’s European Union membership, whilst no doubt being astute political moves, add further uncertainty to the UK economy until and after the next UK General Election in 2015.
- Finally, whilst economic conditions may have generally slightly improved this year, a further geopolitical risk emerged at the World Economic Forum in Davos last January – the Sino-Japanese spat over the islands of Diaoyu/Senkaku and the willingness of both sides to engage in a ‘limited’ military action to resolve it. This reminded everyone of historical precedents, where seemingly small events triggered bigger ones. In addition, the Ukraine crisis has added further geopolitical risk.
So all in all, whilst clients may be more confident than they were in September 2008 post-Lehman, with stronger balance sheets, sub-trend global GDP growth combined with these levels of uncertainty and increased corporate governance scrutiny make them unwilling to take further risks. They remain focused on a strategy of adding capacity and brand building in both faster-growth geographic markets and functional markets, like digital and containing or reducing capacity, perhaps with brand building to maintain or increase market share, in the mature, slow growth markets.
This approach also has the apparent virtue of limiting fixed-cost increases and increasing variable costs, although we naturally believe that marketing is an investment not a cost. We see little reason, if any, for this pattern of behaviour to change in 2014, with continued caution being the watchword. There is certainly no evidence to suggest any such change in behaviour so far in 2014.
Chapter 6 of 13