Introduction to InnovationLabs White Paper #3 in the Series
Prelude: What’s Next?
What’s going to happen in the next six months?
It’s a big and very important question, which we tackle here. We gather evidence from a wide variety of sources, including Shell Oil, JPMorgan, Commerzbank, Warren Buffet, Forbes, The Economist, Fannie Mae, Governor Andrew Cuomo of New York, the Bank of England, and a recent survey of 281 CEOs, to come up with a model of what’s emerging for all of us.
Based on what we can surmise, it’s going to be … unusual.
The phrase “business as unusual” has been used by entrepreneurs and authors during the past few decades to depict an idiosyncratic approach to business. Anita Roddick, founder of The Body Shop, used it as the title her book about her iconic and highly unusual company, and others have used it to convey the same meaning.
We’re using it here because we believe that now it won’t just be the iconoclasts who have to embrace the unusual, it’s all of us.
Covid-19 and society’s response to it has led to a new and unprecedented situation, which is, we believe, going to lead quickly – possibly immediately – to permanent change in the structure of society and the economy.
So although we want to, we’re just not going back to the way things used to be, which means that we all must accept the unusual, embrace it, learn to live with it, and find new ways of living, working, and thriving under a quite different set of conditions.
This blog post excerpts our latest Covid white paper, and examines what may be up next for business leaders on this journey of adaptation, and suggests four specific action items that should probably jump to the top of the to-do list.
White Paper #3
The first white paper in our series on Covid-19 was a thought experiment published March 26, 2020 which applied the technique of scenario planning to examine the paths that the Covid crisis might take in the coming months and years, and posited the likelihood of a number of (bleak) possibilities for the future.
The second paper was published three weeks later on April 14, 2020, by which point the possibility of bleakness had turned to reality. It thus explored the likely and emerging impacts on society and business, and came away with two key insights:
- We are heading not for a recession, but a full-on depression.
- Business leaders must seize this moment to consider how they can transform their businesses to adapt to the new conditions, which will have to be considered permanent.
Both papers have reached far larger audiences than we had expected, and we have received a great deal of very helpful feedback from readers around the world. We greatly appreciate their comments, and we welcome yours as well.
This paper focuses on the challenges specifically for business leaders, while a fourth paper, which will be published in a couple weeks, will look at the situation from the broader political and macroeconomic perspectives.
Contents
- Living Under Uncertainty
- Four New Scenarios
- A Slow or No Recovery: Downward Spiral
- Your Covid Action Plan
- Conclusion
Appendix 1: Debt Deflation
Appendix 2: Resources
Living Under Uncertainty
At this stage of the crisis we have achieved a clear understanding of what happens when vast stretches of the economy are abruptly shut down: market demand collapses, and an economic crisis immediately ensues.
Once it became clear that social distancing was urgently required, the retail, restaurant, travel, transport, education, entertainment, sports, and tourism industries contracted instantly and massively, and the fossil fuel and manufacturing sectors followed immediately thereafter.
They have stayed down, casting many millions into unemployment, and at this point the only segments of the economy that have not been crushed are health care, the internet-based tech and entertainment sectors, and e-commerce.
But those are not enough to carry the economy, and consequently it’s clear that unless the damaged sectors revive, and major rehiring occurs quickly, the recession that we’re now in will soon turn into a depression.
But revival of the closeted sectors depends upon the course of the pandemic, and what we do not know is … everything important about what’s going to happen:
- We don’t know if the current viral hot spots such as New York City will cool down and allow a return to social contact.
- We don’t know if infection with the virus confers any long-lasting immunity.
- We don’t know if the virus will make a major return visit later in the year and we are forced to return to large scale lockdowns.
- And we don’t know if a vaccine can be developed.
All of which means that we don’t know when or if the damaged sectors of the economy can resume, and so we don’t know how long this ordeal will last.
Or in the words of Warren Buffet, “We do not know exactly what happens when you voluntarily shut down a substantial portion of your society.”
We can, however, readily anticipate that the longer it lasts, the more cautious consumers and businesses will be with their spending, and consequently the slower any recovery would be.
Aside from the economic situation, which is unprecedented, the social and psychological situations are equally so. For 75 years we’ve lived in a certain type of social and market environment, and in the space of a few months that has evaporated.
Since no one knows what’s next, we turn again to the scenario planning technique to consider what might happen with respect to what appear as of today to be the two most critical short term factors.
Four New Scenarios
In our first white paper, published 6 weeks ago, we considered the ten key forces that were driving the situation then, some of them specific to the virus and others arising as results of the virus. We mapped these into twenty scenarios, which allowed us to explore key unknowns such as the virus deadliness, the government response, the crisis duration, and its economic and social impacts.
We came away with useful insights about the importance of leadership, governance, the health care sector, and the nature of crisis itself.
In the intervening six weeks many of those questions have been answered, bringing us now to focus on the two critical factors we must understand, “market demand” and “social distancing.”
Market Demand: The onset of crisis and the imposition of lockdowns caused the collapse of demand, so the key question is, “What happens if demand recovers nicely, and what happens if it remains collapsed?”
Social Distancing: Social distancing is a proxy indicator for the course of the virus, its spread, its fatality rate, its persistence in society, the presence or absence of treatments or vaccines, and immunity. The question is, “Will social distancing still be required, or are we done with it?”
Putting these together gives us the 2×2 matrix we’re now familiar with based on our previous scenario discussions:
The titles of four quadrants guide us to expect one of three outcomes:
Scenario 2 shows a Zippy Quick Recovery. Wouldn’t that be nice. The birds are singing again!
Scenario 3 suggests a Slow Recovery, which feels like pushing the giant rock up the endless hill.
Scenario 4 is the Non Recovery, where we’re drowning in a depression of merely long or utterly and excruciatingly long duration.
And Scenario 1 is An Entirely New Economic Model. Government would presumably play an increasing role in boosting demand, but for this to happen it’s necessary to forge a new social contract, a Renewed Deal.
If it turns out to be #2, Zippy Quick (hurray!), then this event that we’ve been living through for the past few months becomes an historical blip, a strategic bump in the road, but something we’ve gotten readily past.
If it turns out to be #3 or 4, though, the Slow or Non Recovery, then we’re in a deeply serious situation, perhaps as serious as it gets, which we’ll discuss at length below under the heading “A Slow or Non Recovery.”
And if it turns out to be some variation on #1, then we enter a realm of social and macroeconomic inventions and hypotheticals that makes for fascinating speculation. We’ll address that in the next white paper, out in a few weeks.
Having framed four different views of the future, let’s now take a quick look what the evidence from the last couple weeks is suggesting.
Indicative Data
As usual, there’s a vast ocean of data to tap into, from which we have selected some data points that will perhaps provide useful perspective:
From January to March 2020, the gross number of hours worked by hourly employees in US small businesses dropped by 70%. Annie Lowrey of The Atlantic is now referring to this as “the small business die-off.” (May 4)
Harvard Business Review published the results of survey by researchers at U Chicago, U of Illinois, and Harvard which found that a quarter of America’s small business do not have enough cash on hand to last a month.
https://hbr.org/2020/04/a-way-forward-for-small-businesses
As of mid-April, Goldman Sachs expected the US unemployment rate to reach 15%, higher than any time during the last century. As of May, it seems that the actual rate may be climbing even higher than that.
Payroll processor ADP reported on May 6 that US companies dropped 20 million employees during April, the worst job loss in the history of its report.
Check out the fascinating 27 second gif history of unemployment in the U.S. created by Len Kiefer, Deputy Chief Economist at Freddie Mac:
Meanwhile, oil prices plummeted, regarding which renowned oil expert Daniel Yergin, author of the definitive history of the oil industry, The Commanding Heights, noted, “Nothing like this has ever happened before.” Oil prices are now in the low twenties, having even gone weirdly negative for a very brief period (i.e., sellers had to pay buyers to take oil). This price is far below the $30 to $50 per barrel level that most of the industry needs to remain solvent. The low price has already forced some debt-heavy oil producers into bankruptcy, and if it remains low then others will surely follow.
An initial wave of Covid bankruptcies has begun, and thus Forbes has initiated a “Coronavirus Bankruptcy Tracker,” with J.Crew, Gold’s Gym, Virgin Australia Airlines plus three smaller airlines, Modell’s Sporting Goods on the list so far, along with 42 other companies (the threshold to make the list is you have to have more than 500 employees).
https://www.forbes.com/sites/hanktucker/2020/05/03/coronavirus-bankruptcy-tracker-these-major-companies-are-failing-amid-the-shutdown/#5c1785853425
Neiman Marcus declared bankruptcy today, and J.C. Penney is reportedly nearing bankruptcy as well, and we can thus expect further waves or cycles of bankruptcies in the months ahead. As the retailers drop, their landlords will begin to feel their pain, and major real estate holders will tumble as well. The Economist refers to this as “the insidious means by which weak sectors of the economy will infect otherwise moderately healthy ones.” It’s a nasty chain reaction that spreads the pain.
And in the event that Covid makes a return appearance later in the year, which health care professionals are now warning of, we’ll experience yet another episode of economic contraction when we’re forced to revert to lockdowns.
For the airlines, meanwhile, which have been badly hammered, the International Air Transport Association (IATA) estimates that they’ll lose at least $300 billion this year.
And finally, a forecast issued by the Bank of England on May 7 observes that the UK economy is headed for its worst crash in more than 300 years. The report from CNN states the following:
The Bank of England said that GDP contracted by 3% in the first quarter of this year and would fall by as much as 25% in the second quarter, leaving the economy about 30% smaller than it was at the end of 2019. Unemployment is expected to increase to 9%.
The central bank expects a swift economic recovery in 2021, but it cautioned that its forecast, which assumes a gradual easing of social distancing measures and “very significant” monetary and fiscal stimulus, depends on the “evolution of the pandemic, and how governments, households and businesses respond.” And the bank warned that it’s more likely to have underestimated the scale of the economic crash than to have overstated it.
Economists at Commerzbank said that they expect more economic scarring and a slower recovery. Historic examples suggest there will be a more permanent loss of output, they said, and more persistent unemployment.
Charles Riley, CNN Business. “The UK economy is heading for its worst crash in 300 years.” May 7, 2020. https://www.cnn.com/2020/05/07/economy/uk-economy-bank-of-england/index.html
Some key points to reiterate here are, first, the Bank’s forecast is actually optimistic, in that it assumes social distancing can be eased. If the virus perseveres and social distancing remains necessary, then things become even worse, which the bank actually does admit in noting that they may well have underestimated the scale of the crash anyway.
And the note from the German Commerzbank affirms the notion that the crisis will likely result in permanent structural change to the economy even under the most optimistic of scenarios.
On top of all that, a new forecast from the US government projects that the daily death rate in the US will continue to rise, doubling from the current rate to reach 3,000 fatalities per day by June, largely occurring as a result of the easing of social distancing. In an ominous sign, eight states that have begun to reopen are already seeing increases in the number of Covid cases (Alaska, Indiana, Iowa, Kansas, Minnesota, Nebraska, Tennessee, Texas).
https://www.forbes.com/sites/lisettevoytko/2020/05/04/report-internal-trump-administration-coronavirus-model-predicts-3000-daily-deaths-by-june/#4cac8309ad4a
This is apparently providing a vivid picture of the experiment embedded in the trade-off between ‘a return to economic activity’ and ‘a greater risk of getting sick and dying.’ How this will play out in public opinion over the next couple months will be fascinating to observe, and certainly central to the upcoming election: will Americans choose to risk their lives to restore their economy?
And indeed, all of this gives us a great deal to think about as we consider what’s next for the economy.
A Slow or Non Recovery:
Downward Spiral
In the previous white paper we discussed the possible shapes of the recession/depression curve, and we presented these five possibilities:
“V” indicates a sharp decline and a quick ascent.
“W” is a double dip, a false recovery followed by another decline, and then a real recovery.
“J,” the optimist’s curve, says quick descent is a prelude to even greater heights.
“U” is a slow decline and slow recovery.
“Oscillation” is a prolonged period of ups and downs.
Now that we’re a couple months into this, though, none of those are looking quite right. Instead, there are two shapes that seem most plausible, a “Lazy J” and an “L.”
The “Lazy J” describes a precipitous decline, which is indeed what we have just experienced, followed by an agonizingly slow recovery.
Between the “J” and the “L,” this would unfortunately have to be considered as the “optimistic” scenario, because the “L,” on the other hand describes not only a depression, but also a significant restructuring of the economy that involves massive uncertainty, and a lot of social and economic pain. It’s the Non-Recovery scenario.
This is what was implied in the observation by the Commerzbank., whose economist Peter Dixon said this: “Current conditions are unprecedented in our lifetime and all forecasters are struggling to make out where the economy stands now, never mind what happens in future. But it is clear that the next few months are going to produce some of the biggest output falls on record.”
This is also in line with the expectation of Shell Oil, as expressed by its CFO Jesscia Uhl. She told investors on April 30, 2020 that she sees, “major demand destruction that we don’t even know will come back,” and that Shell expects an “L-shaped recovery” in the wake of the pandemic. She warned that the “relatively disorderly way in which all systems start to shut down is also going to affect us in ways that are very hard to predict.”
https://earther.gizmodo.com/shell-ok-we-may-actually-be-fucked-this-time-1843200534
https://www.naturalgasintel.com/articles/121841-shell-ceo-says-covid-19-may-capitalize-society-to-reduce-long-term-oil-natural-gas-demand
The “L” shape isn’t exactly a recovery though. It describes a significant decline in economic activity followed by a prolonged period in stasis, which is effectively a non-recovery.
The underlying economic process, which no one in government really wants to talk about publicly, is the cascading impacts of a decline in demand.
The sequence unfolds something like this: Demand collapse leads to massive layoffs (seen that), which then exacerbate the decline in demand because fear sets in (seeing that now). Entire industries contract, and so do government tax and fee revenues, and unfortunately this is exactly when governments must spend massively more to prop up the health care sector, public transit (because fare revenues plummet), as well as unprecedented unemployment benefits.
What happens next in this situation is that many business and family borrowers have lost so much income that they cannot cover their debt payments, so many are forced to sell the underlying assets. But they are selling into a depressed market, so they don’t get full value. Alternatively, borrowers just default on their loans, and hand devalued assets back to the banks, who assuredly don’t want them.
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The paper goes on to consider the economic process that an “L” depression would be likely to follow, a nasty downward spiral (it’s not pretty).
But then we go on to propose four critical items for
Your Covid Action Plan
1. Find the Future
2. Collaborative Inquiry
3. Business Model Innovation
4. Learn from the Data
Our notion is that in addition to the many actions you’re taking to protect your business, you should also consider the many opportunities that the Covid crisis is creating, particularly in areas like business model innovation.
You’re invited to download the full white paper here, and to share it with friends and colleagues.
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As always, we welcome your comments and suggestions.
Thanks!
Our global team stands (or sits) ready to support your innovation journey with an ever-improving suite of remote support tools and methods, to help you and your teams achieve high performance and exceptional creativity in these exceptional times.
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