Why you must adapt to economic change

Companies are changing their strategies in the challenging economic environment … and so must you.

Summary: Australian per capital income growth is declining, and GDP growth also is likely to fall over time. For businesses to succeed in an environment like this will require very different strategies to times when you simply ran with the growth in income per person.
Key take-out: When the profit season begins in August, look for companies that are aiming to reorganise their strategies and invest in efficiencies to cope with this new environment.
Key beneficiaries: General investors. Category: Economics and investment strategy.

When Treasurer Joe Hockey reveals the first budget in the Abbott administration, I think you are going to see just how difficult restoring the health of the Australian economy is going to be.

That is why both Hockey and Prime Minister Tony Abbott are seriously considering increasing income taxes via a levy, even though they had promised not to do so in the election campaign. (It is a 50/50 call as to whether they proceed with the levy). But the difficulty in repairing the Australian economy is going to have a profound effect on the income of all Australians, because stimulus is being cut back over a wide front. In turn that will trigger a new direction for the strategies of many companies.

My text today comes from two graphs that have been prepared, not by me but by an organisation that does not want to be revealed. The first graph plots estimated Australian per capita income growth using an allocation of a forecast 10-year rolling average of gross national income (not salaries).
Graph for Why you must adapt to economic change

You will see that between 1983 and around 2009 Australia enjoyed a strong upward trend in the growth of gross national income per person. But we are now on a slippery slide down, and on a 10-year rolling basis we are set to have lower growth rates than at any time in the last half century. And that forecast decline is a key element in why it is so difficult to recover the budget situation.

It is happening because Australia saw itself as the lucky country, and did not start to work smarter and increase productivity as we had done in previous decades. And when the Gillard government introduced its disastrous industrial relations reforms a lot of companies just gave up on labour productivity.

The second graph shows just how remarkable the last 22 or so years have been. We take for granted the fact that we have had just over 22 years of continuous GDP growth, and all our projections have it continuing at least for another decade.
Graph for Why you must adapt to economic change

But the only other developed country in the last half century to exceed our current achievement is the Netherlands, which chalked up 26.6 years of continuous GDP growth between December 1981 and 2008.

If Australia continues GDP growth for another decade, then by 2024 we will have achieved 33 years of continuous growth, which has never been achieved by any major country in the last 50 years. Without making a forecast, the odds are against it.

Around our communities we are going to increasingly see signs of the falling income growth, which shows up on the first graph. For example, we are seeing price competition among independent schools and, in Victoria, the opposition ALP party is planning to freeze council rate increases to CPI (the Consumer Price Index).

We are struggling to fund health, education and disability. To date profit growth amongst Australian companies has been maintained, mainly because companies have kept a very close watch on labour costs.

But that is squeezing families in the middle-class because salary rises are hard to achieve. The squeeze would have been even greater but for the supermarket price reductions, albeit that they came at a cost to many suppliers.

At the same time the number of people in the lower-income levels has increased substantially. For businesses to succeed in an environment like this will require very different strategies to times when you simply ran with the growth in income per person. Two companies who have realised that the local and international environments have changed are Woolworths and BHP.

Woolworths, under managing director Grant O’Brien, has launched what it calls a Mercury Two organisation program. Mercury One was undertaken by former CEO Roger Corbett, who adapted the supply chain techniques embraced by Wal-Mart in the US to Australian conditions. This slashed Woolworths’ costs and he distributed the benefits between prices, further investment and shareholders. His successors tended to swing the benefits to shareholders, which left the company exposed to a price campaign by Coles.

Mercury Two is designed to prepare the company for a much higher level of online trading and will reorganise its purchasing and distribution systems so that it can deliver online home delivery orders on a same-day basis, if required. Mercury Two will do this also and enable a pick-up of online ordered goods, not only in the stores where the customer made the purchases but in other parts of the Woolworths’ group. And so, a person who orders online from the supermarket division will be able to collect their order not just at a supermarket but at a Big W, Caltex service station, Dan Murphys or Masters. That requires an enormous change to the way the group operates.

Coles has so far not followed Woolworths down that track, although almost certainly Coles’ supermarket customers will be able pick up their goods at Shell service stations. But extending the network to Bunnings is so far not being planned. Bunnings has achieved most of its success by concentrating on bricks and mortar retailing. If Woolworths is right it will re-establish a significant lead in Australian retailing.

In the case of BHP, CEO Andrew Mackenzie can see a new international environment and is reversing the historical strategies of his predecessors who prided themselves in having a long string of new projects in the pipeline. BHP has mothballed projects like Olympic Dam and Port Hedland’s outer harbour. It is proceeding with potash in Canada, but on a restrained basis, and will also be restrained in its new investments in oil and copper.

Rio Tinto boss Sam Walsh is going one step further – he has started automating his iron ore mines with some 53 driverless trucks and he is moving in a similar direction on trains. Walsh is planning to use new technologies to lessen the labour content in mines and replace it with capital city controls. He is also looking at radical new ways to process minerals by examining the new sciences and what is done in other industries, such as agriculture. It will make Rio a unique miner – but that’s the sort of approach required over a wide area.

Once BHP has completed the current expansion programs designed in its old regime it will have a lot more cash to distribute to shareholders. When the profit season begins in August, look for companies that are aiming to reorganise their strategies and invest in efficiencies to cope with this new environment.

And governments will have to change as well because the cash is not there. Rationalising state and federal government expenditure on health and education makes a lot of sense. In health, the new technologies (like iPads) can slash the costs and improve the services. Modernisation is desperately needed in hospitals to deliver better outcomes at lower costs.

The companies that understand this new environment will prosper. Those that don’t will have a hard time.