Get Out! Get Out Now! … or some unintended consequences of Brexit

Just been mulling over some possible emergent properties of the decision-making systems being constructed in UK big business at the moment. These are mainly based on risks involving Brexit, how it’s going to land and the possible contingency plans that could be put in place. The conclusion to these thoughts is rather sobering.

I need to open with the view that trying to predict the future based on the past is a waste of time (see Kahneman’s Thinking, Fast and Slow and Taleb’s Black Swan on why human beings are rubbish at accurately predicting the future) and so I hold no particular prophecy to whether Brexit is going to be good or going to be bad financially for the UK. I’m wistful about the more ephemeral loss of a sense of ‘belonging’ to Europe, of being a European free to move and work on the continent, but really, that’s by the by.

In short, this blog entry is not about the economic result of Brexit. However, it is attempting to predict what individual companies might do to prepare for Brexit, and if they behave rationally (not always the case, see above) then we may already be in trouble.

Let me sketch out the decision-making system involved. It all comes down to a simple formula on risk and contingency planning.

Imagine a scenario: a company doesn’t know if we’re going to get a ‘soft’ Brexit or whether we might crash out to World Trade Organisation (WTO) rules. A wise business will acknowledge the risk and will try to mitigate it accordingly, planning and possibly even putting in place a contingency plan. A possible contingency plan might be to move some or all of their business from London to Paris, for example.

There are some key variables in the formula:

    Ps = Drop in profit for next x years if least impact (for example, soft Brexit)
    Psc = Drop in profit for next x years if least impact but with contingency plan in place
    Pw = Drop in profit for next x years if worst outcome (for example, WTO rules)
    Pwc = Drop in profit for next x years if worst outcome but with contingency plan in place
    C = Contingency plan one-off cost
    L = Likelihood of Worst Outcome (%)
    Risk = L x P…

Let’s assume the same contingency plan for either ‘least impact’ or ‘worst impact’, and assume it’s a big expensive plan, designed to mitigate the effects of worst outcome. That means, it would be foolish to invest in it if there was a good chance of ‘least impact’ occurring. Or would it?

Let’s run a couple of scenarios:

Scenario A
Business say they don’t want to invest in contingency and just see what happens come March 2019.

    Risk of drop to profits over next x years if WTO happens = Pw x L
    Risk of drop in profits over next x years if WTO does not happen = Ps x L

Scenario B
Business says they will invest in contingency now (because it will take that much time) and then see what happens come March 2019

    Risk of drop to profits over next x years if WTO happens = (Pwc x L) + C
    Risk of drop in profits over next x years if WTO does not happen = (Psc x L) + C

I’m not going to plug numbers into these formulae (because I’m lazy) but it doesn’t take much to see that, given the right configuration of variables, the risk to profits might be considerably higher if the business decides not to implement their contingency plan and just wait and see. Put another way, though the contingency plan is eye-wateringly expensive, to not implement is too risky, no matter what the eventual outcome is to the negotiations.

As an alternative to the numbers, imagine the following conversation …

‘But moving our entire business to Paris is going to cost £200m … how can we justify that?’
‘Well, we’re going to lose £50m every year through WTO tariffs, at least until they agree trade deal, which could take years…’
‘That assumes WTO rules will apply. What if we have a soft Brexit?’
‘Even soft Brexit means we lose profit, just not as much as WTO rules, say £10m a year.’
‘So, it needs to be 20 years before we make our money back on the contingency plan?’
‘Yes, but then it’s a gamble, isn’t it? And remember, we have to implement the contingency plan now in order to get ready for March, don’t we?’
‘True…’
‘Wouldn’t you rather be set up in Paris as soon as possible, with everybody clear about their future and their strategy, even if it means a short-term upheaval and possible losses that come with not being in London? Even if it is a soft Brexit … or possibly even no Brexit, how much worse is Paris to London?’
‘Now that you put it like that …’

I think, taking into account the large number of businesses affected, some of their decision-making systems must already be giving them the one answer:

Get out! Get out now!