By Irving Leveson.
The $100 billion GNSS industry is already stressed. How deeply and how long the pressures persist depends to a great extent on the performance of the world economy. In a time of extraordinary uncertainty and change, the industry faces great challenges over the next 2–3 years and beyond: potential delays in availability of satellites and ground support, adaptation to multiple constellations, shifts associated with the proliferation of portable electronics, and fluctuating demands from governments, businesses, and consumers. Vulnerabilities are already increased with the weakening of the slow U.S. recovery, with recession in Europe, and slowdowns in many other nations. Potential shocks could cause economic conditions to deteriorate further.
Outcomes for the GNSS industry will depend very much on developments in the U.S. and global economy and associated government decisions. Effects on the industry will be far-reaching. Of course, non-economic factors will weigh in as well, but are beyond the present scope.
At mid-summer 2012, the economic environment is too fluid to rely on a single forecast. To explore the issues, I compare four scenarios in a discussion that considers what the scenarios depend on, their likelihood, and their consequences for the GNSS industry.
At the time of this writing, the consensus is that the U.S. and Europe will muddle through and that economic growth will be somewhat higher in 2013 than in 2012. This is evident in the forecasts of the Organization for European Cooperation and Development (OECD) and the International Monetary Fund (IMF). For example, the IMF in its July report expects world gross domestic product (GDP) growth to slow to 3.5 percent in 2012 from 3.9 percent in 2011, but then to rise to 3.9 percent in 2013. It expects GDP in advanced economies to be up to 1.9 percent in 2013 from 1.4 percent in 2012. This is in spite of a greater decline in public consumption.
I consider global recession scenarios to be more probable than such a rebound. Moreover, there is a risk of a severe world recession led by developments in both Europe and the United States. In all four scenarious outlined here, serious long-run problems remain unresolved.
Scenario Traits and Probabilities
Table 1 lists the four scenarios and suggested probabilities, contributing factors, and global manifestations. A fuller description of each scenario comes in the next section.
In the two Global Recession scenarios, the problems in the United States and/or Europe lead to worldwide recession, which is defined by a sharp slowdown in global growth. The Europe- and U.S.-led global recession scenarios are associated with greater government budget cuts and tax increases than in the other scenarios, and with greater political uncertainty, gridlock, and substantial contagion effects. Governments are less able to act, and some policies may be ineffective or counterproductive. Output declines in the U.S., Europe, and Japan, and slowdowns in growth occur in developing countries.
The recession scenarios are negative for consumer spending, business investment, hiring, and risk-taking. Information technology spending is cut back. While cost pressures abate, companies have little ability to influence pricing; profitability declines.
In the Muddling Through scenario, crises go to the brink, and little is done to immediately solve fundamental problems, but policies temporarily prevent severe economic and financial disruption. The Rebound scenario is facilitated by the most extensive delays in spending cuts and tax increases, together with increased confidence from agreement on long-term solutions. Serious but incomplete efforts are made to reduce impediments to growth and adjustment.
As of mid-summer, I rate the probability of a Europe-led global recession and a U.S.-led global recession each at 25–30 percent, with global recession most likely fully underway some time in 2013 in each case. The probability of a more severe global recession led by both Europe and the United States I put at 30–40 percent. The probability for muddling through is 25–30 percent, and for the rebound scenario it is 15–20 percent.
Developments and impacts are not quantified here, nor are longer-term prospects considered. More extreme possibilities are not addressed; these include wars, a major breakup of the euro in the next two or three years, a large energy price shock, massive immediate U.S. budget cuts beyond the sequester, extensive increases in U.S. regulation after the election, or a Chinese economic collapse.
I now turn to elaboration and discussion of each scenario.
Europe-Led Global Recession
Efforts by European institutions and the IMF to prevent debt defaults by southern European countries by extending credit only delay financial crises into 2013 or early 2014. With a major problem of insolvency (liabilities greater than assets) and not simply liquidity, a Europe without a fiscal union, common banking rules or even deposit insurance is unable to implement new structures in time to forestall severe adjustment. Increased bank capital requirements on January 1, 2013 also restrain lending. Financial market contagion spreads with rising interest rates on debt of already stressed countries, accelerated bank runs, and capital flight.
These problems spill over to the United States and the rest of the world through declining securities values, losses of financial institutions that are then less able to lend, and declining trade. U.S. business is adversely affected by a strong currency as investors seek relative safety in the dollar. This slows U.S. exports and eventually expands exports from Europe and other countries into the United States. It also leads to lower overseas earnings for U.S. companies as a result of less favorable currency translation.
Efforts to reduce debt in Europe create ongoing financial pressures on many countries, including Brazil, India, and China, and other countries whose economies are already slowing. While the greatest problems are in southern Europe, many other impacted countries including the United States take years to return to pre-crisis levels of growth.
U.S.-Led Global Recession
The U.S. economy is thrown into recession by a combination of tax increases and budget cuts (the sequester) that together constitute the January 1, 2013 so-called fiscal cliff. Tax and spending changes are modified, but the remaining tax increases from the end of the Bush tax cuts, together with those in the Affordable Care Act, weaken incentives to save, invest, and take risks. Additional pressures come from increased bank capital requirements and other financial regulations that restrain lending.
The recession in Europe and slowdowns in other countries further weaken the U.S. economy. High debt and unfunded obligations limit the ability to stimulate the economy with additional spending and limit the effectiveness of additional stimulation. Congressional gridlock prevents strong action, and the Federal Reserve has little additional room to stimulate the economy. The U.S. recession exacerbates the recession in Europe and weakens the global economy. U.S. and European recovery is very slow.
Muddling Through
The U.S. manages to “kick the can down the road” with enough policy changes to avoid the worst crises, but is unable to stimulate much growth. Tax increases and budget cuts are largely delayed in response to high and rising levels of unemployment but hold back recovery when they return. Economic and policy uncertainty and high levels of financial and business regulation continue to restrain growth and employment. However, underlying technological change is strong and enables continuation of modest growth, along with very low interest rates. Recovery in construction is limited.
Europe also is able to delay the worst crises, such as would occur if there were insufficient resources to prevent major bank failures or one or more countries abandoning the euro. However, it must work through a recession that is severe in some countries and dampening growth in others. The United States, France, Japan, India, and China institute additional economic stimulus.
Rebound
In this scenario the United States temporarily avoids a recession by delaying most tax increases and budget cuts and delaying or modifying some of the most intrusive regulations. A new round of stimulus measures that includes major tax restructuring and infrastructure spending is instituted. A bipartisan plan for long-term fiscal discipline increases confidence. Businesses and consumers take advantage of technological opportunities, low interest rates, and moderated energy prices. Construction begins to recover with renewed housing demand and increased government spending on infrastructure. U.S. banks, with strong balance sheets and modest amounts of loans to Europe, are not heavily affected by the European financial crises and recession. Strong equity prices, bolstered by demand from foreigners seeking a safe haven, boost confidence and add purchasing power. Businesses are willing to take more risks.
Improved U.S. growth somewhat tempers problems in Europe and elsewhere. Europe manages to implement policies to get through its challenges without a deep crisis or creating severe contagion effects. Counterproductive labor rules in Europe are modified, and tax avoidance is reduced. Austerity is modified and more emphasis is place on growth. The slowdown in the world economy abates, facilitated by the temporary resolution of problems and increased public and private investment in several countries.
Implications for GNSS
The most severe consequences for the GNSS industry come in the case of combined U.S.-led and Europe-led recessions, a prospect with a 30–40 percent probability. The reduced contribution of the GNSS industry will in turn impact economies, for which GNSS benefits are great. The effects of deep recession can be seen in the behavior of GPS equipment revenues in North America, which grew 7.9 percent in 2008 and declined by 3.6 percent in 2009, after earlier increases of 17.3 percent in 2006 and 14.5 percent in 2007. Table 2 summarizes the broad implications of the current possibilities for the industry.
Overall Influences
Even if the budget cuts from the U.S. sequestration are delayed or reduced, the Department of Defense faces severe pressures from the remaining 2013 budget and in out years that are likely to cause launches of GPS satellites to be stretched out. Efforts by House and Senate Appropriations Committees to dramatically reduce the civilian portion of GPS funding in the Federal Aviation Administration FY2013 budget, threatening the timing of civil signals and the ground support system, are a sign of things to come. Delays and modifications are greatest in the recession scenarios. In global recession, plans for GPS III crosslink and spot beam capabilities are dropped.
The Air Force has requested funding to develop dual-launch capability for GPS III in its 2013 budget. Budget pressures could lead to a more final decision to proceed with dual-launch within the next two or three years if it can be shown to reduce costs. That could make up for the delays later on, but not before several years of falling behind schedules. Budget-induced delays in other programs could alleviate a shortage of launch capacity in the United States, offsetting some of the impacts of shortages on GPS. However, a slowdown in ordering launch vehicles could negate the lessening of delays. Budget pressures also could result in a reduction in the number of satellites in the GPS constellation below 30, as satellites age and replacement slows. Only 24 GPS satellites are guaranteed. Only in the rebound scenario could launches be on track for the next couple of years.
Budget stringency also affects research and development and production for capabilities that are planned for later years. Military GPS user equipment purchases are stretched out by funding constraints to various degrees depending on budget levels. Military developments could change any aspects of the outlook.
Budget pressures from the European recession could cause Galileo satellite launches to be stretched out and/or the constellation to stop short of 30 satellites. Russia’s GLONASS program is unaffected by budget pressures as long oil prices do not fall dramatically below the $80 level. China’s Compass program is not likely to be subjected to delays due to funding even if the Chinese economy slows dramatically. However, economic weakness does cause delays in Japan’s QZSS system and India’s IRNSS system.
Government budget pressures on both sides of the Atlantic, which are greatest in the recession scenarios, could make resolution of the MBOC patent dispute on the common GPS-Galileo civil signal more difficult and drawn out, adding uncertainty and delaying efforts to take advantage of the common signal.
The impact of economic weakness on private R&D funding for user equipment and services could be substantial in all countries. The private GNSS investment climate is favored by low interest rates, rapid technological change in the industry and in information technology generally, by the evolution of several GNSS systems, and by the growth of markets in developing countries. However, with economies slowing, investment risk remains high.
In the United States, investment in GNSS product and production process development is hampered by political/policy uncertainty, including satellite deployment, spectrum issues, and European licensing demands. Capital investment and merger and acquisition incentives depend significantly on prospects for scheduled tax increases on capital gains and dividends, and for investment and R&D tax credits, but the composition of tax revisions is not predictable in the present political climate. In Europe, private investment is adversely affected by recession and uncertainty about the economic and policy outlook.
Business costs decline in the recession scenarios as demand for materials weakens from many industries and the labor market loosens. Company borrowing costs remain low from low interest rates but can rise because of higher risk premiums from lender concerns about the health of borrowers. Costs start to increase in the recovery scenario.
Percentage swings in profits are much greater than those in revenue, and some firms move from profit to loss when economic conditions deteriorate. Profits fall sharply in the recession scenarios as effects of weakening demand on revenue and unit costs greatly exceed the benefits of lower input costs.
Prices of products such as chips, antennas, and receivers that have been declining over time fall more rapidly in recession. In the early stages of recession, inventories can pile up, but production cutbacks are incomplete at first because of uncertainty about demand. This contributes to declining profits. More extensive cutbacks that follow are insufficient to offset the allocation of fixed costs over a smaller production base for most companies. Competition intensifies as companies adjust inventories and vie for a shrinking market or one that is growing less rapidly than expected.
Mergers and acquisitions tend to be most prevalent at the ends of the economic spectrum. When the industry is in recession, some companies merge to obtain cost savings. In early stages of recovery, it is less expensive for companies to acquire existing assets and companies than to build new. When times are good, mergers often occur because the value of the more successful acquirer’s stock is high relative to the stock of the acquired company, and because of a desire to obtain scarce technology and talent. There may be greater interest in bringing a product that has had a limited market to the acquiring company’s larger customer base when the market is growing more rapidly. Over the last century, merger booms in the United States have largely occurred during stock market booms. Initial public offerings of stock also are more frequent during periods of generally high stock prices.
Mergers and acquisitions can permanently alter the structure of the industry, leading to fewer, more dominant players and redefining customer, partner, and supplier relationships. Some acquisitions may increase pricing power in the long run. More GNSS companies will be owned by firms providing instrumentation, information technology, and other products. Some companies such as Trimble and Hexagon have strategies of making numerous strategic acquisitions; their pace of acquisitions may not vary as much with business conditions as those of more opportunistic acquirers.
Prices of stocks in companies in the industry tend to move with trends in overall stock markets, but also reflect specific industry developments such as product cycles, technology shifts, and sources of competition. For example, some companies that have thrived with GPS may not be the same ones that are most successful in offering GPS+GLONASS receivers to industry. Some European companies may get a head start in making user equipment that takes full advantage of Galileo. However, a slow product market may give some suppliers a chance to catch up in product development.
The shift from consumer receivers to smartphones has reduced the stock prices of consumer receiver manufacturers such as Garmin and TomTom. The Navteq division of Nokia and the TeleAtlas division of TomTom that supply maps have had to face great pressures from new sources of competition from Google, Microsoft, Apple, and others just when they had to deal with economic slowdowns.
Application Sector Impacts
Both business and consumer demand for user equipment decline in the global recession scenarios. In the muddling through scenario, consumer demand for receivers and smartphones is saturating. Commercial demand continues at a moderate pace, spurred by opportunities for multi-constellation equipment. Demand from both businesses and consumers improves in the rebound scenario.
Recession scenarios adversely impact demand for GNSS equipment for survey and construction around the world. A U.S. recession would reverse the mid-2012 fledgling start of a housing recovery, but increased spending on infrastructure would raise public construction spending. In the rebound scenario, U.S. private construction picks up along with other investments. Greater construction spending increases demand for survey and construction applications, with public construction heaviest on road paving and building, and private construction heavier on energy and other engineering construction projects. Telecommunications and information technology are encouraged as part of the emphasis on infrastructure.
A severe outcome for the European economy in the Europe-led global recession scenario stalls growth. Demand for equipment to take advantage of Galileo is slow in the next 2–3 years. In the rebound scenario, European stimulus has only limited impacts on construction because of financial constraints and an overhang of supplies from overbuilding and weakened demand. Financial problems of regional and local governments, for example in the United States, Germany, and Spain, adversely impact construction, especially in recession scenarios. Demand for GIS systems depends both on construction and on government use and is especially sensitive to economic and government budget conditions.
Economic rebound raises commodity prices, increasing demand for agricultural and mining GNSS equipment. In a stronger U.S. subsidy-cutting environment and/or if there are large declines in commodity prices from economic weakness, demand for GNSS agricultural equipment is reduced. Demand for GNSS mining equipment is closely aligned with the behavior of commodity prices, which are very sensitive to economic conditions.
Demands for aviation and marine systems are subject to cyclical influences in both transportation and recreation uses. Demand for scientific uses is heavily influenced by government budgets.
In the rebound scenario, the shift from consumer receivers to smartphones is accelerated as more households are able to afford data plans, and more businesses take advantage of mobile connectivity. In the recession scenarios, receiver markets become saturated more quickly as demand ebbs. Some consumers switch to smartphone use of GPS where it is free, to avoid the cost of purchasing receivers. Nevertheless, smartphone use of GPS grows less rapidly because of a slower shift from unconnected phones to connected smartphones. Purchase of new or upgraded vehicle GNSS systems is more cyclical than the already highly cyclical demand for vehicles, and is further impacted in recession by the availability of phone-based alternatives. Location-based services continue to grow rapidly in all scenarios, with the rate of growth moderated by conditions in the various economies.
Conclusion
The overall outlook is cautious in the face of large potential threats and uncertainties. However, the industry has weathered many storms before, and its long-term outlook remains strong.
Irving Leveson of Leveson Consulting is an economist and strategic planner who has worked extensively on GNSS markets, benefits, and financing. He previously served as director of economic studies of the Hudson Institute and senior vice president and director of research of Hudson Strategy Group. He received his Ph.D. from Columbia University.
