By: Jorge Omar Moreno
and Paula Beatriz Morales

On April 5, 2011, Mexico City mayor Marcelo Ebrard presented a Bill on a new regulation called “Rule 29: Improvement In Equity and Competitiveness Conditions for Public  Provisioning”,  which was added to the city’s Delegation Urban Development Program,  Chapter 4, Territorial Organization, Section 4.5, Organization Rules, Point 4 .5 .2, General Organizational Rules.  The new rule reads as follows:

“Commercial establishments that intend to sell primarily articles that make up the basic basket of staple goods, complemented by clothing and footwear, under the supermarket system, through the use of food retailing establishments, supermarkets, mini-supermarkets or convenience stores, may only be situated in areas whose secondary zoning is Mixed Residential (MR) as well as on land that abuts public thoroughfares subject to some “roadway organizational rule” under which it is assigned MR zoning, as indicated in the corresponding Delegation Urban Development Program.  Commercial establishments that are designated as small dry goods or general stores are exempt from this rule.”¹

Rule 29 creates a monopolistic incentive for tienditas because it creates a legal barrier that impedes the entry of mid-sized and large supermarkets and allows tienditas to be created and to operate in communities that intend to favor small businesses.

In principle, this rule directly contradicts Article 28 of the Political Constitution of the United Mexican States, which prohibits monopolies, monopolistic practices, price controls, tax exemptions and other conditions created by laws by granting monopolistic power to small-retailers over other retail alternatives.  Additionally, the proposed change to Rule 29 mentions that “any concentration or hoarding of necessary articles of consumption in few hands [...] as well as any agreement intended to inhibit free competition between businesses and to oblige consumers to pay exaggerated prices, shall be severely punished.”

The theory of perfect competition is a fundamental paradigm in the study of industrial organization, because it permits us to study the degree of competitiveness of a market and therefore the potential benefits of improving competitive practices in that market in particular.  This model of market behavior is based on four basic assumptions which are shown in table 1.

Table 1.  Basic assumptions of the theory of perfect competition and its relationship with Rule 29.

There are few examples of markets that can be defined as “perfectly competitive” in the strictest sense in economic theory terms; however, many markets display characteristics very close to perfect competition given that participating offerors face very elastic demand curves² or it is impossible for producers or offerors to keep prices higher than the marginal production cost in the relevant market where they operate.

The retail consumer product market, specifically in communities like neighborhoods or small housing developments, does not meet the definition of perfect competition.  Tienditas and supermarkets both take advantage of consumers’ need for the basic products they offer, and since consumers take time savings and transportation costs into account when they weigh shopping options, they may be willing to pay higher prices at a locally situated tiendita than at a supermarket³.

In this case, tienditas in isolated communities are more similar to a monopolistic seller of the staple goods they provide, since if they decide to raise the price of a good that they offer, they needn’t worry about competitors that charge less in their relevant market.  This relevant market is not only defined by the type of goods it offers, but by the distribution of potential competitors in the neighborhood or in proximity to the neighborhood where they operate.

Thus, the proximity of small stores to consumers’ homes, and the need for the buyer to have the article at that moment, generates a degree of monopolistic power that increases with the creation of loyalty to the “brand” (nearby tiendita or established market), and as a result of all of this, the seller can charge a price higher than that of the competition.

The social cost of this monopoly by tienditas, because of the extent to which it inhibits the free competition of supermarkets and mini-supermarkets, results in higher prices in the tienditas and, as a result, the loss of benefits for buyers and the abnormal enrichment of these establishments.  In general terms, there is an irrecoverable loss of efficiency provoked by the power of the monopoly, a phenomenon known as “social inefficiency triangle” or “social loss by monopoly.”⁴

In contrast, in the particular case of supermarkets or mini-supermarkets, prices are set by the socioeconomic group of consumers as well as by their location.  This means that the same line of stores can offer different prices for the same product depending on whether a store serves consumers in the A/B socioeconomic bracket or in the D+ socioeconomic bracket⁵.

But the negative consequences of Rule 29 for consumer well-being stem not only from the way in which it promotes higher prices by inhibiting competition, but in its tendency to limit a shopper’s choices for purchasing other goods or performing other services.

For example, normally consumers value having a number of choices for a single product, since this enables them to buy not just at the price, but also the quality offered by different brands of the same product (for example, milk, bread, eggs, oil, etc.).  With these choices, the consumer can weigh price and quality and decide which is the best option.  This possibility is not available in a small establishment, where the range of merchandise is limited to a few brands, or even a single brand for each type of product.

Furthermore, because consumers value their time and take into account the cost of the distance they must travel, they tend to make bulk purchases when doing their supermarket shopping, meaning they acquire not just one good, but a list of the goods they need.  This is efficient from economic standpoint, because by making only one trip they can minimize the transportation cost and time they spend shopping.  The lack of a mid-sized or large supermarket in a community makes it impossible for shoppers to purchase their entire shopping list, which means higher costs for consumers because they have to make multiple trips to acquire the goods not sold in the tienditas protected by the Rule 29 barrier.

Finally, consumers can take advantage of mini-supermarkets and major stores not only to buy the consumer products they require, but also to take advantage of the complementary services offered, like the payment of utility bills (electricity, water, and gas), loans for durable goods (like refrigerators, irons and other appliances) and other businesses that are often found near the major retail establishment, like bank branches.

Characteristics of supermarkets and tienditas

According to Marín (2004), a food retailer or supermarket is one that sells groceries at retail.  Additionally, they must have annual sales of more than 2 million dollars and have more than 9,000 m² of sales floor area.  The National Association of Supermarkets and Department Stores (ANTAD) defines these stores as a direct-to-consumer system that displays products and articles on open shelving, classified by categories and types, primarily dry goods, perishables, clothing and general merchandise.  They offer the greatest service with the least intervention of personnel and an area for clients to pay, with point-of-sale systems at the exit.

¹ Translator’s note: the terms tiendas de abarrotes and miscelaneas refer to small, single-proprietor establishments that sell basic staple goods and are generally located in residential areas. Because there is no precise equivalent in English, we have used the Spanish term tienditas throughout.

² Elasticity is a measure of the percentage variation in a variable provoked by a 1% increase in the other variable. This is a useful tool for determining the degree of market power company has, by determining its capacity to select production and price based on the demand it faces.

³Becker (1971) calls “total price” the price of a good aunt acquisition cost plus the cost of the time taken to seek it out and consume it.

⁴This social loss would be eliminated if the monopoly-holder were to impose perfect price discrimination, charging each consumer the most that he or she would be willing to pay. However, the discrimination would be a total transfer of the benefits of the relevant market to the business that holds the monopoly.

⁵In Mexico, individuals are classified by income levels and consumer habits into six categories: the A/B bracket is the segment made up of people with the highest standards of living and income in the country; socioeconomic bracket C+ encompasses people with a slightly above average income level or standard of living; the C bracket includes people with middle income or medium standards of living; the D+ socioeconomic bracket covers people earning slightly below the average; the D bracket is made up of people earning a low income with an austere standard of living; and the E bracket encompasses inhabitants of the country at the lowest end of the income and standard of living scale.

Gomez and Setién (2001) say that Mexican consumers have various options for acquiring almost any type of product, since there are various stores formats where there is a wide range of products available.  According to these authors, the advantages of supermarkets over tienditas are the following: because they stock directly from producers, they eliminate extra links in the distribution chain, and therefore offer lower costs; they have greater negotiating power with suppliers, and as a result obtain better discounts and more favorable forms of payment; they achieve economies of scale, and thus reduce their operating costs; they use more advanced technologies, like computer systems, barcode readers and point-of-sale cash registers.  All this makes their operation and customer service more efficient.

Furthermore, because the supermarket segment handles a larger volumes of merchandise, they can offer more attractive prices.  In general terms, supermarkets and food retailing establishments have gross margins of between 20% and 22%; in contrast, tienditas run at gross margins of up to 40%.

Another very important benefit of supermarkets and mini-supermarkets is the increased quantity and variety of goods and services (payment of taxes and fees, purchase of airtime for cell phones, cash withdrawals, etc.).  There is a wide range of brands and extensive product lines, and shoppers can pay with credit cards or vouchers.  Additionally, some supermarkets offer e-commerce and home delivery, as well as phone shopping.

According to information from ANTAD, figure 1 shows purchasing patterns in Mexico City.  Although most of the shopping takes place in supermarkets, the situation varies depending on social class, since more than 80% of the members of socioeconomic brackets A/B and C shop in supermarkets, while people of the lower socioeconomic brackets tend to purchase in established markets and tienditas.

Figure 1.  Consumer shopping patterns.

Figures from the National Survey of Household Income and Spending show that the average household spends 612.96 pesos per week on food, beverages and tobacco.  According to ANTAD, the typical shopper visits these establishments once a week and buys food 5.6 times in a week to complete their shopping.  It is also interesting to note that only 16% of supermarket shoppers change establishments.  Of this percentage:

• 51% do so to obtain better prices
• 30% do so because another establishment is better located
• The rest do it for reasons of variety or selection

These results show that consumers effectively weigh price, quality, and alternatives for the consumer products they decide to purchase, in their decisions.  Thus, because  Rule 29 creates a legal barrier to the entry of mid-sized and large retailers into mixed housing zones, benefit tienditas, but at a high cost to consumers, who have fewer alternatives and choices for acquiring goods and services at a lower price.?

References

Becker, G. S. (1971). Economic Theory. Alfred A. Knopf.

Gómez, V. y Setién, N. (2001). “Tiendas de autoservicios y tradicionales en México”. Tesina. Instituto Tecnológico Autónomo de México. México.

Lassala, R. (2008). “Modelo de análisis cuantitativo para oligopolios”. Tesis. Instituto Tecnológico Autónomo de México. México.

Marín, J. (2004). “Conducta de las empresas en los oligopolios: Tiendas de Autoservicio en México”. Tesis. Instituto Tecnológico Autónomo de México. México.

Nash, J. (1951). Non-Cooperative Games. The Annals of Mathematics, Second Series, vol. 54, núm. 2 (septiembre de 1951), pp. 286-295.

Pindyck, R. y Rubinfield, D. (1998). Microeconomía, 4a. ed. Prentice Hall.

Tirole, J. (1988). The Theory of Industrial Organization. The MIT Press. Cambridge, Massachusetts, y Londres,

Websites

Asociación Nacional de Tiendas de Autoservicio y Departamentales, A.C.

http://biblio.juridicas.unam.mx/libros/2/641/6.pdf f.

Constitución Política de los Estados Unidos Mexicanos, http://www.diputados.gob.mx/LeyesBiblio/index.htm.

Encuesta Nacional de Ingresos y Gastos de los Hogares.

http://www.inegi.org.mx/est/contenidos/Proyectos/Encuestas/Hogares/regulares/Enigh/Enigh2010/ncv/default.aspx.

Gaceta Oficial del Distrito Federal. 20 de Mayo de 2011.

http://www.paot.org.mx/centro/leyes/df/pdf/GODF/GODF_20_05_2011.pdf.

Instituto Nacional de Geografía, Estadística e Informática. Consultada el 4 de abril de 2012. http://www.inegi.org.mx/.

Procuraduría Federal del consumidor. Consultada el 26 de marzo de 2012 y el 4 de abril de 2012. http://www.economia.gob.mx/economia-para-todos-rss?start=14.

Secretaría de Desarrollo Urbano y Vivienda del Distrito Federal. Consultada el 26 de marzo de 2012. http://www.seduvi.df.gob.mx/portal/images/stories/pdf/articulo14/fraccioni/Manual_Administrativo_2012.pdf.

By: Francisco J. Fernández

A crisis raises striking and often contradictory scenarios. Fast food chains rack up increasing profits while long-standing prestigious restaurants are forced to close. Low-cost carriers run solidly in the black while traditional airlines struggle to re-invent themselves and barely skirt the red. But the inappropriately named luxury sector has seen double-digit growth in recent years, in segments as diverse as cars, retailing and real estate.

What place does coaching play in this? Or rather, where does the market place it? Is it a product of mass consumption, or is it an elite but widespread luxury? Is it a strong brand? Is there some permanent place it can aim for, or will it end up being a “cork” service that bobs along wherever the current takes it?

A lot has been said about coaching, both good and bad. My approach to the topic began with hearing comments in personnel or human resources departments. I decided that the best way to learn about it was to talk in greater depth with experts in the field, and before I knew it, I was a certified coach. Since then, besides working in that capacity with people in the business world, I’ve continue to read and speak with coaching professionals, and I think there are questions that can be addressed from both sides of the counter.

The way I see it, there are three things that raise concerns about this discipline, some of them justifiable and some from hearsay: a diffuse, ill-defined methodology that tends toward superficiality; purely short-term results; and finally, the possible hazards of working with emotional aspects.

Let’s begin with the methodology. Objectively, coaching has two facets. First, the process is defined in clear phases, and even has a procedure that may be surprising to some once the details are known. The steps run from introducing oneself to the coachee and how and what to explain about what comes next, to the process of follow-up and closing. Because we’re talking about people and not, for example, nuts and bolts, I don’t think the coaching methodology is any more diffuse than a strategic plan, which is applied once we have conducted the evaluation and other necessary processes to thoroughly understand a company’s philosophy and identity. Yes, there are intangibles, which tells us that coaching is also something of a craft, and they give it value.

Moving on to the second concern, regarding the timing of the method. For obvious reasons, short-term results are the easiest to quantify. In coaching, these results come when the objectives of the coachee and the mirror of the coach are in tune. Normally, coaching includes six to eight conversations of about 90 minutes with mature, trained people, all of them with their own manias, phobias, philias, prejudices and other obstacles. Coaching can modify a behavior, but if we expect someone to change much after these encounters and the work done, we’ve made the mistake of harboring excessive expectations. When the process is deeper (and more prolonged), we can generate a personal transformation. Good coaches have been there. It becomes obvious during the training, and is then transmitted in the relationship and work with a coachee.

The third concern is the psychological impact of working with other people’s emotions. This is something that can happen. People become honest with you, tell you intimate things. They do it because they believe the coach can help them get what they want. That’s why this can happen, because two people are talking, one of them confident that they will receive all or at least enough of the information, and the other confident there is a different way to focus on what is obstructing the other. The same thing happens between a boss and a subordinate, or between two friends. There are no magical recipes or instructions; there is just reflection, and the possibility of seeing things in a new light. And there are always irresponsible people.

Coaching should be associated with a professional development plan, and serve as one more tool for closing the gap between the finish line in a competition, and the real situation. It doesn’t work in every situation or for everyone. There has to be a frame of action. If the sessions are built on thin air, the results will be carried away on the wind.

To attain goals in the professional world, one has to have a thorough technical knowledge of the coaching process. But to be an executive coach requires even more. Sufficiency comes from an affinity with the coachee in his or her environment. It is very important to speak the same language as the other person, because that why you understand each other better.

To conclude, the coaching business needs a standardization and alignment of service through certifications that guarantee a certain minimum. There are already international certification organizations, like the ICF, ICC, IAC and ECI. It is essential that we avoid intruders and separate the wheat from the chaff to position coaching as a serious, professional and well-controlled activity.

In Roland Emmerich’s film “The Day After Tomorrow,” climatologist Jack Hall predicts a sudden worldwide climate change due to global warming. The planet’s momentum was irreversible, and the movie shows us striking images of the scale of the catastrophe. It would not be wise to allow this sort of momentum to take over our profession. It would be much better if it were like what we saw during the transmission of the Annual Awards of the Cinematographic Arts and Science Academy of Spain–The Goya Awards–during which at least two actors thanked their teams, their families and their coaches.?

By: Edmundo Ramírez

Agustín Castañeda

Master Research

According to Master Research, Telcel’s website generates 1,290,000 visitors, or hits, per month, followed by Nextel with 402,000, Movistar with 396,000, Iusacel with 260,000 and Unefon with 95,000.

Comparative data from March 2011 to March 2012 indicate that Nextel was the operator with the greatest increase in the number of hits, with an increase of 95%, whereas Telcel fell by 16.5% and Movistar by 22%.

The mobile phone market in Mexico is composed of five service operators: Telcel, Nextel, Movistar, Iusacell and Unifon. Telcel is the leader with 68 percent of the market share. The number of lines that correspond to the pre-paid option stands at 84 million, while the mixed rate scheme totals 2.9 million lines.

There has been a transformation in communication needs. This change is reflected in the increase in the number of smartphones sold at the end of the first quarter of 2012, which reached 3.8 million. By the end of this year, this figure is expected to increase by 78%, which represents an increase of 9 million above the 5.08 million sold in 2011.

Digital Intelligence, the market research division of the firm Master Research, developed an analysis of user interaction on the electronic websites of the five cell phone operators in the country. Telcel is the company with the greatest amount of traffic a month, with 1,29000 hits, followed by Nextel, with 402,000, Movistar, with 396,000, Iusacell, with 260,000 and Unefon, with 95,000 hits per month. However, the users of Movistar stay longer on the site – an average of 27.3 minutes per user per month. The users of Iusacell stay 12.6 minutes and Telcel customers remain only 10.1 minutes.

Table 1 compares the cell phone service companies operating in Mexico: Telcel, Nextel, Movistar, Iusacell and Unefon, from March 2011 to March 2012.

Table 1. Competition of operators on the Internet

Edmundo Ramírez, director of Master Research, says, “The research that we conduct in the area of Digital Intelligence shows us the profile of the users who visit the operators’ electronic sites. The majority of users are between 15 and 24 years of age, a group that seeks to obtain better equipment. For that reason, information is provided about the characteristics and functions of the different options, in addition to focusing much more on multimedia communication.”

Nextel is unlike the other operators because it is directed toward the business segment, and for that reason the average age of its visitors is between 25 and 34 years, which differs from that of Telcel, Iusacell, Movistar and Unefon. In addition, the age range of most people who interact and relate to the Nextel site is between 45 and 54 years, while for the rest of the competitors it is between 25 and 34 years.

After analyzing and comparing the number of hits in March 2012 to those in March 2011, the area of Digital Intelligence of Master Research found that Nextel was the operator with the greatest increase in the number of visitors – an increase of 95%, followed by Unefon, with 90%, and Iusacell, with 20%. On the other hand, the companies that presented a drop in the number of visitors were Telcel, which fell by 16.5% and Movistar, by 22%.

Table 2. Annual trend of visitors by portal, March 2011 to March 2012.

El equipo de Digital Intelligence de Master Research midió la conversación, la influencia y el tono en las redes sociales. En el caso de las compañías de telefonía móvil, se encontraron los siguientes resultados al 30 de abril de 2012:

The team at Digital Intelligence of Master Research measured the conversation, influence and tone in social networks. In the case of the cell phone companies, they found the following results, up to April 30, 2012:

FACEBOOK. According to the Socialbakers website, in Mexico there are 32,950,780 Facebook users, making it the fifth country with the largest number of subscribers. The penetration in the population is 29.30%.

• Telcel has a fan page with a list of 434,659 “likes,” and has specialized pages on various topics and services like: Ideas Telcel (3,359 “likes”), Rockampeonato Telcel (5,3520 “likes”), Círculo Azul (5,818 “likes”), Equipo Telcel (1,443 “likes”), Servicio Telcel (459 “likes”) and WWF_Telcel (1,707 “likes”).
• Nextel, after its change of image, had 301,000 “likes” on its main fan page. It promotes the benefits of its products through Nextel City, with 612 “likes,” and uploads cultural content with Theater Nextel Del Parque with 1,539 “likes.”
• Movistar has 190,249 “likes” generating dynamics for its fans. It is the third cell phone company with the most movement on this network.
• Iusacell has a total of 120,890 fans (“likes”) on its site. It also has a page dedicated to business, which highlights the fiber optic network called Iusacell Link, with 8,702 “likes.”
• Unefón has 10,308 “likes” on Facebook. There was no other alternative page in this social network.

TWITTER/KLOUT

Twitter, the network with 140 characters, recorded 10.7 million accounts in Mexico. In addition, according to Ramírez, in this study we used Klout to know the degree of influence of the cell phone companies’ accounts.

In social networks, Telcel is the company with the largest number of followers on Twitter and “likes” on Facebook, and has a degree of influence of 66. This company changed its advertising strategy more than a year ago and has channeled the budget allocated to television stations to other media, including social networks.

Nextel comes in second place on Facebook and third in the number of followers on Twitter, with a degree of influence of 58.

Movistar is an interesting case because its activity on Facebook puts it in third place in “likes;” on the other hand, its official account on Twitter only has 8,130 followers, unlike its customer service account that has 43,741.

“Applying the research of Digital Intelligence provides an opportunity to learn about the trends of user online behavior. In addition, it helps to create better marketing strategies and involvement that is appropriate to the needs of the client, as well as to detect hot spots, like brief navigation time, decrease in the number of hits on the website, and the navigation path of our visitors, among others,” Ramírez said.

*Social network data updated to April 30, 2012.

Master Research, the market research firm with two decades of experience, is known for its loyalty to its customers, who define it as a highly reliable company for its competence and involvement in the business of its clients, its research processes aligned since 2004 with quality and ethical standards of the Mexican Association of Market Research and Public Opinion, which was awarded in 2005 the Service Standard for Market Research in Mexico certificate 2.0. Master Research is the pioneer in the development of methodology of competitive benchmarking in Mexico and invests in the training of its staff to keep it always in the forefront. Master Research has a presence on @MasterResearch, and Facebook/MasterResearch, and generates useful information for its followers.?

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rp@masterresearch.com.mx

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Just when it seemed that the world was recovering from its past financial scandals, in only weeks another one emerges.  So far in 2012, first JP Morgan Chase announced the loss of more than 2 billion dollars due to trading errors relating to credit derivatives (in later revisions, the loss was estimated at closer to 9 billion dollars).  A few months later, there was news that the practice of manipulating the LIBOR rate, which was seen in 2008, seems to have continued to the present, and that the world’s largest banks had been understating borrowing costs to avoid revealing their true financial position.  We now know that several banks, among them Barclays, city and J.P. Morgan, submitted incorrect information to the central banks.

Major financial scandals over fraud, mishandling or simple errors of perception are not new.  But the number and frequency with which they occurred in recent years have heavily damaged confidence in the financial industry throughout the world.  The destruction of savings caused by neglect or ethical failures have affected large and small investors alike.

In this disheartening climate, we spoke with Javier Domenech, president of the CFA Society of Mexico, to learn about the global initiatives that the CFA Institute has developed to restore trust in the financial markets.  Javier is also director of long-term debt at BBVA Bancomer Asset Management and Professor in the Master’s degree program in finance at Universidad Anáhuac.  He has 18 years of experience in the financial industry in Mexico and New York.  He has an undergraduate degree in industrial engineering from the Universidad Anáhuac, an MBA from the University of Michigan and has earned both Chartered Financial Analyst (CFA) and Chartered Alternative Investment Analyst (CAIA) certifications.

The CFA Institute and its chapter in Mexico have recently assumed a much more active role in promoting and defending ethical behavior in the investment markets, not only establishing guidelines, but identifying and reporting unethical behavior.  In May 2012, the Institute published a document entitled “The Integrity List: Fifty ways to restore trust in the investment industry.”  The document contains 50 tangible steps through which investment professionals can help rebuild confidence in the industry.  This trust needs to be restored from within and from without, and only daily actions by the professionals that participate in the markets can make this happen.

In your opinion, and in the opinion of the Institute, how did we arrive at such a severe crisis of confidence?  After 2007-2008, it would seem that industry participants completely abandoned their fiduciary responsibilities to their clients and employers.  How did the situation get this bad?

Well, I believe that the crisis of confidence is largely part of the result of what originally generated crisis and got worse from there.  Really, if you see the crisis from the standpoint of the general public, a lot of trust was lost in the financial system.  Specifically, people were hit on two sides.  First, those that invest in real estate lost their home and may have taken a loss, but they also lost money on their investments.  I think it all came from the fact that the interests were highly divided, and everybody was looking out only for themselves.  Everyone was watching their own back.  Every industry just saw its own little piece, without seeing the whole picture.  You have a real estate broker who earned a commission just for selling an apartment, and all he was interested in was that.  You have a person who originates the mortgage and just charges a fee to place the loan, that person is only interested in volume, not quality.  Then you have people who packaged debt, and those people just made money on the volume, and the rating agency charged a commission to rate, and at the end of this chain there was an investor whose only interest was buying paper as long as it was rated.  Bit by bit, the quality of the origination began to deteriorate.  Actually, nobody acted dishonestly in this process, but everybody was interested solely in turning over a high volume of business, without really looking at everything that was happening.

After this, obviously, the industry looked very bad.  A lot of people lost money, their savings, their homes, and then there was the stock market crisis.  Time went by and there is still tremendous disillusionment with the financial industry in particular.  Something else that has been surprising over time is that this crisis has dragged on, and scandals keep cropping up.  The most recent one is the LIBOR rate, which is a very delicate issue because this rate is used to put a price on a great many credits and a great many derivatives.  There are 500 trillion dollars in derivative products whose price is set according to the LIBOR.  The truth is the new scandals keep coming and coming.  With the LIBOR rate, we’re talking about the same dates and probably the same causes of the 2007-2008 crisis.  The problem apparently arose because during the crisis, banks did not want to disclose any of their problems.

In light of the great number of financial scandals, the Institute made a list of what it calls “50 measures to restore trust in the investment industry.”  Basically, the list was put together with industry practitioners.  The Institute brings together a large number of investment industry participants, and that’s how it came up with this list.

So there are errors, there are incorrect decisions and there is negligence in the processes.  Where is the line that separates errors from ethical failures and fraud?  The general public, which is the client of the financial system, wants to know: how much of it is an outright crime, and much is simply human error?

Yes, of course.  Actually, I believe we have to analyze what happened on a case-by-case basis.  But one thing that is very important is to turn around and examine, on a global level, if the little piece that each one handles effectively produces a benefit for society, and if interests are aligned.  There is even a distinction, for example, between the problems faced by the industry on a global level and what is going on with J.P. Morgan, which is a more local problem.  At the local level, we have not seen scandals of this type, and in fact, I think that regulations are much better here.  Local issues are really a whole different matter.

Now, where is the fraud?  I believe you have to analyze on a case-by-case basis, and that’s where the legal system comes in, and this can be very difficult to prove.  I think it is important that in the industry, the people are trained, in principle, and to the extent possible, that the clients’ interests are aligned with the interests of those serving them.

One of the components of the CFA Institute code and standards of ethics is that professionals should do their jobs carefully and diligently, and the processes are well aligned.  The Institute is very insistent on this, and now the “list of 50 steps” underscores the fact that errors cost so much money that doing your job with diligence, care and dedication is actually an ethical issue.  The Institute encourages professionals to take responsibility for protecting the interests of clients and fulfilling their responsibilities with their employers, and avoiding allowing this type of problem or large-scale error to occur.

Obviously, I share in this effort to promote ethical behavior.  I believe that the ethical approach and relevance of this Institute comes from the fact that when professional standards of conduct were originally developed, they were done with an eye to sound business practices.  This was an important topic in which people that were studying finance had to be educated.  With this recent crisis, this issue has become much more important, and for the Institute, it is good to be viewed as a benchmark of high ethical standards in this crisis.  Hence its decision to come out with this list of 50 ways to restore investors’ trust.  Something this Institute is interested in doing is to serve as a kind of “bolder voice.”  In other words, a stronger voice, because before, an ethical person was one who did their job well, but now the position the Institute is taking is that the person must also point out when things are wrong.  This is, I believe, the new direction that this list represents.  Before, it was totally focused on what we should be, and many of the points on the list continue to be about what we should be, but now it also moves us in the direction of becoming a more critical voice about what is wrong in the industry.  It even encourages us to work with regulators on determining where we need stricter regulations, in other words, criticizing.  This criticizing the bad things about the industry is an important point; it’s something that was not seen before.

How did this initiative come into being?  What was the motivation?

The list was first published in the annual conference of the CFA Institute in Chicago in May 2012.  What we did was to seek out ideas from all our members on how we could restore confidence in the investment industry.  We received more than 1500 ideas and then later, through a huge effort, we compiled all these ideas into these 50 points.  Many of those original ideas were probably duplicated or represented two sides of the same case.  Finally, we came out with a list, and the idea is to send a strong signal to regulators, investment companies and professionals to work together and restoring investor trust.  That this be at the top of their list of priorities.

Was the list created in blocks, following the seven ethical standards of the Institute, or was it not necessarily so detailed, presenting general ideas instead?

Actually, they are general ideas.  The code of ethics and standards of professional conduct are list of things that must be done in the industry, and obviously there’s a lot of overlap in many of the points.  For example, the code of ethics contains the obligations to employers and to investors, and one of your obligations to investors is placing their client’s interests above your own, and this is something that you will find both in the code of ethics and in the list.  This is the kind of overlap we’re talking about.  But there are things that are not in the code of ethics and that “the list” says are elements that need to be addressed to restore trust.  For example, the use of social media to publicize your values, writing articles, speaking to the public about ethics, in other words, becoming a stronger, more critical voice on ethics or on ethical topics.  These are important elements for restoring competence, but they are not included in the code of ethics.  Many of the points on the list coincide 100% with the code, like making a commitment to ethics, staying up to date with the latest regulations, knowing and applying regulations, etc.

The first 10 points on the list are in boldface.  Was the intent to give them greater emphasis?

Obviously they wanted to make a distinction about these first 10 points, and I believe these 10 things are the first things that everyone can do.  They are actions that can apply to everyone, while the others depend on the situation.  For example, if you don’t have contact with clients there will be some points that don’t apply to you.  But the first 10 are something that everyone, to the extent possible, can do from where they are.  Even so, although we wanted to place a little more stress on the first 10 points, this does not detract from the importance of the other points and probably, in the specific situation of one professional or one brokerage firm, the subsequent points could be much more important.  We did make a small distinction for the first 10, but it is not a very profound distinction, it’s rather question of stressing that at least we have to act on these 10 tangible steps and try as hard as we can to apply the rest of the 50 within our own sphere of professional activity.

How does the Institute perceive its responsibility as a professional association?  The Institute establishes principles, expresses opinions, but when it comes time to put them into practice, how do you, the certified members of the Institute, view responsibility of housecleaning from the inside?  Have certified members made a pledge, and belonging to the Institute, about taking responsibility for cleaning their own house?

The Institute, as the name indicates, is an Institute.  It was first created as an educational institution and I believe it has been transformed into something that is much more than that.  Part of this transformation was precisely this intent to promote ethical values and, in this sense, the Institute is doing a huge job as well as it can.  First off, it encourages all industry participants to adopt sound corporate practices.  It also urges members to adopt a code of conduct and the integrity list, and maintains very good relations with many regulators around the world.  Our relationship with regulators has been very fruitful, because these are also interested in promoting the Institute’s ethical standards in their markets.  In this regard, there has been a very strong sense of common purpose.  From there, putting this into practice in each of the countless industries and practitioners involved in this market is an additional step.  Working hand-in-hand with regulators enables us to work on restoring confidence from the regulatory standpoint.  In brief, the job this Institute is doing, and our relationships with regulators of all the countries where we are present, are truly remarkable.

Point 36 on the list makes a distinction between “earning money” and “making money.”  How do you see this distinction?

The financial services industry is the custodian of and has a fiduciary duty regarding practically all of the people’s monetary savings.  That is why it collects fees and commissions.  Basically, what this point is saying is that you should try to charge fees and commissions that are appropriate the product or service that you are providing.  Even at the level of the Institute there was a discussion about whether commissions should be charged on highly liquid products, and what commission would be fair.  For example, if you create a huge infrastructure or need a very large infrastructure to reach individual client, may be a commission is justified, but if you’re a small investment office that takes some money and invests it overnight, your cost for doing that is very low, and if you charge very high commission, in that case you would be “making money” but not “earning money.”  If someone is doing that, they might be very profitable, but really the products and services they are providing do not justify charging a consultancy fee.

So this is something that is directed at people who offer financial services, not so much for investors.  What you’re telling us is that on this point you’re insisting that ultimately, you should charge what is there for your services?  If your services require an in-depth analysis, financial engineering, complex structures, then you have every right to charge high commissions and keep some of the returns.  But if, as you explain it, you’re simply investing in overnight treasury certificates with no complicated strategy, the service does not cost much and you shouldn’t charge much for this service.

Exactly.  I believe that in this case it is justified if you do it for the overall investing public and need, like Mexico’s major banks, thousands of branches, then you have to reflect some of this cost in your commissions.  But I believe that each institution is responsible for deciding how much of this cost should be reflected, and put a price on it.

To conclude, now these tangible steps are in writing, what’s next for the Institute?  What is next for the CFA Society of Mexico?  You have recently been appointed president, congratulations, by the way.  What’s next for you?

It’s not very different for the Institute and for the Mexican chapter.  If you are a “bolder voice,” you need to be heard by the right people.  Who are the right people?  The first ones that are going to hear you, and this is pretty easy, are the members of the Institute, and is important that the members play an active role in the Industry.  Industry participants in general are those who are more involved in implementing ethical practices in the elements of the integrity list.  At the next level are regulators, who also have an interest in promoting these standards through ethical education, and regulators must also encourage competencies.  This is done by issuing regulations, rules, and sanctions for those who do not exercise ethical practices.  Also, the Institute has a good relationship with universities, and I believe that is another way we can pursue this ethical orientation.

At the level of the Society in Mexico, I want to point out and recognize the great job that Ana Cecilia Reyes Esparza did at the event commemorating the 50th anniversary of the CFA Institute and the 20th anniversary of the Society in Mexico, on May 29.  There was a panel in which Ana Cecilia commented to regulators on this integrity list.  She read through some of the points that seemed personally more important to her and mentioned that she would turn the list over to regulators for them to become familiar with it.  This was very good way to disseminate the list in Mexico, because every peso that is invested and regulated in Mexico was present and represented at that event.  Participating institutions included the National Retirement Savings System Commission (CONSAR), the Mexican Bankers Association, the National Banking and Securities Commission (CNBV) and the National Insurance and Bonding Commission (CNSF).  Practically every area of finance in Mexico that is regulated was present at the event, in addition to the chairman of the Mexican Stock Exchange.  This forum seemed to me very interesting as a starting point for promoting the list and we obviously will continue to promote it in all the events we organize as a society.

Any final remarks?

I’d like to thank you for this opportunity, and point out that the local level, as an industry, we are in a much better position than many other financial industries around the globe.  I’d also like to commend Mexican regulators for their good work.  Perhaps something I would like to see particularly at the local level is more competition in the industry. But, in general,  all the participants we have here in Mexico–banks, pension funds, mutual fund managers and investors–are all reasonably well regulated and it is important to bear this in mind. About this list, there is always work to be done in restoring trust in the financial industry, but in Mexico this trust is not in as bad shape as it is in other parts of the world, and even seeing it from the inside, I myself have a lot of confidence in this industry and in the people who are working to make sure we continue to earn this trust.

References

CFA Institute Integrity List:50 Ways to Restore Trust in the Investment Industry, mayo de 2012. http://www.cfainstitute.org/about/vision/serve/Pages/integrity_list.aspx

Code of Ethics and Standards of Professional Conduct, http://www.cfapubs.org/doi/pdf/10.2469/ccb.v2010.n14.1, CFA Institute, junio de 2010.

Standards of practice handbook, 10th edition, CFA Institute, 2010. http://www.cfapubs.org/doi/pdf/10.2469/ccb.v2010.n2.1

About the CFA Institute and the CFA Society of Mexico

The mission of the CFA Institute is to lead the investment industry in establishing the highest standards of ethics, education and professional excellence. The organization provides education to investment professionals using its Global Body of Investment Knowledge(TM), which encompasses all aspects of the investment profession, including ethics. At present, the CFA Institute offers two education and accreditation programs: The CFA program, which offers the title of Chartered Financial Analyst® (CFA®), and the Certificate in Investment Performance Measurement (CIPM), which offers the title of CIPM®.

The CFA  Institute has more than 110,000 members in more than 135 countries, 90% of them CFA certified.  In Latin America and the Caribbean it has more than 1,200 members, including 87 members in Mexico. Our members are employed in a wide variety of positions and include professionals in investment portfolio management, research analysts, executive directors, consultants, investment banking analysts and account managers.

By: Ma. Fernanda Gómez

There is no disaster that can’t become a blessing, and no blessing that can’t become a disaster.

Richard Bach

Our planet has been hit by countless disasters in recent years.  Devastating earthquakes, volcanic eruptions, floods, hurricanes, tsunamis and other events have put humanity to the test.  Most recently, on March 11, 2011, Japan was struck by the most intense earthquake in the last 140 years, 8.9 points on the Richter scale.  A crushing wall of water swept away rice fields, flooded villages, tore homes from their foundations and leveled everything in its wake.  This was no mere accident; it was an unexpected event that practically destroyed the country.  Little more than a year after this tragic event, Japan is barely beginning to recover.

But the fury of nature, despite the human tragedy that it causes, would seem less dangerous than what we ourselves do as a species.  What better example than the recent and persistent debacle in the financial markets?  Volatility and skittishness in the markets have shaken the largest and most prestigious corporations and institutions in the world and have tested Latin American, Asian and European countries at various moments.  Who would have thought that General Motors, the age-old automotive giant and creator of prestigious brands like Buick, Cadillac and Chevrolet, would be on the verge of collapse, or that Lehman Brothers, the fourth-largest investment bank in the United States and with more than 150 years of history, could crumble from one day to the next?  The social, productive, political and economic implications of the markets’ vulnerability have proven a costly burden for society.  What exactly has happened?

What history tells us

Some years ago, financial crises were the result of current-account problems.  What often happened was that a country might have a trade deficit because of an overvaluation of its currency, and over expansion of its economy, or both.  Then the countries would run up debt and have little money to pay the interest; reserves were rapidly exhausted and there were no available loans.  Savings levels were low and inflation rates relatively high.  As a result, a devaluation or recession would improve the situation of national accounts, but this had an inevitable impact on families’ pocketbooks.

More recent crises, like Mexico in 1994-1995, have also affected the private sector and its financial health.  In these cases, borrowers found it impossible to refinance their debt and the financial system verged on collapse.  In Mexico’s case, factors like excess confidence among investors with the signing of the North American Free Trade  Agreement (NAFTA) fueled an excess of credit, an unrestricted inflow and outflow of capital, and a lack of regulation, oversight and transparency, which weakened the financial structure and led to a deep recession, collapse and later bailout of the system.  Interest rates rose, the peso devalued and many families and businesses went broke.  The cost was equivalent to 14% of the country’s gross domestic product.  Many lessons were learned: the banks were sold off to foreign investors, the regulatory framework was strengthened, monitoring was perfected and today we have a banking system that meets international criteria for liquidity, solvency and capital sufficiency.

Mexico’s crisis had little impact on the international financial architecture.  But the Asian crisis, which began with the devaluation of the Thai baht on July 2, 1997, fueled a wave of turbulence that affected eastern Asia and other countries like Argentina, Brazil and Russia.  It also unleashed a chain of devaluations in the region and an unprecedented plunge in the stock markets of various countries.  At the corporate level, the expansion of bank lending to the private sector was excessive.  Much of this debt was in foreign currency, at short terms, and was used for long-term investments in foreign currency, creating a mismatch in both expiration terms and currency denominations.  Vulnerability was also created by the derivative market risk of leveraged positions in high-risk financial assets.  The weakness of the banking system and lack of market discipline encouraged excessive risk-taking.  Weak prudential regulations and dubious accounting practices enable banks to hide their real situation, even though they were on the verge of bankruptcy.

Traditional economic indicators, like economic growth, inflation, trade deficits and reserves, were no longer enough to explain the real situation.  Indicators of financial vulnerability of the nation or a business became more important.  Participants began to insist on developing an appropriate body of regulation with adequate capitalization level and continuous oversight; the Basel Committee on Banking Supervision issued a first guide on Bank corporate governance.

A few years later, history repeated itself with a new financial disaster: the subprime crisis of 2008.  Companies that seem solid collapsed.  The breakup of Lehman Brothers, the acquisition of Bear Stearns by J.P. Morgan, the sale of Merrill Lynch to Bank of America and the bailout of AIG all once again revealed how vulnerable the financial system had become, and chaos was inevitable.

The reasons behind this new crisis involved economic, financial, institutional and regulatory factors.  Among these were the following:

• Current account imbalances in various countries.  Asian and exporting countries had surpluses, while the United States, the United Kingdom and several European countries had a deficit.
• The increasing sophistication of financial instruments, which make them difficult to value and more risky, while low interest rates elsewhere in the market drove investors toward these high-yield instruments.
• An expansion of mortgage credit to families in the United States and the United Kingdom, accompanied by relaxation of credit rating standards and an initial rise in real estate prices.
• An increase in bank leverage and the development of an unregulated parallel banking system (called the “shadow banking system”), with deep positions in securitized mortgage credits and related derivatives.
• A lack of liquidity in the system, as the volume of financial instruments grew more rapidly than economic activity and outstripped the financial system’s capacity to raise enough liquidity from its deposits.
• An incompatibility between executive bonus and incentive systems, risk management, and internal controls.

The result was a weakening and loss of confidence in the financial system, which fell into a profound economic recession from which it has still not entirely recovered.

In 2010, two years after the subprime crisis, a crisis began in the euro zone.  What seemed like a dream has become a nightmare.  The very validity of this monetary union, intended to eliminate exchange-rate crises, promote growth and multiply the economic power of Europe, is now being questioned.  The system worked for two decades, during which time a less productive companies, like Greece, Portugal and Spain, came up to the levels of their more productive peers, like Germany and France.

The purchase of luxury cars and beach houses, construction of airports, highways and hospitals proved to be a fleeting satisfaction.  Today, Greece is bracing to exit the euro zone.  The Spanish government and banks are facing tremendous challenges.  Italy does not know how much longer it can hold on.  Among the biggest difficulties facing the euro zone are:

• High debt levels and budget deficits in some countries of the zone.
• The weakness of the European banking system in an economy heavily dependent on banking.  According to figures from the European Banking Federation, in November 2010, the percentage of bank assets to total financial assets in Europe was 75%, while in the United States it was only 25%.
• Economic recession and high unemployment in some countries of the euro zone.
• Persistent trade balance weakness within the euro zone.
• Differing opinions between Germany, France and the European Central Bank on how to respond crisis.
• The lack of a true fiscal and financial union.

Some factors seem similar to those of other crises and, as on previous occasions, the banking system is involved, despite regulatory changes, complex financial models and studies on corporate governance.  Why?

What makes banking different from other industries

The basic role of banks is to serve as middlemen between  parties offering and demanding funds, and channeling those resources to more productive activities.  This contributes to the growth of the country and the well-being of society (Figure 1).

Figure 1.  The traditional role of banking

In this process of intermediation, there are two characteristics that define banking operations and make them unique:

1. Qualitative transformation of assets.  The banks, in their traditional function, attract resources from savers at short terms and low risk, and turns them into loans that it extends at long terms and high risk.
2. Brokerage operations.  The bank has the capacity to develop economies of scale, with which it can obtain and analyze information efficiently, and facilitate economic transactions.

Only banks can conduct these activities efficiently.  The model seems clear and simple; but the current situation shows this is not the case.  What has happened?

Regulatory changes, globalization, the advance of technology and appearance of new participants and instruments in the financial markets have all led to a sweeping transformation of the basic functions of banks.  Today, banks act as investment banks by placing instruments, speculating as brokerage firms, and seek to place the greatest number of loans in order to improve their returns.  They have become large, complex financial institutions (LCFI) that are difficult to manage, regulate and monitor.  For example, the five largest banks in the United States are: J.P. Morgan Chase and Company (JPM), Bank of America Corp. (BAC), Citigroup Inc., Wells Fargo and Company (WFC) and Goldman Sachs Group Inc.  These banks had 8.5 trillion dollars in assets at the end of 2011, equivalent to 56% of the US economy, according to the Federal Reserve. Their large-scale international businesses make them more dependent on market stability, so liquidity and market risk are increasingly correlated and risk management becomes even more important.  The system requires strong international cooperation to supervise their activities, and it would seem that regulations have not progressed toward this mandate.

Unlike other companies, what jeopardizes banks are the following characteristics:

1. The qualitative transformation of assetsleads banks to operate with an imbalance between the term of the assets and the term of the liabilities; this is known as a maturity gap.  The former are long-term, illiquid, and high risk; the latter are short term, low risk and highly liquid.  For any other company, this would create liquidity problems and would be unsustainable.In this case, the banks are viable, but their survival depends on their access to an ongoing flow of liquidity through the deposits themselves, short term financing in the interbank market or with the central bank asking as lender of last resort.  If this does not happen, they can face serious liquidity risks.
2. Capital structure.  Banks are highly leveraged financial institutions that can have up to 85% more of debt in their capital structure, while industrial companies generally have only as much as 40% in debt, with a significant portion at short terms.  Banks also do business by placing a large number of long-term loans, which means they assume risk and charge interest in return.  The banks seek to finance these loans or assets as cheaply as possible through deposits.Financial theory predicts that when we increase leverage, risk rises, which means savers and shareholders demand higher yields.  But does this really happen?  Perhaps shareholders in the financial markets do demand higher premiums; but it would seem that the savers who deposit their money to organize their daily transactions do not monitor the process appropriately.  This is in part because there is a safety net (insurance deposit) that makes them less sensitive to banking risk than other investors, and therefore they do not ask for a satisfactory compensation for the risk assumed.  Also, banks can raise cheap funding, which encourages the availability of attractive investment opportunities that might otherwise not appear.
3. Bank balance sheets are more “opaque” then those of non-financial firms.  Bank assets are not clearly observable and it is difficult to determine the quality of a loan or the investments made.  In industrial company, for example a carmaker, a group of individuals can determine the quality of the vehicles, but the same thing does not happen with a loan or deposit.
4. There is a significant interrelation between joint operations in the banking system.  In contrast to non-financial firms, Banks’ competitors can be “commercial partners,” which increases counterparty risk and generates a major systemic risk.  Systemic risk occurs when a trigger event, like the failure of the company, provokes a chain reaction that affects other institutions, the market, and the economy at large.  The banking system is particularly vulnerable to systemic risk, because problems can spread from bank to bank, to the financial system, to the economy and to other countries.  It is also an industry that is closely related to the productive sector.  A weakened banking system cannot finance company growth; in turn, a weak corporate sector hampers the development of the banking industry, as we saw in the Asian crisis.
5. The nature of assets and the risk profile can change rapidly when firms hold portfolios of derivative instruments or securities with options attached.  This is possible because complex derivatives are exposed to risk factors that make them sensitive to market conditions.  Banks may renegotiate loans with those who cannot pay, making the work of rating agencies more difficult.
6. Finally, banking firms are highly regulated and monitored institutions, because they are sources of systemic risk.  The objective of regulations is to avoid problems of moral hazard and adverse selection resulting from the asymmetry of information.  Despite the progress in efforts made, recent events have revealed some major loopholes in both control and supervision.  In response, a new prudential framework has been created for bank capitalization levels, an important part of which is liquidity and operational risk.

What remains to be done

It would seem that crises are increasingly frequent, global and long-lasting; they require difficult and radical decisions to remodel international architecture.  Whether the result of an economic cycle, disequilibrium in the balance of payment or the sophistication of markets, investors and financial systems, the costs are enormous.  If we cannot avoid crises, what can we do to contain them once they arise?

• Banks are part of the system, and their objectives, elements and interdependence should be congruent with the interests of all participants.
• Regulation is one element in the system, but it is not the solution. The regulatory framework should be clear and transparent, but we must also watch out for overregulation or the proliferation of complex and unnecessary rules.
• Economic analysis should be incorporated into Prudential regulation, because the two are closely related.
• Financial models, methodologies and techniques can help us to understand and measure risk, but they are not a crystal ball. Understanding, interpreting and making decisions depends on who makes the decisions, on what criteria, and for what objectives.
• It is impossible, and inordinately expensive, to eliminate all risk, but we must try to keep it at tolerable levels.
• The function of the banking system will continue to evolve. Financial innovation must go on, because this is just as important in the financial system as it is in any other industry.

?

Referencess

Kaminsky, Graciela, y Reinhart, Carmen M., “Financial crisis in Asia and Latin America: Then and now”, American Economic Review, vol. 88, mayo de 1998: 444-449.

Musacchio, Aldo, “Mexico’s Financial Crisis of 1994-1995″, Harvard Business School Working Paper, núm. 12-101, mayo de 2012.

Nelson, Rebecca M., Belkin, Paul, et al. “The Eurozone Crisis: Overview and Issues for Congress”, Congressional Research Service, mayo de 2012.

Mulbert, Peter O., “Corporate Governance of Banks after the Financial Crisis – Theory, Evidence, Reforms”, EGCI Working Paper, abril de 2010.

By: Gerardo Weihmann and Esteban Figueroa

Infrastructure projects, whether developed by the public sector or by private enterprise, are complex and have a tremendous impact on society, so they require careful planning, particularly when each project is not replicable, but is rather sui generis..

Every problem of complex nature presents at least one of the following properties: i) multiple attributes; ii) large number of factors; iii) more than one decision-maker; and iv) uncertainty. With respect to this last property, uncertainty exists when we are unbable to predict with precision the result of a future event; however, only uncertainty that has a significant impact on the well-being of individuals can be considered a risk¹. Thus, all risks entail uncertainty, but not every uncertain event entails risk. Peter L. Bernstein sustains that the revolutionary idea that marks the boundary between the past and the modern age is the understanding and quantification of risk.¹ The capacity to manage risk enables us to make more rational decisions, and this has been the driving force in technological progress, economic growth and improvements in quality of life for all humanity.

Considerations on the development of infrastructure projects

Every infrastructure project, but particularly those that Mexico needs today, involves the following key factors: i) a comprehensive vision and long-term strategy for the different types of infrastructure projects across the nation; ii) the ability to address a social problem or situation; and iii) environmental protection.

Comprehensive vision and long-term strategy

In today’s world, both technological and social changes have been accelerating almost without interruption, and as the pace of change increases, so has the complexity of problems and with it the time needed to solve them. This increase in the speed of change makes problems more variable and reduces the lifespan of any given solution; thus when we finally seem to have found a solution to a certain problem, the problem has changed so much that the solution is no longer effective or becomes irrelevant.

Russell Ackoff notes that until recent times, changes were slow enough to give people time to assimilate them, either by making occasional minor adaptations or by simply accumulating and transferring them to the next generation, for it to deal with these changes. In the past, because changes put no significant pressure on individuals, they did not receive the appropriate attention. Today, adaptation to accelerated change, both at the business and government levels, requires more frequent, greater and more effective adjustments, both in what is done and how it is done. With the growing inter-connectivity and interdependence of individuals, groups, organizations, institutions and societies, the environments have become much more complex and less predictable, in other words, more turbulent.

The time that elapses between the stimulus and the response leaves room for crisis situations to emerge and develop. Ackoff also says that a growing proportion of society’s responses to the problems it faces are reactions, born out of desperation, not proactive initiatives, born out of deliberation. Furthermore, solving a problem correctly requires finding the right response to the right problem; many times, the failure of a given solution lies more in the misidentification of the problem than in a poor solution to the right problem.

In the past, every problem of complex nature, like an infrastructure project, could be broken down into simpler problems that could be managed by different disciplines. Thus, every discipline solved part of the problem and all these partial solutions were once again integrated into a single solution, in which the total was equal to the sum of the parts.

But with the increasing complexity and interrelatedness of the components of a problem today, this method of optimizing each component separately no longer brings us to the best total solution. Consequently, in both public and private strategic planning, we must incorporate a systemic view, in which the system is divisible from a structural standpoint, but from a functional perspective it is indivisible, in the sense that when separated out into components, it loses some of its essential properties. Thus, the performance of the system depends critically on how well each component works and how they all fit together, not simply how well each component works separately and independently.

With this in mind, infrastructure projects require comprehensive, long-term strategic planning, that seeks to maximize financial and economic returns of resources, which are generally much less than those required to meet all the needs of the population. So, besides deciding on the optimum allocation of the scant available resources, we must necessarily clarify, at least, another three key purposes of this planning process:

• Adapt the private or public entity to deal with both future threats and opportunities, identify relevant strategic options and adjust to its environment.
• Integrate strategic activities to magnify strengths and minimize weaknesses in order to attain goals as effectively and efficiently as possible.
• Create a learning system so that human resources can benefit from the feedback of strategic decisions made in the past.

¹ The development of the mathematical theory of probability is recent, because it only began to emerge around the middle of the 17th century, when French nobleman Antoine Gombauld, also known as the Chevalier de Méré, put a series of questions to mathematician Blaise Pascal regarding games of chance, and Pascal exchanged ideas with his fellow mathematician and lawyer Pierre de Fermat.

We therefore need to specify clear strategic objectives and prepare detailed strategic programs to create the infrastructure each sector most requires. We must also prepare detailed budgets to control strategic and operating activities. In Mexico’s case, these programs must be planned to transcend each six-year presidential administration, extending for at least the next 25 years, to determine when, where and what type of project will be executed, both initially and in subsequent phases. Finally, because we cannot administer what we cannot measure, we must establish monitoring and control systems, as well as incentive systems aligned with the objectives and the programs created. This process is more complex when dealing with the public sector than the private sector.

The process of strategy definition requires us to identify, measure, and manage risk, and to implement techniques to find an optimal relationship between risk and return in infrastructure projects. It is also increasingly necessary that we have a systemized process for reviewing risk management strategies.

Identify: Find the greatest risks, which requires a comprehensive view, because there may be one risk that has a negative correlation with another, so that its negative effect would be partially neutralized by the opposite effect of the other.

Measure: Quantify the exchange ratio between the risks, their costs and likelihood of occurrence, and the benefits of different infrastructure options.

Manage: There are different ways to manage risk, the most prominent of which are:

• Avoiding risk
• Controlling risk to reduce its negative impact through actions taken previously, concurrently, or after the appearance of the event.
• Absorbing risk, including the option of deferring a decision when there is not yet available some relevant information that might be accessible in the immediate future and that could change our decision if we were to decide at this time.
• Transferring risk, which is a strategy that is generally the most efficient in economic terms.

Implement: Apply the selective strategy, with an eye to minimizing its costs.

Review: Systematically review strategies for infrastructure projects, because it may be that when all the answers are finally in place, the questions have changed.

Addressing social problems

Mexico is the world’s 11th largest economy in terms of gross domestic product;² but in terms of income distribution, in the year 2011 this country had a Gini coefficient (an indicator of income inequality among inhabitants) of 51.7.³ This indicator was 48.2 in the year 2008.

This inequitable distribution of wealth and regional disparities pose a serious problem for Mexico. Mexico City, Campeche and Nuevo León present much higher levels of development than the states of Guerrero, Oaxaca and Chiapas. It is primarily because of this disparity that in 2011 Mexico ranked second in the world in terms of wage remittances from abroad (22.73 billion US dollars), coming in only behind India (56.43 billion dollars), but above China (19.80 billion dollars). These revenues also represent the nation’s second largest source of foreign revenues, after oil exports (56.43 billion dollars) and greater than tourism revenues (11.66 billion dollars), which accounted for 2.0% of GDP in 2011. Infrastructure is highly necessary, though not in itself sufficient, for reducing this regional disparity.

Mexico’s 115 million inhabitants comprise 29 million families, almost three-quarters of which live in urban areas. It is estimated that in half a century, the number of families in urban zones will double, while those of rural areas will have grown by only around 30%. So, Mexico faces the challenge of doubling, in less than 50 years, the urban environment that it has created throughout its entire existence and also modifying the prevailing socioeconomic framework of the rural sphere to reverse this trend of migration toward major cities, with an effort to reduce inequality, exclusion and extreme poverty and ensure alimentary self-sufficiency. Infrastructure projects are key to meeting these challenges.

Creating new sources of jobs is also a pressing need, because it is estimated that out of 46 million Mexicans that currently earn a wage, 20 million are employed in the informal sector of the economy. So, in the same 50 year period, our country faces the challenge of increasing its supply of formal jobs to incorporate at least another 60 million Mexicans.

Although major infrastructure projects bring significant benefits to Mexican society as a whole, at times the incremental costs exceed the corresponding benefits at the local level. Adding to this asymmetry is the presence of outside economic and political interests, which further complicate the societal problem, reduce economic efficiency and may even lead to the project’s cancellation, even though it may be feasible from a technical, financial and economic standpoint. It is essential that we promptly and effectively address any potential social problem with a proactive, rather than reactive, vision, before it grows and becomes more complex.

There are a number of possible strategies for reducing negative societal effects; some of which are: i) maintain direct and constant communication with local leaders, seeking to involve state and municipal governments, because they are more familiar with the idiosyncratic problems in the region than the federal government and because otherwise they might sabotage the project; ii) open the possibility of new jobs and training for the inhabitants of the communities by developing new activities related to the infrastructure project, both during the construction phase and during its operation; iii) undertake complementary works not directly related to the project but which benefit the community, like schools, health centers, new roads, bridges and interchanges; sewage and water supply, electrical energy, and others.

Environmental protection

In infrastructure planning, the issue of environmental sustainability has become an inevitable concern, both nationally and globally, in light of increasingly stringent environmental legislation. We must analyze and incorporate environmental considerations into the project, starting from the planning and design phases, and their costs, which are also steadily rising, must also be factored into the financial and economic evaluation of the project. Inappropriate environmental management of the project, like ignoring the societal aspects, could punish the financial return on a project and, in extreme cases, lead to its cancellation for lack of budget resources.

² Ten years ago (2001) it was the ninth largest economy in the world.

³ Maximum equality in income distribution is indicated by a coefficient of zero, and maximum inequality is indicated by a coefficient of 1.00 (all income concentrated in a single person). Sweden has the lowest coefficient: 0.23, and Namibia the highest: 0.70. The more developed European countries and Canada have Gini coefficients of between 0.24 and 0.36. The average Gini coefficient for the world is estimated at between 0.56 and 0.66.

Need for human resources

Technology cannot in itself produce development. It must be accompanied by increasing productivity among workers. For Ackoff, development bears little correlation with the accumulation of wealth; it does not depend so much on what one has, but on what one does with the resources at hand, in pursuit of a continuous improvement in quality of life. Project development requires the ability to develope and apply knowledge; it requires the ability to adapt to both internal and external change.

Around the world, engineering and its importance as a driver of development must be better understood, both by those in charge of developing and enforcing public policy, and by society at large. This need is even greater in times of global financial crisis, because infrastructure projects can have multiplying effects that trigger and lead economic reactivation and job generation.

The United Nations Millennium Development Goals state that science, technology and engineering are the pillars of every socioeconomically sustainable development, because they can reduce poverty and attenuate climate change. The UNESCO’s first world report on engineering⁴ concludes that today more than ever, the world needs solutions contributed by engineering, particularly in developing countries. The current and projected supply of engineers is not up to the level of this growing demand for engineering skills, a problem magnified by “brain drain” from these countries. The reduction in the number of young people, particularly women,⁵ studying engineering is not limited to developing countries. In Germany, the number of engineering students is declining and in Denmark, one study estimates that by the year 2020 there will be a deficit of 14,000 engineers. In Japan, Norway, the Netherlands and South Korea, since the end of the last century, enrollment of engineering students has declined by between 5% and 10%.

In contrast, many young people are focusing on finance and other fields of study not related to science and engineering, in which wages and benefits are often more attractive, but ourthese are professions that make no sense without the existence of productive projects, developed from based on scientific knowledge and technological application.

The quality of higher education and professional training is also a source of concern. According to the World Economic Forum 2012, Mexico ranks 72nd in this category and 114th in terms of labor market efficiency.

Impact of infrastructure investment

The Executive Board of the International Monetary Fund saidstated in 2011 that it is crucial for Mexico to undertake ambitious structural reforms to increase productivity and promote investment. The success of these reforms lies in the ability to make labor markets more flexible, improve access to credit for small and midsize businesses, generate greater work opportunities in the formal sector and improve regulations on competition, while strengthening corporate governance in state-owned enterprises.

In its August 27, 2011 number 27, the British magazine The Economist reported that economic growth in Mexico in the last 15 years, albeit unspectacular, hads been significant. The article also pointed out that Mexico could have seen stronger performance had it not been for monopolies and cartels, both private, governmental and union. In the year 2008, the OECD reported that the lack of competitiveness in Mexico places a substantial drag on its economic growth, citing, for example, that 30% of household spending goes to markets that are either monopolies or where competition is limited, while companies face high input costs that directly affect their sales prices.

An infrastructure development plan, as good as it may be, is not enough to change this momentum. We must start from a view of reality, perform an accurate diagnosis and take measures to modify what is necessary. Although correcting this lack of competitiveness requires in-depth legislative changes and political will, intense investment in infrastructure is also crucial, particularly given that the Global Competitiveness Report 2011-2012 ranks Mexico 66th in the world in terms of infrastructure quality. Of the nine variables that make up this index, mobile telephony and electrical supply earned the worst ratings, coming in 96th and 83rd., respectively.

Although infrastructure projects are regional, they have nationwide effects. Investment in these projects, both public and private, through joint public- private partnerships, bring a series of benefits to society as a whole, including:

• Supporting the integration of the national territory and helping to create productive chains as a way to make the country more competitive.
• Magnifying international opportunities for the benefit of the nation, creating a logistical platform that takes advantage of our geographic position and Mexico’s network of international treaties.
• Encouraging sustained development and productive activity, including tourism (the country’s third-largest source of foreign currency revenues), which reduces regional socioeconomic imbalances.
• Increasing and improving access to public services and promoting education, health and housing, particularly in the neediest areas of the country.
• Generating new needs and driving other investments.
• Intensively promoting direct and indirect jobs.
• Joining short-term challenges and immediate actions to put people to work in quickly developed, efficient projects (water, drainage, housing, highway maintenance) as a countercyclical measure, with long-term strategies and development plans that facilitate and accelerate the generation of human capital, the basis of productivity and growth.
• Protecting and preserving the environment.
• Helping to prevent and mitigate natural disasters.

Conclusions

Infrastructure projects provide an instrument for articulating public policy strategy toward a set of interrelated objectives. Promoting any productive activity that can help turn the current economic and social situation into the desired and idealized future, requires a modern and efficient infrastructure. It also encourages the development of financial markets, because behind every financial instrument, an intangible asset in the economy, there must always be a productive structure that generates real tangible wealth; the former cannot subsist and flourish without the latter.

In the last decades of the 20th century, there was a pressing need for infrastructure and a number of structured projects were planned, but there were serious financial limitations for their execution, particularly in developing countries. Now, however, the start of the 21st century, global financial markets enjoy a certain liquidity, which is awaiting investment options. Unfortunately, investment opportunities in infrastructure have been scarce because of the lack of professional capacity to develop them. This scarcity is the result of a bias in education toward disciplines that support production, like law, systems development, finance and marketing, among others. It is urgent, then, that we align the need for infrastructure with the available financial resources and professional training, so that we can develop projects at the pace society requires.
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About the authors:

FIGUEROA PALACIOS Esteban:

General Director AFH consultores y asociados, S.C., a consulting firm specialized in planning, financing and management of infrastructure; as well as associations public and private and risk analysis infrastructure investments. Professor of Planning at the Faculty of Engineering at UNAM. Civil Engineer from the Faculty of Engineering at UNAM, Master of Science in Civil Engineering in Infrastructure Planning and Administration at Stanford University.

EIHMANN ILLADES Gerardo Johannes:

Associate Consultant at AFH consultores y asociados, SC, a consulting firm specialized in planning, financing and management of infrastructure; as well as associations public and private and risk analysis infrastructure investments. He has experience of more than 23 years as a Professor at I.T.A.M. Professor at School of Law, Panamericana University, for 15 years. Civil Engineer graduated with honors ( Gabino Barreda Medal of University Merit) at UNAM, Faculty of Engineering. Master of Science in Civil Engineering, Infrastructure Planning and Management at Stanford University. Master of Management Science and Engineering at Stanford University, and Master in Business Administration at Pennsylvania University.

References

Ackoff, Russell L., Creating the Corporate Future, John Wiley and Sons, 1981.

Ackoff, Russell L., Redesigning the Future: A Systems Approach to Societal Problems, John Wiley and Sons, 1974

Banco de México, Informe Anual 2011, Banco de México, abril de 2012.

Bernstein, Peter, Against The Gods: The Remarkable Story of Risk, John Wiley and Sons, 1996.

Bodie, Zwi, Merton, Robert C., Cleeton, David L., Financial Economics, Pearson Prentice-Hall, 2a. ed., 2009.

Central Intelligence Agency, The World Factbook, 2011.

Colegio de Ingenieros Civiles de México, Infraestructura Estratégica: Programa para el Desarrollo de México: 2007-2030.

Colegio de Ingenieros Civiles de México, Planeación Estratégica de la Infraestructura en México: 2010 – 2035, México, Universidad Nacional Autónoma de México, Instituto Politécnico Nacional, Universidad Tecnológica del Valle de Chalco, Secretaría de Educación Pública, 2009.

Hollloway, Charles, Decision Making Under Uncertainty: Models and Choices, Prentice-Hall, 1979

Lorange, Peter, Corporate Planning: An Executive Viewpoint, Prentice-Hall, 1980.

OCDE, The Mexico-OECD Co-operation to Strengthen Competitiveness in Mexico, 2008.

Piña Garza, José, Políticas Públicas y Acciones de Fortalecimiento para el Desarrollo de la Infraestructura en México, documento inédito, agosto de 2012.

Presidencia de la República, Programa Nacional de Infraestructura 2007 – 2012, julio de 2007.

⁴ UNESCO: “Engineering: Issues, Challenges and Opportunities for Development”

⁵ Worldwide, in the last two decades of the 20th century, the proportion of women with engineering degrees went from 10% to more than 20%. But starting in 2000, this portion began to decline again, and in some countries, the figure is now less than 10%.

By: Nathan Moussan

Introduction

The purpose of this article is to provide an analysis and diagnosis of the current status of the Mexican corporate debt capital market and its recent evolution, and on this basis, to the weigh the benefits for companies of obtaining short and long-term funding through the debt capital market.  The public market offers many opportunities to guide mid-sized and large companies in assembling a package of measures for managing their liabilities, in order to obtain different funding alternatives, and thus to improve their financial costs.

Companies take on debt for many reasons.  The main reason is that debt can be cheaper than internal financing, because, generally speaking, investors demand higher yields.  The company’s management must decide how and where to raise the funds they need to attain their growth goals, whether through private sources, loans from financial institutions like banks, or through the public markets, which involves placing securities on the debt capital market to be acquired by investors.

Issues of corporate debt in Mexico generally take the form of Certificados Bursátiles or  debt certificates, which provide operating flexibility by enabling companies to obtain funding through one or more issues within an overall placement program.  The company can decide on the most appropriate amount, timing, and characteristics for each issue.  They can also set the size and general payment conditions, such as interest rates.

Background

The international financial crisis that broke out in United States in 2007 with the subprime mortgage debacle produced structural changes in the way Mexican corporations raise funding.  In September 2008, with the announcement of the breakup of Lehman Brothers in the United States and Comercial Mexicana’s default in the Mexican market, access to bank credit dwindled a mere trickle, and issues of commercial paper became the only available source of funding for some investment-grade firms, although the financial costs were high and the terms extremely short.

But thanks to support programs introduced by the Mexican federal government in 2009, like partial guarantees from the Sociedad Hipotecaria Federal (Federal Mortgage Agency) and NAFIN/Bancomext, Mexico’s corporate debt market recovered more quickly than expected.  In that same year, Mexican corporations were able to restructure most of the financial liabilities that had experienced payment problems.  Non-bank banking institutions called Sofoles dealing in mortgage loans ceased to be one of the most important sources of funding and many of them went to default.

In 2010 and 2011, most issues were long-term, fixed-rate paper, placed by corporations with different rating levels to take advantage of extremely low funding rates in Mexico.  Starting in 2012, banks have become once again more involved in the lending activity, because institutional investors have been more selective with corporations and have been investing only in high-grade credit issues.

Evolution of Mexican corporate debt

Most Mexican corporations that were facing short-term debt maturities, lacked liquidity or external sources of financing ended up restructuring their liabilities to extend their maturities to longer tenors.  Although lenders were rewarded with higher spreads, much of the restructures were based on floating rates, so in a cycle of declining interest rates in Mexico, funding costs have dwindled overall.

Additionally, major corporations that already had a healthy financial position and liquidity took advantage of the downward cycle of Mexican interest rates, and in 2009 these corporations were highly active in the debt capital markets, issuing long-term debt and raising low cost funding to finance long-term projects.

The Mexican corporate debt capital market has undergone sweeping transformations and gone through a boom in recent years thanks to a stable macroeconomic climate and low interest rates. It has withstood the recent turbulence of the global financial crisis and is receptive to issues with the highest credit rating.

In 2010, a record 253.3 billion pesos went out on the Mexican debt capital market, from issuers such as Pemex, America Móvil, Telefónica, Peñoles, Televisa, among others.  Investors showed a keen interest in corporate issuances, acquiring a heavy volume of debt issues in diverse sectors.  In spite the prevailing climate of market volatility, in 2011, total placement volume on the long-term corporate debt capital market declined by 11.2%, totaling 224.90 7 billion pesos.  In the first seven months of 2012, debt issuances once again dropped from the year-earlier period, due to the absence of recurrent issuers such as Pemex, financial institutions, and structured issues.

Meanwhile, the amount of commercial paper-with issue terms of up to one year-outstanding on the market also diminished sharply starting in October 2008, after reaching its highest level in recent years in August 2008, when the outstanding amount was 76.95 billion pesos. In 2009, outstanding amounts were lower than their year-earlier levels, because corporations, particularly in the automotive industry, stayed out of the debt market, and the climate remained difficult for mortgage sofoles. The financial crisis dried up market liquidity, increased spreads and reduced the size of offerings placed by major issuers.

Since the crisis broke out, only issues with the highest credit ratings have been able to access the debt capital market.  This phenomenon was caused partly by some high-profile defaults: Comercial Mexicana, Metrofinanciera and Hipotecaria Crédito y Casa, which caused investors, both institutional and retail, to become more cautious about the financial strength of the companies in which they invest.  Issues rated AAA account for 76.9% of outstanding private debt amount, while issues rated AA+ and AA account for only 12.2% of the total volume.

The market has recently seen a preference for longer term fixed-rate issues, taking advantage of low interest rates.  Of the current issues of long-term corporate debt, 65% are denominated in pesos and remaining 35% in UDIs (inflation-indexed “investment units”). Floating-rate issues make up 46% of the total (pegged to the 28-day TIIE), inflation-indexed issues 35% and fixed rate issues 19%. Furthermore, 81.0% of the outstanding amount of long-term issues is represented by only 10 issuers.  The largest proportion of outstanding debt on the local debt capital market corresponds to state-owned enterprises like Pemex, CFE, and Infonavit, which account for 34.0% of the total, followed by financial institutions and banks, and then telecommunications firms.

New products

New products have come out of the Mexican market since 2009, like equity certificates known as CKDs or Certificados de Capital de Desarrollo, which attract financing from institutional investors, primarily pension funds and insurance companies, and channel it to trusts, which in turn support projects with long-term growth potential, such as infrastructure, energy, real estate, industrial, toll roads, or private equity to support for mid-sized companies with the potential for medium-term growth.

CKDs are hybrid equity-long term debt securities, similar to equity instruments in that there is no obligation to pay principal or interest.  The yields on these securities are tied to the profit generated by the assets, goods or rights, and their holders are entitled to the products of the investments made, or the proceeds of their sale.  CKD issues do not require an official rating of their credit quality, nor of the issuing trust or trust creator.  At least 20 individual investors must participate in each placement, and the issuer must comply with the corporate governance regime that grants rights to minority bondholders.

This new asset class implies a higher risk, but also offers higher potential yields.  Today, 20 CKD issues have gone out on the market, totaling 50.40 billion pesos.  The most important thing is that the complexity of these instruments is translated into a language more easily understood by investors.

So far in 2012, four CKD issues totaling 8.20 billion pesos have been placed.  These issues began legal documentation filing in 2011, enabling them to negotiate in advance with pension fund managers. The issues have incorporated adjustments to the regulatory framework regarding the mechanisms of capital calls, minimum number of participating investors, and pension fund investment criteria.

Institutional investors

The Mexican debt capital market has grown in recent years, and one of the main reasons for this has been the expansion of institutional investors’ portfolios.  Pension funds called Afores, mutual funds, insurance companies, corporate pension funds and bank treasuries have all substantially increased the amount of their assets under management available for investment. As of June 30, 2012, these institutions had a total of 4020 billion pesos, 815 billion of which were invested in corporate debt, or 21.0% of the total amount.  The main bondholders are  the Afores, which held 32% of the total amount of corporate debt outstanding.

Generally speaking, liquidity runs high on the local debt capital market.  The Afores receive an ongoing inflow of contributions from workers and have found few investment options beyond government and financial institutions’ debt.  At the close of June 2012, total assets under management by institutional investors (pension and mutual funds) totaled 3169 billion pesos, equivalent to approximately 20.4% of Mexico’s GDP (estimated as of the second quarter of 2012).  This is 15.7% higher than in the same period of 2011.

Conclusions

In general terms, the local debt capital market enjoys a high level of liquidity, because there is a strong demand from investors but a limited supply of new issuers; however, the base of investors in Mexico is highly concentrated, compared to international markets.  Pension funds portfolios are heavily diversified across various types of assets, issuers and regions, because of a widespread easing of investment regimes, including authorization to invest in productive projects, which has allowed them to obtain attractive yields while in turn serving as a source of funding for Mexican companies.

References

INEGI, Estadísticas Históricas de México, México, 2012, disponible en http://www.inegi.org.mx.

Banco de México, Estadísticas, México, 2012, disponible en http://www.banxico.org.mx.

Bloomberg, Página principal, disponible en http://www.bloomberg.com. (Última consulta, 3 de agosto de 2012.)

Bolsa Mexicana de Valores, S.A.B. de C.V. México, 2012, http://www.bmv.com.mx.

Boletín Estadístico de Banca Múltiple, Comisión Nacional Bancaria y de Valores, junio de 2012.

Graphs and tables

Gráficas y Tablas

By: José Frank González

There are no desperate situations, only despairing people in certain situations.
Tibetan proverb

Negotiation can be defined as the interaction between two or more parties designed to bring their different positions closer together and to reach an agreement that is beneficial to all.

Negotiation starts when differences exist in the positions that the parties have maintained. If their positions coincided, there would be no need to negotiate.

Negotiation seeks to eliminate these differences, usually by gradually bringing positions together until they reach a point that is acceptable to all. To initiate a negotiation, all affected parties must show an interest in reaching an agreement. If one party is unwilling to come to an understanding, then there cannot be a negotiation.

A rule that should govern any negotiation – and which makes it much easier to reach an agreement – is respect for the other party. The opponent should not be seen as an enemy that must be beaten. On the contrary, he should be seen as a collaborator with whom you are going to work closely together to overcome existing differences and reach an acceptable agreement.

It is important to understand that when you negotiate you confront problems, not people. You need to seek an agreement that meets the needs of everyone involved. However, this fundamental rule is often not respected and the negotiation becomes a fierce struggle in which each party tries to impose their point of view, looking to get the maximum benefit at the expense of the opponent. In this case, the chances of reaching an agreement are significantly reduced, and even if reached, there are certain risks:

• That the losing party does not comply with what is agreed.
• That the losing party complies with the agreement but is unwilling to ever negotiate again with the winning party, which makes it impossible to establish lasting economic relations.

In short, you need to find an equitable solution that takes into account the views and interests of all parties involved. In this way, everyone considers the agreement as his or her own, not as an imposed solution. In addition, all will be satisfied with the negotiation, with the intent to comply with what is agreed upon and with interest in maintaining this professional relationship that has proved to be so beneficial.

This way of understanding negotiation based on cooperation may not be shared by the other party, which seeks to impose their particular confrontational style. You must not fall into this trap. On the contrary, you need to continue seeking collaboration, trying to convince the other party of its advantages.

In his book Getting Past No (1991), William L. Ury presents a five-step strategy for conquering the obstacles that prevent cooperation, that is, to reach a joint solution to the problems in each negotiation. To achieve this cooperation and satisfy your interests as well as those of the your counterpart in a negotiation, the author points out that you must overcome five obstacles to achieve an agreement that satisfies all:

• One’s own reaction. The problem that one confronts in negotiations is not only the uncooperative behavior of the opponent, but also one’s own reaction to this behavior.
• The opponent’s emotions. Negative emotions that the other party may have in the negotiations, such as fear and lack of confidence.
• The opponent’s position. People’s tendency to stick with one position and try to make the other person give in.
• The skepticism of others. This occurs when others cannot see the benefits of an agreement. Although the interests of the other person are met, he fears losing face for having given in.
• The power of others. If the other party sees the negotiation as a matter of winning or losing, this becomes a very difficult situation because he will seek any means to defeat the others.

According to Ury’s book, the best way to overcome these five obstacles is to implement the strategy of penetration. The negotiation of penetration is the opposite of imposing a position on the other party. Instead of harping on a new idea in the exterior, stimulate the other party so that he envisions it within. The essence of this strategy is indirect action. It is not directly opposed to the opponent’s strength, because the negotiators of penetration treat their adversaries as partners.

Although this strategy delivers excellent results, the success of any negotiation depends on preparation. Even if the negotiator knows the strategy perfectly well and has mastered each of the steps, if he is not prepared for the negotiation the chances of success are significantly reduced.

Preparation time depends on the importance of each negotiation. How much time you spend on preparation is related to how much you value the interests that are at stake in a negotiation.

Preparation for negotiations begins with planning to reach an agreement that is satisfactory to both parties, taking into account the following points:

Interests

Interests are the intangible motivations that lead a negotiator to support a position. They are his needs, desires, concerns, fears and aspirations. You first must decipher your own interests and give them priority. You can achieve this with simple questions like: Why? Why would I want this? What is the problem I want to solve? Subsequently, you must decipher the interests of your counterparts because the most important skill of a negotiator is to put themselves in the shoes of another. Someone who does not understand the way other people perceive situations will never succeed in the negotiations.

Options

Options are necessary; insisting on a single solution or a single position is a common error in the field of negotiations. When there is an opening to consider several options, new possibilities open up and increase the possibility of satisfying both parties.

Rules

The use of fair rules that are independent of the interests of both parties prevents a power struggle that could erupt into a conflict, and transforms the selection process into a joint search for a just and satisfactory solution.

Alternatives

All good negotiators must know their BATRA: Best Alternative To a Negotiated Agreement. This BATRA is one alternative that the negotiator must use as a last resort. There are three steps to obtain the best BATRA:

• Identify the BATRA
• Promote the BATRA
• Decide if it is necessary to negotiate or if the BATRA is preferable before any agreement can be reached in the negotiation
• Identify the BATRA of the other party

Proposals

The difference between a proposal and an option is the commitment. A proposal is an agreement that the negotiator is willing to accept in its entirety. Here are guidelines for formulating a proposal:

• Aspire to something big, always realistic but big; in other words, aspire for something that is within the framework of the law and within the possibilities of the negotiation itself.
• Prepare a retreat, which is the minimum agreement that you are willing to accept.
• Devise a stop sign; an agreement that barely covers the minimum interests and that will serve as a warning of a possible bad agreement.

The objective of a strategy of penetration is to remove the obstacles that exist between the no and the yes to make an agreement satisfactory to both parties. The goal of any negotiator is not to beat their counterparts, but to win them over.

Strategy of Penetration

First step. Do not react: Go to the balcony

Suppressing your instincts and not reacting to the counterpart’s behavior is the first step that any negotiator should put into practice to reach a satisfactory agreement that meets the interests of both parties. The most common responses are to react, give in, or break off relations.

You should analyze things objectively. To achieve this, the negotiator should be able to observe the negotiation from the outside, separate himself from his impulses and emotions, and devote himself to obtaining his interests in a fair manner, that is, to consider negotiating from another point of view, from the outside, by “going to the balcony.”

The negotiator must identify if the other party is immersed in some of the following techniques in order to neutralize their effect: stonewalling, (take it or leave it!), threats, dirty tricks or lies.

You should never allow anyone to pressure you into making quick decisions. Some ways of gaining time are: pause and silence, repeat the tape, take notes, procrastinate, and request a recess.

Second step. Do not argue: Put yourself in your opponent’s place

Negotiators must create an atmosphere that is conducive to the joint solution of problems. They should disarm the opponent by doing the opposite of what the counterpart expects. The other person expects that the negotiator will act as an adversary, so he must stand by his opponent’s side, recognizing his interests, points of view and emotions. The foregoing involves three things:

• Listen carefully to what the other party says. When your opponent feels as though he is understood, you have created an atmosphere that will change the course of action. Use patience and control, and do not interrupt.
• Recognize the opponent’s point of view, his feelings and prestige, and the need for recognition, and create a favorable climate for the agreement. It is not necessary to agree with him, only to understand his point of view.
• Give in as often as possible. Direct the conversation toward the points where both parties agree, turning an antagonistic discussion into a sensible dialogue.

Third step. Do not reject: Rethink

Rethinking means diverting the other person’s attention away from his fixed position and directing it to identify interests, devising creative options and discussing fair rules to make choices.

Once the negotiator has managed to put himself in the shoes of his counterpart, they will attack the problem together, acting as partners rather than rivals. This will allow the negotiator to better understand the options of his counterpart, and instead of rejecting them and strengthening one position, he will rethink them seeking the satisfaction of all interested parties.

Fourth step. Do not pressure: Build a golden bridge

Resistance can manifest itself in several ways: lack of interest in your proposals, ambiguous approaches, delays, lack of follow through or direct rejection. To overcome it, try to draw the other person from his position, without pressuring him, in the direction that the negotiator wants to go, starting from where he is at.

This step involves presenting an easy path for the other person to follow, taking him from his original position toward an agreement that is beneficial to both parties. You must be aware that by taking this path, the counterpart may lose sight of the benefits that he will receive from the agreement if he feels defeated. The negotiator can help the other party save face and make it appear as though he came out ahead.

Fifth step. Do not attack: Use power to educate

Instead of using power to force the other to his knees, use it to help him come to reason.

When the counterpart does not want to reach a joint solution to the problem, it is likely he will try to utilize his power to try and make the negotiator yield. You should use the necessary restraints to avoid falling into the trap of the other party. It is very easy to rely on threats and coercion, but they only lead to blind alleys. The negotiator must show the other party that he cannot win on his own – he needs to work together.

Conclusions

Two people are needed to negotiate, but only one is needed to unravel a complicated situation. That is the role of a negotiator as he searches for a joint solution to a problem, with a spirit of cooperation and with a willingness to meet his interests and those of the counterpart in a fair manner, as partners rather than rivals.

You should make an effort to resolve difficult issues through interests. The important thing is not to impose conditions on the other party, but to guide him so that he makes a fair decision that meets the interests of both sides.

Preparation is essential in a negotiation. You cannot reach a negotiation without being prepared. Do not fight over all the details because it is important to maintain good relations.

Corollary

Key Points

• Keep an open mind. Understand the other party.
• Ask if he subscribes or signs.
• In Mexico, one does not ask for recesses.
• Negotiating is the beginning of new relations.
• To negotiate, you must have an objective.
• Do not think of “winning at all costs,” but “in all fairness.”
• Negotiating is to give and receive, give and give (the majority remain here) and receive and receive.
• It is not a question of intelligence, but of boldness.
• Expert negotiators first speak about the environment and then about what they are going to negotiate.
• You should develop a negotiating agenda.
• BATRA: Best Alternative To a Negotiated Agreement.

Myths about Negotiation

• Good negotiators are born with the skill.
• Experience is the best teacher.
• Good negotiators take risks.
• Good negotiators rely on intuition.

Successful Negotiation

1. Satisfies interests: ours (good), theirs (acceptable), others (tolerable).
2. Commitments are well planned, realistic and operational.
3. It is fair for all; no one is surprised.
4. It is one of the best options and not a compromise solution. The solution to a commitment is to renegotiate; in this case, you must ask in exchange for what.
5. The process is efficient when there is good communication.
6. The process helps to establish a permanent relationship.?