Hysteresis is a phenomenon in which a temporary change in one factor causes a longer-lasting change in another (which is technically called remanence). The concept which originates from physics (and which applies to climate controls, for example) has many applications in economics and business worth investigating.

Many economists, including Larry Summers and Olivier Blanchard (1986), argue that the natural (long run) rate of unemployment rises after a prolonged period of high unemployment rate (as experienced in Europe in the early 80’s), thereby structurally affecting an economy’s output potential. In other words, unused labor production capacity erodes itself over time, which implies that aggregate demand can influence aggregate supply. Concretely, according to sources cited by the Fed, the level of potential output in the US may be 7% below what it would have been based on pre-Great Financial Crisis trends. Larry Summers argued in 2017 that the massive monetary stimulus required over eight years to move the economy towards a pale 2% growth rate and full employment validates the thesis whereby going back to the original, pre-shock equilibrium is hard work—due to hysteresis (see home-made charts below).

Now, it may also be possible that growth, once engaged, drives the global output beyond the currently assumed potential. Hysteresis can work in reverse according to a 2016 speech by Mrs. Yellen: ‘Increased business sales would almost certainly raise the productive capacity of the economy by encouraging additional capital spending, especially if accompanied by reduced uncertainty about future prospects. In addition, a tight labor market might draw in potential workers who would otherwise sit on the sidelines […]. Finally, albeit more speculatively, strong demand could potentially yield significant productivity gains by, among other things, prompting higher levels of research and development spending and increasing the incentives to start new, innovative businesses.’ A high-pressure economy could lift the economy’s output potential in a lasting manner.

In business, hysteresis is observed in marketing and competition according to findings summarized in an M.I.T. Sloan article. Its author uses many examples to demonstrate that a significant, albeit temporary change in market stimuli (e.g. an aggressive price reduction associated with a marketing campaign blitz) can lead to a permanent change in market share. In the words, the fundamental perception and positioning of a company can be changed by an exceptional ephemeral marketing boost if well-timed. Recognizing hysteresis in marketing may help a company grow in bursts rather than in increments. Or fend off competitors seeking to implement such a strategy.

Building on these observations, there are implications for equity stories and more generally investor communication in Diversified Industrials (and beyond). Hysteresis suggests that a high profile marketing push (triggered by some large M&A activity, for example) could be used to fundamentally reposition a company and capture a greater share of investors’ mind in a lasting fashion. This may not be a reason to engage into large acquisitions per se, but at a minimum, the opportunity to heavily market a sizeable M&A move as a truly transformational one should never be missed.

Make hysteresis a friend since it can be a powerful enemy!

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