Dane Chamorro, an American consultant based in Singapore, explains how companies are continuing to misjudge some of the risks involved in global expansion.
We live in a world of global companies, global supply chains, global 24/7 media coverage and daily analysis of the growth prospects of emerging economies. Yet, the truth is that expansion into a foreign market, whether moving from East to West or from West to East, is no easy feat.
Systemic differences make for different business rules
Despite all the books and articles about the lure of emerging markets (EMs), it is a challenging experience to step out of your own business norms and culture and operate effectively in a developing world economy.
Even at the most basic level, systemic and cultural differences can trip leaders up, with anything from how local governments operate to the appropriate time to arrive at a meeting (you’ll want to be punctual in Tokyo, while everyone in Jakarta understands jam karet or “rubber” time due to the traffic jams). At the macro level, political, regulatory, reputational and corruption risk can be more than daunting, but understanding them can make the difference between success and failure. An example might help.
Some years ago, I was advising a retail grocery group about entry into China. We went through the usual checklist of fundamental questions: what is your existing business model and how might it work in China? Should you consider joint venture partners or licensees? Is the talent you need available locally? Why are you doing this and why are you doing it now? What is your key advantage, what can you bring to this market that no one else does? People sometimes get stuck in an “EM growth” mindset and then “deal destiny” takes over – that is, you’ve started the deal so it will conclude. But there is a vast difference between EMs, so, for example, differentiating between why you would consider an investment into India vs China – two very different markets despite their similar sizes – is a key question.
It turned out that this retail company was seen as a high-quality provider in Europe and wanted to bring that capability to China as its key differentiator for a market that is highly sensitive to food quality issues. It was also after growth, of course, given that OECD market growth in the sector was typically no more than 1%. We explained to them that in their current market, the top 10 players (of which they were one) supplied 80% of the market; in China the market was much more fragmented, with only 8% of the market supplied by the top 10. They would need a new value proposition and a sizeable investment to be successful under these very different commercial conditions. They nodded “yes, yes” but without really listening – it was clear that they had their instructions and they were already on to execution phase. They entered the market with a local partner, but pulled out after two years. They could not make a success of it by using the same business model that worked so well for them at home – and they blamed it on the “complexities” of China. This illustrates what I would always explore with a prospective investor at a first meeting – get the strategy right first.
The tactics, such as who is your best joint venture partner, can follow.
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The basics: what is EM risk?
When assessing risks, work from macro to micro, starting with the jurisdictional environment within which the business will be operating.
Start with some basic questions:
- What is the government structure and how does it operate? (one-party state, messy democracy, centralized or federal, etc); What are the politics like – party or personality-based? How does the government fund itself? (Most Asian countries have a low tax base and collection is highly corrupt.)
- Is there a competent bureaucracy? Is it pro, neutral or anti-business? (for example, in India and Indonesia, socialist sentiment is strong). How capricious? How corrupt?
- Is my industry regulated? (Even seemingly innocuous sectors like retail are regulated in Asia); If so, is it transparent? Does my regulator own my largest local competitor?
- Is there a functioning court system that can enforce a contract? Is it subject to inducements (for example, can judges be bought)?
- Is there local currency exposure? (A good guide is the Bank for International Settlements’ trade-weighted value of currencies). Are profits repatriatable? How do foreign exchange regulations work?
- What are the corporate ownership structures (most Asian businesses are either state-owned or family businesses, even if they are publicly listed)? Are there a few families/cronies that dominate key sectors?
- What are the infrastructural and logistics challenges? How is land acquired and/or how do leases work?
- How free is the media, social or otherwise? Does it have an anti-foreign bent? Does it shape public opinion or regulation?
- Is there activism of local communities, religious groups, labour unions, NGOs?
The answers to these questions provide a basis from which to understand the macro environment. It also never hurts to study the history of the place to understand the sensitivities – for instance, neither Thailand nor China were formally colonized in the last century, yet while the Thais are quite proud of maintaining their independence compared to their neighbours, in China the period from 1850 to 1950 is considered a source of national humiliation and a sore point.
Visitors to the countries will find these alluded to routinely in conversation and it helps to have the context in mind so as to avoid alienating your counterparty. You can see this playing out now in Chinese government accusations against foreign companies for “gouging the Chinese people” on the prices of some products.
Then you can progress to the “micro” side involving your particular industry, investment or business interest – for example, type of investment structure, business model, sales structure, manufacturing/distribution model, human resources, licensing, and so on (see Figure 1, page 45).
The best-managed firms do these assessments as a matter of routine, with or without external assistance. A small number even understand that it is not just the direct risks to their business, but also the vicarious risks posed by third parties acting on their behalf. This may be the freight forwarder that pays a bribe to a customs officer to clear your shipment or it may be a key supplier that is located on a flood plain and suffers a total loss of business in a particularly bad Monsoon season (this happened to a lot of companies in Thailand in 2010).
But very few companies do these assessments on a rolling basis and, as a result, they are often caught unawares when the political or regulatory environment shifts or when their country manager secretly colludes with a competitor or vendor.
Successful incumbents keep alive to change
Sometimes, even successful incumbents get caught out. Let’s take a look at the healthcare industry in China.
There is a number of global healthcare companies that have built successful businesses in China – but now the operational environment has changed and it is largely down to politics. The reason is simple. EM consumers are highly sensitive to increases in the cost of living, especially in daily needs – items such as mobile telephony, health- care, education, transport and food. A sudden rise in the price of onions has brought down an Indian government (this means the government fell because it was not able to control inflation in a basic food staple). China’s Communist Party is highly sensitive to its history – the battle against hyperinflation was a significant factor in winning urbanites to the CCP against their Nationalist Party adversaries in the late 1940s and also played a large part in the Tiananmen incident of 1989.
The Chinese government has been messaging healthcare reforms for many years and passed new legislation dealing with corruption in health- care in 2010. But it is China’s new leadership under Xi Jinping and Li Keqiang that came to office with a necessary goal of introducing some tough reforms across the economy – including a liberalized financial sector.
And to do that in any system, the leaders need to have the support of the people. The best route to garner support is to go after what irritates your constituents – high prices driven by those firms that have pricing power. It is even better if those firms happen to be foreign multi- national corporations, because they do not have the rear guard political connections that China’s state entities do. Politics by any other name – but with a uniquely Chinese twist.
The good news is that China’s government is relatively efficient compared to some others
like India’s or Indonesia’s and, if you under- stand how to listen, the changes are broad- cast for a long time in advance before they are put into action. The bad news is that if the state turns its attention to you, it can be ruthlessly efficient at achieving its goals – and Chinese enforcement agencies, be they anti-trust authorities or the police, do not work like their Western counterparts.
Unfortunately, established corporate structures are not always open to change, or open to changing fast enough. If your business model is, or has been, based on big top line growth in EMs to bolster the corporate P&L, revisiting the business model and reducing growth estimates can make for some difficult conversations with the board. Add to this, the fact that China is not a traditional EM – it is the world’s largest economy managed by a Leninist bureaucracy steeped in 3,000 years of Chinese history with an increasingly sophisticated PR capability and riddled with corruption. Most managers with EM experience have never dealt with anything like it.
A taxonomy of risk
The challenges facing companies that want to do business in Asia can be arranged into four broad areas based first on whether the investment is new or existing and then by the nature of the issue (macro or micro or both). In the previous case of the food retailer, the business issues were about the pre-market entry challenge of business model adaptation to a new market (macro) and due diligence on potential partners (micro) (see Figure 2).
Healthcare companies operating in China are dealing with the post-entry issue of a politically-driven change in the regulatory landscape (macro) coupled with the integrity of their business processes (micro) – for example, bribing doctors to promote their brands.
If you are selling soap powder, how important are you to the government? Answer, not very – so if you have a problem with your contracts, suppliers, partners, and so on, no one in a position of authority is going to assist. What if you are building power stations? More so, and you get more assistance “protection” as a result.
All politics are local – so are ethics
A good example of this, is a question asked by a Chinese national at a presentation by the Securities and Futures Commission (SEC equivalent) in Hong Kong; “Why is insider trading illegal?” This question, almost unimaginable in the West, reflects a fundamental difference in perceptions of what is right, fair and ethical. Some companies suspect or discover that their local management is involved in some form of self-dealing, conflict of interest or malfeasance with outside vendors. The first question to consider is what your policies say about the issue under scrutiny and whether you have trained people on the policies. We tend to assume that these “rules” are obvious, but they stem from a very Northern European ethic that is not shared by most of the globe.
Again, you may encounter these “unwritten rules” on the macro side just as easily. A financial services company was considering opportunities in Myanmar. The company representative said: “Myanmar is a medium-term opportunity, right now I need to know what’s not written down about getting a business licence in Singapore because I know only 90% of what I need to know is in the regulations.” Smart – even in a highly transparent environment like Singapore there are still unwritten rules.
The not-so-secret secret is to do your home- work or in the words of Solomon: “With all thy getting, get understanding.”
● Dane Chamorro is a managing director at Control Risks and has more than 20 years’ experience in the Asian region. He regularly advises strategic and portfolio investors on political and partner risks, corporate governance and high-profile business disputes. He is a fluent Chinese speaker and an honours graduate of both Georgetown University’s School of Foreign Service and the US Army Intelligence School.