Category Archives: International Strategy

Multinationals Struggle in Emerging Markets: Wash, Rinse, Repeat

A recent article in the Economist highlighted the struggles of developed-country multinationals in emerging markets (see Emerge, Splurge, Purge). Multinationals struggling in emerging markets is nothing new. The surprising part to me is that we still haven’t learned our lesson from years of mistakes. Every wave of emerging market investment seems to be justified by some variant of the “this time will be different” meme—i.e., the opportunities are limitless and the risks are diminished. We’ve witnessed this type of behavior in the investment run up before the 1997-98 Asian financial crisis; the irrational exuberance leading up to the 2007-08 global financial crisis; and now, in the period of central bank easy money and yield chasing in the wake of the global financial crisis. But now, every time the Fed utters the word “taper”, markets in the emerging world wobble and multinationals suddenly discover that profitability in emerging markets has failed to live up to expectations. According to the Economist:

American firms made a 12% return on equity in 2012…But having grown fast, profits are now falling…There has been a long bout of share-price underperformance…Western firms with high emerging-market exposures [have] lagged the broader S&P 500 index by about 40% over three years…The emerging-market rush may end up like a giant version of the first internet boom 15 years ago. 

The decline has been broad-based. Current laggards include some of the world’s largest, and best known, companies. For example, Proctor & Gamble’s global margins are half of its U.S. margins, and its performance in emerging markets is especially weak. Not only that, but Western multinationals have struggled in the previously high-flying BRIC economies—China, India, and Brazil, in particular.  The root of the problem:

During a boom every firm thinks it can be a winner, leading to excess investment and saturation. The more capital-intensive the industry is, the greater the pain in store for its weakest members…most Western businesses have low gearing… Without their emerging-markets pep pill many firms would have dire revenue growth. The developing world has supplied 60-90% of the growth of Europe’s big firms in recent years.

One comment here: Growth is not the same thing as profitability. And managers often conflate the two. But beyond the obvious pursuit of growth, expressions of managerial hubris, and increased market volatility, multinational managers often make poor decisions about the underlying risks they will take on in emerging markets. Globalizing companies tend to systematically overestimate the benefits of entering emerging markets while underestimating the costs. This is because developed country multinationals bear heightened political, economic, regulatory, and cultural risk in emerging economies. And those risks are not adequately priced. As I’ve written before (see So You Want to Do Business In a Developing Country? or U.S. Banks Pin Hopes on Emerging Markets):

There are many compelling reasons that companies look to developing countries for growth. Less-developed countries hold the promise of large, fast-growing consumer markets (e.g., the BRICs); an abundance of cheap labor; and access to otherwise unavailable natural resources. Managers are often lured by this unbridled potential. But there is a reason these countries are considered “developing” – largely because of the under-developed state of their institutional environments… Although developing markets hold jaw-dropping potential, it often remains just that. Realizing potential from developing markets is incredibly challenging. Companies often find that the institutional (cultural, political, and economic) environments in the developing markets they enter…are so vastly different from anything that they encounter in their own domestic market (or even in other developed markets) that the costs involved in navigating them exceed even their most conservative estimates.

The takeaway here is that ventures into emerging markets should be considered with appropriate risk pricing tools. Judging by the recurring bouts of poor multinational performance in emerging markets, we haven’t quite reached that goal. But maybe, just maybe, next time will be different.

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Offshores Coming Home (Part II)

I periodically revisit the trend of “reshoring” – the process of bringing activities that were off-shored back to the home country. According to a recent article in the Financial Times, the shift from off shore manufacturing to domestic manufacturing has become increasingly pronounced (see US manufacturers ‘reshoring’ from China):

…[A] Boston Consulting Group survey found that 21 per cent of a sample of 200 executives of large manufacturers were either already relocating production to the US, or planning to do so within the next two years. A further 33 per cent said they were considering it, or would consider it in the near future.

Those figures are sharply increased from a similar BCG survey early last year, which found 10 per cent of respondents moving production to the US, and a further 27 per cent considering or close to considering it.

The article attributes the driving factor to wage inflation in traditionally low cost manufacturing countries. However, as I’ve mentioned previously, there are various other factors affecting those decisions as well, including increased automation in manufacturing, changes in long term strategies, and quality differentials (see Offshores Coming Home).

In fact, there is a long standing debate about the perceived benefits of offshoring versus its actual costs. And as I’ve noted (see Small Business in US Reevaluate China Outsourcing Strategy):

I have found that managers typically overestimate the benefits…i.e., the ability to access cheap labor…and underestimate its costs (e.g., those born out of cultural, political, economic, and regulatory differences across countries)…

Although I agree that there are compelling business reasons to consider offshor[ing], it is also important for managers to recognize that the practice is not without strategic consequences.

All things considered, it seems there is something to the reshoring trend. The phenomenon has garnered more and more interest over the years (as depicted in the Google Trend Report below). And given recent technological advances, coupled with  political and economic developments in emerging markets, I fully expect the reshoring trend to continue.

Screen Shot 2013-10-14 at 11.35.52 AM

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Offshores Coming Home

A recent issue of The Economist magazine contained a timely special report on offshoring and outsourcing.

In a series of insightful articles, the magazine highlighted the trend of companies rethinking their offshoring strategies and bringing work back home (see Welcome Home).

According to The Economist, the “reshoring” trend is being driven not only by increased automation in manufacturing, but also by rising labor costs.

…The pull of low-wage countries is weakening. In a survey of big American manufacturers by the Boston Consulting Group last spring, nearly two-fifths of firms said they were either planning to move or thinking about moving production facilities from China back home…Consultants at both BCG and Alix Partners reckon that by 2015 it will cost about the same for an American firm to manufacture in America as in China.

It is only natural that as labor becomes increasingly more expensive overseas, and as automation tools become increasingly cost competitive, companies will reconsider their decision to offshore work. But the calculus doesn’t end there.

Western firms are also finding that innovation is easier when manufacturing is in the same place as research…early pioneers of services offshoring are bringing work back home, having discovered that looking after customers and developing new IT tools are in fact a “core” part of business.

It’s not solely about the nominal wage differences, but the hidden costs associated with managing far-flung activities. In many cases, cost differentials don’t compensate for quality differentials or its long-term strategic consequences. As I mentioned in prior blog posts (see Small Business Reevaluate Outsourcing and Revisiting Outsourcing Again):

…managers typically overestimate the benefits of offshore outsourcing (i.e., the ability to access cheap labor) and underestimate its costs (e.g., those born out of cultural, political, economic, and regulatory differences across countries)…[offshore] outsourcing is not without strategic consequences.

Although the economics of outsourcing can seem compelling on its face, the trend toward “reshoring” seems to suggest that managers are finally starting to recognize that the benefits are not quite what they seem.

With all that in mind, I invite you to take a closer look at The Economist special report. You can also watch the accompanying (embedded) video introducing the special report. Enjoy!

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