Emerging Markets Insights

Leadership constraint has been constantly identified as a top business challenge multinationals face in China. Rapid growth over the last twenty years has created a huge imbalance in demand and supply of experienced managers and leaders. Shortage of managerial talent has fueled wage inflation in China, and compensation for senior executives has skyrocketed as many companies compete for a small pool of managerial talent (see charts below).

*Source: Frontier Strategy Group Analysis, Mercer China Monitor Report, EIU

To make it worse, multinationals are facing increasing competition from local Chinese companies, which offer attractive financial packages and perceived better career development opportunities to attract seasoned Chinese executives working for multinationals. However, many Chinese executives who have built their careers working for multinationals often found it was difficult to adjust to a local company’s culture and experienced “reverse culture shock.”

*Source: Frontier Strategy Group analysis, 中华英才网 (ChinaHR.com)

Most leadership challenges in China can be attributed to either a capability gap or talent shortage, or sometimes a combination of both. FSG recently created a comprehensive framework to identify key leadership challenges and develop best practices to strengthen the leadership bench through retaining key individuals, leveraging global scales, strengthening the fundamentals, and adjusting to a new reality.

Senior Chinese managers are motivated more by symbolic recognition such as enhanced decision making power, rather than material recognition such as financial compensation. So it is important for multinationals to realize that seasoned Chinese leaders want to achieve “self-actualization” by creating a vision for the business and having an impact on other people.

Local Chinese managers are already commanding an equal if not higher compensation than their peers in developed markets, and yet they are subject to higher attrition risk due to strong demand. One solution is to tap into experienced managers in talent surplus areas, such as Western Europe, who are more willing to relocate to high growth regions like China for an “expat light” package.

Share/Bookmark

U.S.-based multinational corporations lost an estimated $50 billion as a result of currency volatility in 2012.  As I referenced in my previous post, FSG projects currency volatility to increase in 2013.  No longer can executives only rely on corporate treasury to manage these risks as the potential impacts on profitability and performance are too great.

To better understand some of the operational strategies that executives can use to reduce currency risks, FSG turned to one of our expert advisors, Professor Gordon Bodnar:

• GB: “I encourage companies to think about structuring their operations as much as possible to have flexibility to respond to unexpected currency movement.  If currency moves in our favor, can you take advantage of not just increasing dollar price and dollar revenue stream by providing additional service?  Same thing for operations on the downside, how are operations structured so that over the short-term you can make adjustments to the pricing or costs structure such that you see a devalued currency by 10% your costs rise by less than 10%”

• GB:  “In markets with high volatility, the goal is an options type payoff.  Companies often don’t want to do this, as anytime you are creating an option there is an upfront cost.  However, the point is that the payment of the premium is necessary to get the payoffs you want…you have the ability to absorb and move across the profitability curve, leading to a higher expected payout”

Larger initial  local investments give executives the flexibility to respond to FX volatility with operational rather than financial strategies.

This is obviously a more risky strategy, and Professor Bodnar was kind enough to share a wide array of less risky strategies that I’ll cover in future posts.

___________________________________________________________________________________________

Gordon Bodnar is the Morris W. Offit Professor of International Finance and Director of the International Economics program at The Paul H. Nitze School of Advanced International Studies. He is presently a research associate of the Weiss Center for International Finance and also teaches in the Wharton Executive MBA program at the Wharton School at the University of Pennsylvania. Dr. Bodnar is also the associate editor of European Financial Management, Journal of Asian Economics, and Journal of International Financial Markets, Institutions and Money. He has held appointments as a Research Fellow at the National Bureau of Economic Research and the IMF. He received his Ph.D. in Economics from Princeton University.

As an FSG Expert Advisor, Professor Bodnar is available to FSG clients for consultation on many business issues with key areas of expertise including corporate and risk management.  Please contact your account manager for further information or contact us at sales@frontierstrategygroup.com.

Share/Bookmark

Here are a few region-specific headlines read by our research analysts this week:

Regional Assembly Now Wants Work Permit Fees Eliminated – Daily Nation

“Work permits fees for citizens from the East African community could be abolished in the medium-to-long term, making it easier for MNCs to move local staff across borders. The current feesfor work permits vary according to country and profession. But nationalist protectionist polcies of some member states, notably Tanzania, stand in the way of greater integration.”
- Anna Rosenberg, Senior Analyst for Sub-Saharan Africa Research

Chile and the Copper Price Rout – Financial Times beyondbrics

“Chile’s concern about falling copper prices is certainly warranted given that copper remains the country’s chief export. However, as we note in our most recent Quarterly Market Review, falling copper prices may bring relief for non-mineral export sectors which have been negatively impacted by currency appreciation in recent months.”
- Christine Herlihy, Analyst for Latin America Research

MP3I Will Push Growth in Eastern Indonesia: Minister – The Jakarta Post

“While Jakarta undoubtedly wants to promote growth in eastern Indonesia via the MP3EI framework, this plan is unlikely to dramatically increase private sector investment in Papua and Maluku. Instead, the real sector will continue to focus its efforts on the infrastructure in Java (and to a lesser degree Sumatra, Kalimantan, and Sulawesi) over the short to medium term.”
- Adam Jarczyk, Associate Practice Leader for Asia Pacific Research

Share/Bookmark

Continuing the conversation from last week’s topic on ways to protect your business in Russia from corruption, Matthew Spivack moderates a discussion on managing compliance standards in Russia with Martina Bozadzhieva, Associate Practice Leader for Central and Eastern Europe.  This podcast summarizes FSG’s recommendations about the nine key practices executives should follow to reduce their Russian business’s vulnerability to corruption.

To listen to or download the podcast, click on this link to access the iTunes store.

Share/Bookmark

Brazil ending a lengthy easing cycle and more nervy news for Europe’s debt round off this week’s headlines highlighted by our research analysts:

[snap]: Brazil Raises Benchmark Rate – Financial Times beyonddrics

“Brazil raised the benchmark Selic rate 25 bp to 7.5%, marking the end of a lengthy easing cycle in an effort to demonstrate that the inflationary targeting regime remains in force as prices continue to rise. While markets had begun to price in a rate hike, expectations were that the Central Bank would wait until later in the year, boding poorly for growth prospects.”
- Christine Herlihy, Analyst for Latin America Research

Putin Envoy Says Recession Should Spur Easing: Russia Overnight – Bloomberg

“Companies should watch for Russian government actions to boost growth – both rate cuts and some form of economic stimulus are likely.”
- Martina Bozadzhieva, Associate Practice Leader for Central and Eastern Europe

IMF: Euro-zone Companies Face Massive ‘Debt Overhang’ – The Washington Post

The IMF estimated that as much as a fifth of the corporate bonds and loans issued by major European companies are “unsustainable.”
– Sam Osborn, Senior Analyst for Global Analytics

Share/Bookmark

Corruption is a perennial issue when operating a business in Russia. Russia ranked 133^rd out of 176 countries in Transparency International’s Corruption Perception Index in 2012, indicating that operating in a compliant manner in the market remains challenging.

However, all too often the conversation about corruption in Russia at the corporate headquarters and regional levels is about a general anxiety about perceived levels of corruption, rather than a pragmatic conversation about the realities of where and how corruption occurs. This results in EMEA (Europe, Middle East, and Africa) executives being asked to “prove” that any further investment in the market will not lead to increased corruption exposure – a task that is clearly impossible and leads some highly risk-averse companies to underinvest in the market.

All too often, as well, companies would not discuss corruption with their local teams and partners, assuming instead that it is understood that corruption is not acceptable. Sometimes this attitude is the result of fears that even raising the issue could expose problems that could disrupt the operations of their Russia business. Other times, it’s the result of a perception that, if no corruption issues have come up, then there must be none. Both of these attitudes are dangerous as they lead companies to ignore the question until it’s too late to prevent or remedy compliance violations.

Instead, EMEA executives should take a leading role in managing how corporate compliance standards are implemented and interpreted at the local level in Russia. They should act as intermediaries, providing training and leadership for their local team that addresses honestly the specific situations in which their business could run into corruption and how those should be handled by employees at all levels. They should select, train, and support country managers who have a full understanding of how to manage the business compliantly and can serve as role models for the rest of the Russia organization.

The perception that companies with no presence in the market are safe from corruption risk is inaccurate – in fact, companies may be held liable, for example, for their distributors’ corruption, especially after recent changes to Russia’s compliance laws. Instead of ignoring the issue until it comes up, companies should openly and frequently raise it with partners, providing them with training and support to ensure partners understand exactly what practices are acceptable. Due diligence, including explicit compliance provisions in contracts, and frequent monitoring are just a few of the other tools executives have in their disposal to ensure the compliance of their Russian partners.

With all the right practices in place, corruption shouldn’t be an impediment to further investing in the market and taking advantage of its growth potential.

For additional content on protecting your business in Russia from corruption, FSG clients can read a full report on how to manage compliance in Russia here.

Share/Bookmark

Starting now, companies will face increasing workforce risks in Indonesia. Wages will rise by 15-30% over the next 12 months, and a new regulation will be implemented that restricts companies’ flexibility on staffing.

In this podcast, Adam Jarczyk, Associate Practice Leader for Asia Pacific Research, discusses these risks in detail and explains how you can use a 2-pronged approach to limit their impact on your business.  For further information on managing Indonesia’s workforce risks, be sure to read Managing Indonesia’s Workforce Risks in 2013, a blog post also authored by Adam Jarczyk.

To listen to or download the podcast, click on this link to access the iTunes store.

Share/Bookmark

Here’s a look at a few of this week’s global headlines with added commentary by our research team members:

Ghost of Suharto Seen in Boomtowns Leading Indonesia’s Growth - Bloomberg

“Explosive growth in Indonesia’s outer islands offers significant opportunities for companies that can reach them. For more details on where this growth is taking place and how companies are moving to capitalize on it, take a look at our report on scaling your business in Indonesia.”
- Adam Jarczyk, Associate Practice Leader for Asia Pacific Research

Russia Slashes Growth Forecast – The Wall Street Journal

“Russia’s slowdown is set to persist at least through the end of the year, making it even more important for multinationals to have a growth strategy in Russia that does not rely only on natural market rates of growth.”
-Martina Bozadzhieva, Associate Practice Leader for Central and Eastern Europe

Argentina Freezes Fuel Prices for Six Months to Stem Inflation – Bloomberg

“The Argentine government continues to interfere in the economy ahead of October’s elections, indicating that the operating environment for multinationals is likely to get worse before it gets any better.”
-Ryan Brier, Associate Practice Leader for Latin America Research

Share/Bookmark

Peace talks between the Turkey and the PKK, a Kurdish militant organization, are making the biggest progress seen in decades in resolving Turkey’s difficult relationship with its Kurdish population. Although many roadblocks to the successful completion of the process remain, the peace talks warrant multinationals’ attention as they could create increased investment opportunities. The process is already supporting Turkish stocks and ratings agencies are speaking about its potential to bring Turkey to investment-grade status.

Here are some of the implications of successful peace talks for multinationals operating in Turkey:

• Access to new customers – Improved physical security in southeastern Turkey will lead to decreased shipping and insurance costs for getting goods to customers in the region
• Increased private investment – Despite generous government incentives, companies have shied away from investing in the region due to security concerns. Private investment will begin to pick up as companies gain confidence that the ceasefire will hold. Private investment will be led by Turkish players who have deeper regional knowledge and who will be more aggressive in seizing investment opportunities. Multinationals should ensure that they monitor competitor activity in the region to avoid losing market share
• Attractive export hub – Producing in southeastern Turkey could provide avenues for exporting into northern Iraq, GCC, and the Levant. Companies looking to leverage Turkey’s regional hub position may be able to use southeastern Turkey as a cheap production and sales hub
• Branding opportunity – Companies looking to capture market share among the Kurdish population can use the peace process to position their products as part of a historic, positive change happening in Turkish society, especially among young people

Share/Bookmark

“Currencies should not be used as a tool of competitive devaluation. The world should not make the mistake that it has made in the past of using currencies as the tools of economic warfare.”
- George Osborne, Britain’s Finance minister

For emerging market finance ministers, the concept and impact of “currency wars” is very real. As loose monetary policies in developed economies encourage high capital inflows to emerging markets (often referred to as “hot money”), emerging countries struggle to control inflation and the upward pressure on their currencies. This often leads to a surge in competitive devaluations as governments feel compelled to intervene in order to protect fragile domestic economic recoveries, which has the resulting consequence of amplifying currency volatility. However, these competitive devaluations should not be considered as “economic warfare”, they are economic stabilization measures and a natural result of expansionary monetary policy. As many media outlets implicitly (or probably explicitly) understand, conflict is much more exciting than accord. By emphasizing the antagonistic aspects of these decisions, they are unfortunately misleading the public into thinking that these interventions are purely for competitive purposes.

However, multinationals are impacted when emerging markets governments respond to capital inflows by more aggressively printing money to sell on the open market to buy hard currencies. The reality is that the selling of local currency to buy developed-market bonds creates a cycle that further depresses yields in developed markets, pushing more capital to emerging markets, restarting the cycle of currency volatility again. Unfortunately for international executives, currency volatility creates many problems, such as difficulties in:

1. Pricing products
2. Anticipating costs
3. Uncertain business planning
4. Greater reluctance to hire new employees
5. Price instability in commodity markets

For international executives that are increasingly focused on profitability, currency volatility is one of the most important trends to watch this year. For example, a 10% increase in profitability in a given market will be essentially wiped out by a 10% decrease in the value of the local currency when results are reported.

Share/Bookmark