Capitalize on the Evolving Channel Landscape in China

Life is getting more difficult for foreign companies in China because of growing Chinese local competition and invasive government policies that obscure the regulatory environment. MNCs which wish to stay for the long-run will have to adapt their channel strategies to this changing environment. China is set to undergo significant changes, and a few new channel models have already surfaced at a rapid pace and have been adopted quite well by a few leading Chinese companies. Multinationals should be aware of those trends and be prepared to revisit China’s go-to-market strategy a minimum of every two years to stay ahead of the competition.

FSG has summarized three key channel trends to help companies better understand the local nuances and capitalize on the evolving distribution landscape in China:

1. Channel disintermediation

The key issue affecting the Chinese distribution landscape is the fragmented nature of the market. As a result of this high fragmentation, goods move through several layers of distributors before reaching the end customer, thereby creating inefficiencies, high distribution costs, and an intensified frequency of channel conflicts (or Chinese Buzz word, “窜货” pronounced ‘cuan huo’). It has now reached a tipping point, where companies across industries are realizing the importance of developing their own sales and distribution arms. They are choosing to remove intermediaries and cut out middlemen to have better market access, or to just go direct in tier 1 cities.

2. Rise of e-commerce in lower-tier cities

Everyone understands the opportunities that China’s e-commerce market provides, as it has overtaken the United States as the world’s largest market. However, not all companies fully comprehend how to utilize the online channel, especially to penetrate into lower-tier cities. The effectiveness of the online channel is more pronounced in less-developed tier 3 and 4 cities. According to the statistics, the online channel in lower tier cities leads to incremental consumption instead of just replacing the offline spending. MNCs across the B2B or B2C landscape need to start building an effective e-commerce game plan to leverage this channel effectively. FSG has in-depth resources to provide its clients a strong starting point in this regard.

3. Distribution consolidation

Government policies laid out in China’s 12th five-year plan call for consolidation of distributors. In some industries, such as pharmaceuticals and automobiles, numerous acquisitions have already taken place. A few leading distributor groups are expected to benefit from expansion and acquisition policies, while manufacturers (including MNCs) might be negatively affected, because their wallet share in their distributors’ business portfolio will be diluted.

Channel Models in China

*Source: Frontier Strategy Group analysis

FSG is hosting a detailed session on effective distribution management for its clients on April 15 in Shanghai.

Emerging Market View: What Our Analysts Are Reading

EM View

Among the many headlines and articles circulating global news, we are reminded of volatility’s inherent presence in emerging markets.  Antonio Martinez (@antoniojosemc), Senior Analyst for Latin America has been keeping a close eye on developments in Venezuela, one of Latin America’s lowest performing economies in recent years. Good news is hard to derive from Bloomberg’s article on Venezuela’s Bolivar taking a hit on the black market. Antonio comments that the, “SICAD2 will not resolve the distortions in the exchange rate market unless there is sufficient volume of dollars on offer. Continued delays in resolving the foreign exchange rate system will only make the eventual necessary adjustment more economically and politically painful.” Combating the dismal news for Venezuela, Antonio recently authored FSG’s Central America Regional Overview, as well as a blog post which outline opportunities in Central America.

The EMEA portfolio is certainly no exception to volatility either. Following German businesses’ growing concerns over Russian ties, Martina Bozadzhieva, Head of EMEA Research advises that, “MNCs need to prepare for further downside risks to Russia’s performance. Regional teams should work to assess the real impact of sanctions on their business and manage corporate’s perceptions about risk to avoid a costly pullout of resources from the market that could undermine their competitive standing.”

And finally from the APAC perspective, The Hindu reports the Reserve Bank of India (RBI) is likely to hold rates.  According to FSG’s Shishir Sinha, “the Reserve Bank of India is unlikely to cut rates in its forthcoming monetary policy on April 1 even though economic conditions seem to have eased recently with some moderation in inflation and financial market stability, thanks to the election euphoria.”

Central bankers’ decisions could mean changes are in the air for the euro

President of the German Bundesbank Jens Weidmann and other countries’ central bankers made statements during the week suggesting that negative interest rates or even asset purchases (Outright Monetary Transactions, or OMT) may be considered in upcoming monetary policy announcements. These statements represent a material softening of particularly the German political stance against such measures. Any unconventional monetary policy enacted as a result of shifting eurozone economic sentiment would reduce bond yields, helping governments and banks to pay down their bad debts, and relieve upward pressure on the euro, making European exports more competitive and spurring growth.

The timing of this disruption in the consensus view on unconventional monetary action is noteworthy.  In February, Germany’s highest constitutional court criticized OMT and asked the European Court of Justice to determine whether such transactions were even within its mandate, essentially “rejecting” its validity as markets understood the ruling. However, last week the court upheld participation in the European Stability Mechanism, paving the way for further German concessions in the last pillar of the European banking union. This week’s similarly surprising change of heart prompted hopes that OMT actually could be used to support the European economy.

There are several possible reasons for the central bankers’ change of heart. The first is that a slow, incremental shift in consensus has been taking place in economic circles across Europe and is finally coming to the fore. Policymakers and business leaders alike have become less hostile towards unconventional monetary policies, and the fear of unintended consequences from QE has waned. This shift has been even more pronounced since October, when euro area inflation shrunk below 1.0% YOY, a level from which it has not returned. Price growth fell further to 0.7% YOY in February, and data released on Monday is expected to reflect the same weak inflation.

Other drivers of Europe’s re-introduction of OMT could be the result of governments bracing for another difficult year of low economic growth. Risks in Europe, and particularly Germany, are to the downside. Business confidence in CEE, but particularly in Germany, has suffered a sharp fall due to the Crimea crisis. Emerging markets’ currency devaluations have reduced demand for German exports, decreasing new orders for industrial goods. Banks are writing down massive amounts of non-performing loans ahead of ECB bank stress tests, causing a credit contraction that reduces business activity. The risk of a lash-out against austerity in southern Europe has raised fears of increasing political risk and thus higher borrowing costs for those countries, particularly Italy, which could threaten default.

ECB purchases of member government’s bonds and other assets would go far to address these issues. Reduced upward pressure on the euro would help to normalize the exchange rate, making European exports more competitive and improving growth. Lower bond yields would help banks write down bad debt more quickly, reducing the risk of bank failures. Each of these events would improve business confidence, and help bring Europe to a more sustainable recovery.

In short, central bankers’ comments bring the ECB one step closer to assisting its member governments and their banks in balanced deleveraging. This, much more than increased government spending or in lower policy interest rates, would promote growth in Europe.

Nairobi – African Cities Need Urban Planning

Anna Rosenberg, Head of Sub-Saharan Africa at FSG, is currently on a research trip to Kenya, Uganda and Ethiopia. Here are her latest insights:

Kenya Traffic

Yesterday I spent 7 hours stuck in traffic versus 4 in meetings. With more and more cars on the streets, there is no doubt that the middle class is rising… and road congestion along with it. Even after spending some time stuck in Luanda’s traffic – which enjoys an abysmal reputation – I have to say it is nothing compared to Nairobi’s.

My experiences on Nairobi’s roads might have been bad luck or indeed a reflection of reality. Either way, I couldn’t help but notice that this traffic must have a negative impact on the economy. Spending hours stuck in a car with the engine running is expensive, environmentally destructive, and above all, unproductive. People become unhappy and unhealthy.

Cities in Europe have undergone a transformation in recent years that turned them into places people actually want to live in. Bicycles now crowd the roads, and people run and walk to work. London is about to build a garden bridge that will turn the daily commute into a pleasant walk in the park.

Africa, however, is a place of reverse innovation. Just think of M-Pesa, the mobile service that made banking accessible to the unbanked, or M-Health and M-Farming that give advice on better healthcare and farming practices, respectively. Think of Cardiopad, a touch screen tablet that electronically transmits medical tests in rural areas to urban examination centers for diagnosis. However, this innovative spirit highlighted by these inventions is regrettably not evident in urban planning.

Real estate prices are rising fast – one acre of land in central Nairobi costs today between US$ 6.0 to 7.5 million – so everyone involved in construction wants to make a rapid profit, overlooking the fact that cities should be livable places. New apartment blocks need matching infrastructure, such as schools and hospitals nearby, and roads to reach them.

Nairobi’s congestion will only get worse as more people buy cars as the consumer class grows, the financial sector matures and consumer credit becomes cheaper. Cars are a status symbol. To quote my taxi driver: “people would get a loan to buy a car, even though they cannot afford to maintain it, just because their friend also owns a car.”

However, rapid economic growth in Africa’s main cities, rising private and public investment in infrastructure, and long-term national development plans are all ingredients that should be translated into building African cities that are pleasant to live and work in.

As I sit in the taxi, I think that urban planning in Africa should embrace innovation to the same extent as the financial services and technology sectors. Better public transport, safe roads to cycle on, car sharing systems are just some examples that would make roads less congested and people healthier, happier and more productive. International companies should engage with the government and advise city councils on building cities of the future – not just cities.

Kenya’s Tatu city, an urban development that aims to provide living and retail space that is pleasant, environmentally-friendly and within easy commuting distance from Nairobi, could lead by example once completed. But innovation needs to first and foremost take place within existing cities, not only newly-built ones.

For additional insight from Anna’s research trip in East Africa, be sure to read her earlier posts: Kenya – A Regional Trendsetter and Notes from the Field: Kenya

Kenya – A Regional Trendsetter

Anna Rosenberg, Head of Sub-Saharan Africa at FSG, is currently on a research trip to Kenya, Uganda and Ethiopia. Here are her latest insights:

My conversations today with business leaders, consultants and journalists revealed that Kenya is a regional trendsetter for many reasons. The country’s private sector is arguably the most dynamic in the region, benefiting from a free market economy since independence. Kenya is much more open to international business as a result, unlike neighbors such as Tanzania that, for a long time, follow a state-led and socialist approach to business.

Kenya is oftentimes the first point of entry for goods traded in the region through its port of Mombasa. Upon clearance from the Mombasa port, goods are then transported via the Northern Corridor to Uganda, Burundi and Rwanda; and from those countries to South Sudan, and the Eastern DRC. The majority of goods not imported from outside the continent and sold across East Africa are produced in Kenya. Its manufacturing sector is underdeveloped but remains bigger than those of other markets. As a result, Kenyan consumer trends, particularly in fashion and technology, are carried throughout the region.

Historical legacy and better infrastructure are not the only reasons for Kenya’s role as regional trendsetter. Kenya’s financial landscape is more sophisticated and mature than its neighbors’ and Kenyan banks are expanding across the region.  Local retailers, such as Nakumatt, are among the most successful in the region and are on an expansion drive. The country’s talent pool and human capital are strong, as multinationals face minimal problems in staffing their local operations.

Anna Rosenberg visited the headoffice of Nakumatt - a leading retailer in East Africa

Anna Rosenberg visited the headoffice of Nakumatt, a leading retailer in East Africa

However, not all East African consumers are receptive to these trends. Tanzania’s relationship with Kenya is strained. Tanzanians perceive Kenyans as aggressive and are afraid that they might take over Tanzanian businesses if the country opens up more under the East African Community. As a result, Tanzania is hindering faster progress of regional economic integration.

To put it in the words of two executives I spoke to today, “Kenyans are trendsetters in East Africa” but “they are not well liked in the region.”

Central America Offers its Own Set of Challenges and Opportunities for MNCs

As Latin America’s largest markets have struggled in recent years, multinationals are taking a closer look at the opportunities that the smaller markets of Central America can offer, particularly they seek to diversify their regional portfolios. However, the opportunity must be kept in perspective, as Central America only represents around 3.5% of the Latin America’s GDP, making the region the eighth-largest market in Latin America, just behind Peru.

Graph 1 LATAM Blog Post

That said, Central America is expected to experience growth on par with some of the fastest growing markets in Latin America over the next few years. However, individual markets within Central America will experience widely divergent growth prospects, making prioritizing investments within the region absolutely essential.

  • Panama will remain one of the fastest-growing economies in the region, with multinationals increasingly considering the country as a viable hub for operations in Latin America
  • Costa Rica offers a solid business climate, but chronic budget deficits and legislative gridlock cloud its medium-term outlook
  • Guatemala, Honduras, and El Salvador continue to be plagued by weak government finances and drug-related violence, limiting the potential for higher economic growth that might alleviate these countries’ extreme poverty
  • Nicaragua is projected to experience solid growth over the next several years, in part because of its financial position, but the market also remains at risk of severe political and economic instability
  • Belize is suffering from high debt loads and limited opportunities for growth over the medium term

Graph 2 LATAM Blog post

FSG recently published a report that provides multinationals with an extensive overview of the region’s macroeconomic outlook, forward-looking market and industry sentiment, and deep-dives on each of these markets.

Notes from the Field: Kenya

Anna Rosenberg, Head of Sub-Saharan Africa at FSG, is currently on a research trip to Kenya, Uganda and Ethiopia. Here are her latest insights:

Nairobi, Kenya -Anna Rosenberg

Kenya – Security is a Concern
Kenya is an attractive place to do business – that’s the reason I am on the ground doing research. My conversations today with business leaders and ordinary Kenyans alike surprised me in the palpable, growing sense of insecurity they implied. Perhaps our talks were overshadowed by a recent Islamist terrorist attack that had young men storm a church in Likoni, near Mombasa, to open indiscriminate fire, killing six people.

Taking place six months after the Westgate Mall attacks in Nairobi that killed 64 people, the Likoni assault is only a reminder of the underlying tensions within Kenyan society. These tensions do not originate in religious divisions, but economic ones. While Nairobi is bustling with economic activity, the coastal areas are not. Youth unemployment among educated Kenyans is high, which fuels resentment and provides a fertile recruitment ground for radical causes.

Westgate Mall Closed

Nairobi’s shopping mall, Westgate, is closed for reconstruction after a terrorist attack in September 2013

How is this fear impacting business?
I spoke today to the regional head of a company that sells spirits across East Africa. Although his business in Kenya is still growing, he stressed that it is performing worse than other East African markets as consumption activity is shifting to the home, away from public places. Consumers are also buying less alcohol because of negative religious connotations. His employees are scared, particularly when launching marketing events in Nairobi’s flashy Westernized hotels – a prime target for terrorists.

A seasoned Kenyan investor told me that his friends in the tourism industry near Mombasa are severely feeling the economic impact of insecurity. Every incident triggers a drop in prices for hotel rooms, causing dramatic losses in revenues, in turn leading to layoffs that contribute to unemployment. A vicious cycle.

To be clear, as I have heard and seen repeatedly today, Kenya’s business landscape is one of dynamic and fast-paced growth. Business targets typically exceed expectations. Investments in the power sector and nascent oil & gas industry keep rising. Yet for Kenya to remain an attractive hub for multinationals in the region, the government needs to ensure that economic growth creates attractive employment opportunities for the disgruntled youth.

Follow me on twitter @anna_rosenberg

Emerging Market View: What Our Analysts Are Reading

EM View

FSG’s analysts are constantly speaking with senior executives in emerging markets and staying on top of the latest headlines from around the world.  In this week’s  Emerging Market View, the top themes include currency volatility, reform and growth in Europe, and stability in the Middle East and Africa.

Ryan Brier, Head of Latin America Research, recently read an article on Latin America’s weak currencies. According to Ryan, ”the high commodity prices and strong currencies which boosted growth and earnings for multinationals in Latin America over the past few years have come to an end, a fact that will force regional executives to adjust their approach to the region over the next few years.” However, the currency volatility was not entirely unexpected. FSG’s Christine Herlihy (@crherlihy) alluded to Argentina’s peso devaluation, as well other Latin America currencies currently suffering from volatility.

Across the Atlantic, a note of good news from Greece indicating reform and growth within the eurozone as the FT reported Greece reaching a deal with lenders.  ”Greece unlocked a 10 bn euro aid tranche of its second bailout, boosting confidence that Greece is on the way to recovery. Importantly, there will be no more across-the-board public job cuts. A third bailout may still be necessary, but this step forward could help avoid a political crisis that would reverse the difficult reforms that Greece has instituted so far,” said Lauren Goodwin, FSG’s Senior Analyst for Western Europe.  Though Italy’s sweeping tax cuts and consequential debt increase levels sentiment for recovery, Lauren adds, “a move away from austerity would help Europe to recover, but Italy’s tax cuts could upset political stability. The deficit, currently 2.6% for 2014, will increase due to the tax cuts. A deficit higher than the EU limit of 3.0% would not only raise Italy’s debt load but also raise investor skepticism that Italy is on the right track, raising interest rates and increasing the probability of crisis.”

And finally, FSG’s Practice Leader for the Middle East & North Africa, Matthew Spivack (@IMaSpiv), is following the Ukraine crisis’s impact, or rather lack thereof, on the Iran nuclear talks as reported by Reuters. Matthew notes, “early indications are that the Ukraine crisis isn’t impacting today’s Iran talks according to EU diplomats attending negotiations in Vienna. And it is important to remember that Iranian-Russian relations, although warming recently, aren’t totally aligned. For example, Iran could be positioned to steal away Russia’s natural resource customers in Europe if relations are normalized with the West.”

Follow us @FrontierStrtGrp or Subscribe to our Emerging Markets Insights podcast channel on iTunes for more updates on emerging markets.

Businesses Need to Prepare for a Tough Year in Nigeria

Despite a positive medium-term economic outlook, Nigeria is struggling with various challenges that undermine its economic potential: These challenges are coming to the forefront as the country prepares for presidential and national assembly elections on February 14, 2015. Executives should expect political volatility to hinder policy-making, fuel inflation, and currency depreciation. Business customers, partners, and government agencies will be in a wait-and-see mode up to elections. This could have implications for demand, investment plans, and the speed of moving through regulatory processes.

Power struggles ahead of the 2015 elections hinder the passage of important legislation and weaken investor confidence: Political infighting is undermining the current administration’s ability to pass policies. After various high-profile defections from the ruling People’s Democratic Party (PDP) to the newly formed All Progressive Congress (APC), the APC now forms a strong opposition. It is blocking all legislations including the 2014/2015 budget. President Goodluck Jonathan’s politically motivated decision to oust widely respected Central Bank Governor Lamido Sanusi weakened investor confidence significantly. In past months, the president also fired various ministers, including the ministers for information, environment, and foreign affairs. 

Inflation is expected to rise, and the naira is expected to depreciate in 2014. Both trends will put downward pressure on consumer and business demand: Inflation will likely rise to double digits because wealthy individuals are flooding the economy with cash to back candidates and the government is increasing spending. In past elections, an influx of cash into the economy led to currency depreciation and inflationary pressure. Capital outflows as a result of the US Federal Reserve’s quantitative easing program, losses in government revenue because of oil theft and corruption, uncertainty over monetary policy, and weakening investor confidence have led the naira to depreciate. The power sector is undergoing major reforms that also increase prices. Electricity is now more expensive as the state-owned power company privatizes its distribution operations and hikes prices. Moreover, the worsening security situation in parts of the country is leading to higher distribution costs of consumer goods. Businesses producing locally will pass on rising production costs to consumers, who will, in turn, prioritize non-discretionary purchases.

The security situation is worsening ahead of the elections: Nigeria’s security challenges include bombings by Boko Haram and ethno-religious clashes in the northern and central areas, oil theft and piracy in the Niger Delta, and kidnappings in the Southeast. Election-related violence has hit Rivers State as skirmishes erupted between APC’s Governor Rotimi Amaechi’s supporters and his opponents. Boko Haram’s attacks have increased in recent months despite heightened military response.

Unemployment, poverty and corruption remain high and are the real drivers of criminal activity: Although Nigeria’s economy expanded an average of 7.2% per year between 2004 and 2010, the proportion of Nigerians living in poverty is still 62.6%, down only slightly from 64.2% in 2004. Social inequality and theft by powerful elites aggravate the dissatisfaction of ordinary Nigerians, who are then easily drawn into criminal activities because of lack of perspective. Oil theft by criminal gangs costs Nigeria US$ 8 billion per year. Corruption within the state oil company led to the loss of between US$ 10 to 50 billion of oil revenue from January 2012 to July 2013.

Companies should monitor developments closely to get ahead of risks and opportunities: Executives should monitor the pre-election period closely and manage corporate expectations regarding demand. Less risk-averse executives should consider strategic investments now as their competitors are in a wait-and-see mode. Details for what to monitor and which strategies to implement to protect and grow your business despite the worsening environment can be found in our latest report ‘Market Spotlight: Nigeria’.

Despite the tough environment this year, Nigeria’s solid growth will prevail: Nigeria’s medium-term macroeconomic outlook remains positive because of rising private consumption by the country’s 170-million-strong population, the economy’s diversification away from oil, and its attractiveness for investors. The GDP rebasement will also have a positive economic impact. A significant boost to total GDP figures will make Nigeria more attractive in every financial and economic model worldwide, luring more companies to invest locally.

The Philippines – Asia’s Cinderella Story

Everyone loves a Cinderella Story, a situation in which a competitor emerges out of nowhere to achieve great success.  So it’s not surprising to see so many people rooting for the Philippines lately.  After expanding on average by 3.8% per annum from 1990–2010, the country’s economy has ramped up its growth to more than 6% in recent years.  The so-called “Sick Man of Asia” is now the top performer in the region ex-China.  Its stock market is up, its currency is strong, and FDI is beginning to flow.  Some companies looking to diversify away from China are even starting to consider it as an option.

Even so, doubts linger over the sustainability of the Philippines’ growth spurt.  Indeed, this uncertainty was on full display at a Euromoney conference in Manila that I recently had the pleasure of attending.  Although the president gave a rousing speech outlining the country’s progress and the finance minister gave calm assurances that the economy was on stable footing, the same questions kept coming up – What will happen after the 2016 election?  Will the next administration continue the current administration’s policies?  What assurances can you give us?

These questions are critical because in the past, interpretation of laws in the Philippines has changed from one administration to the next. So even if a law or contract was well-written, the way it was interpreted and enforced could change dramatically every six years.  Aside from concerns about corruption – which are also tied to this dynamic – this is one of the biggest reasons the Philippines has had such trouble attracting foreign capital.

Unfortunately, it seems that investors’ questions about policy continuity will remain unanswered for now.  Noynoy Aquino has not anointed a successor, and nobody seems ready to fill his shoes.  The current frontrunner for the next election, Binay, enjoys popular support, but it is not at all clear that he is committed to continuing Aquino’s policies.  And many of the other people who have been cited as potential contenders are old-school Filipino politicians – exactly what the country doesn’t need now.

And so the Cinderella Story continues.  Will the Philippines be able to sustain its growth?  Will the “Sick Man of Asia” break away from his past and continue sprinting ahead?  We’re looking forward to examining these questions and more in our upcoming reports on the Philippines.