Brazil’s Tech Execs are in for the Long Haul

I spent last week in São Paulo meeting with GMs of Brazil and Latin America based there. Among the highlights was a working breakfast with eight country and region heads of US technology and telecom companies. My colleague Antonio Martinez shared the LATAM research team’s latest outlook for Brazil and the region, and we had a robust discussion about the Brazilian business environment and its proper place in the Latin America portfolio. Here are a few of my top takeaways:

  • Tech has outperformed other industries recently in Brazil, but individual corporate performance divides largely by maturity in the market. Established firms are more impacted by the overall economy’s slowdown, but Brazil’s massive size still allows for rapid growth for tech companies that bring something innovative to the market.
  • Brazil’s fragmented tax regime is the biggest headache for country managers. The complexity of state and local tax codes (companies must comply with >200 taxes!) adds to the cost of doing business and impedes companies’ ability to expand into fast-growing cities beyond the highly developed southeast, especially in northern states where millions of people are taking on middle-class spending habits and governments continue to invest heavily in infrastructure. From the LATAM perspective, Mexico’s simple, if higher, tax rate looks better and better.
  • Country managers are in an uncomfortable dialogue with corporate headquarters. Top execs in the US are used to the BRICs story and are having a hard time wrapping their heads around the constant flow of downward revisions in the government’s growth forecasts. Everyone around the table believes in Brazil’s medium term growth prospects (on a 4-5 year horizon), but managing expectations for 2013 is tough. Particularly challenging is helping HQ understand currency volatility and inflation.
  • Horror stories about Brazil’s political culture were abundant. “Labor litigation is becoming a monster.” “The political mentality is: for the friends, everything, and for everyone else, the law.”  But frustrations aside, the group was unanimous in its belief in Brazil’s long-term opportunity and commitment to invest. The lessons learned and innovative practices shared around the table – some of which our clients may well see in case studies later this year – were the true highlight of the session.

Next week I look forward to sharing insights from a similar executive breakfast I’ll be attending in Shanghai, discussing the long-term outlook for China.


The Russia Plan EMEA Executives Should be Writing Now

Israel’s surprise election results indicate that the population is much more interested in the immediate need to stabilize the economy than in the country’s ongoing problems with Iran. This decreases the risk of an Israeli attack on Iran in 2013, and increases the risk facing Russia’s economy. The connection between the two? Predictably, oil prices, which are artificially high due to a political risk premium related to a potential Israeli attack on Iran.

For Russia, reduced oil prices mean significant economic as well as political risk. Sources as diverse as ratings agency Standard&Poor’s and the Russian Ministry of Economics point out that at US$80/bbl Russia’s economy will, at best, slow to a shallow recession. This will be accompanied with rapid and deep currency depreciation, rising inflation, and plummeting consumer spending and business investment. Frontier Strategy Group estimates that there is a 25% chance that this scenario could play out as early as this year, particularly after the Israeli election results.

Surprisingly, few multinationals operating in Russia have plans in place to respond to this scenario. Executives responsible for Russia are, of course, aware of the theoretical possibility of an oil price crash and its potential impact on the economy, but, as with any long-standing risk, they can become gradually de-sensitized to it, focusing instead on more short-term priorities such as growing their business’ presence in Russia’s regions, setting up local manufacturing, or forging new local partnerships. This approach, however, increases their business’ exposure to the market and their potential losses when a macroeconomic shock does materialize. Even if executives get everything right in their business strategy in Russia, an economic crisis could obliterate their success and throw off the most carefully-constructed plans. At the same time, an economic crisis could create unique opportunities to pursue M&A, capture talent, and take market share away from struggling competitors. Companies that are caught by surprise by a sudden change in the economic environment will struggle to both mitigate the risks and take advantage of opportunities created.

This context calls for careful contingency planning. However, contingency planning is frequently done on the corporate level and building a contingency plan for just one, often non-core, market, like Russia, is rarely a corporate priority. The organizations with the biggest stake in preparing such a plan – an EMEA or CEE division, and the local Russia team, frequently lack the resources and the expertise to build a sophisticated contingency plan. More often than not, bridging this gap requires regional organizations to reach out to corporate for support and guidance and to then take the initiative to build the plan in collaboration with their Russian team.

Not only does this process create an “insurance” for the organization when the risk of an oil price decrease does eventually materialize, but the planning process itself frequently yields actions that can be taken now, outside of the context of a crisis, to strengthen the company’s competitive position in the market.

*Listen to our  latest podcast on the Russian business landscape on iTunes.

PODCAST: India’s Latest Reform Efforts Fall Short


In this podcast, Frontier Strategy Group’s lead India analyst, Shishir Sinha, shares his view on India’s latest reform efforts. Although some progress has been made, many of the most important reforms for multinational businesses remain undone.

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

Building long-term distributor relationships, one year at a time

I recently shared some insights into effectively structuring distributor contracts in China that were gleaned from the recent executive discussion hosted by FSG in Shanghai. The eight executives that FSG brought together, representing heads of China or heads of Asia for a range of technology, industrial, and healthcare companies, also spent quite a bit of time discussing two sides of the same coin: building relationships with distributors, with a long-term partnership in mind, and transitioning or ending relationships with distributors.

But, it is hard for us to discuss these two issues without coming back to contracts! The key takeaway on contracts that was discussed in my previous post was the necessity of conducting an annual review and negotiation of the contract. In addition to the benefits outlined in that post, an additional benefit of an annual discussion is the opportunity to sit down across the table from your distributor and level-set on where the relationship stands, what is going well, and what needs improvement. This guidance and feedback, shared in the context of achieving mutual benefit, is the anchor of a strong relationship. It is also the best tactic at your disposal for ensuring that distributors are not caught off guard if you decide to make a change to the relationship (either by ending it, or scaling it back).

Nobody likes surprises. But, even in the best case scenario, when bad news is being delivered to your distributors, there is a risk in the Chinese market of “losing face.” Several executives mentioned instances of terminated partnerships where the local distributor felt that he had “lost face,” and as a result, felt a personal vendetta against the vendor. This could be manifested in the disgruntled former distributor establishing a relationship with a competitor (and taking key accounts along), sharing trade secrets, or poisoning your company’s reputation in the market.

One way to minimize the damage of a perceived loss of face is to ensure that when territories are transitioned, it is from a small distributor to a larger distributor (and not vice versa). A large distributor will have greater power in the marketplace to minimize the damage that could be caused by a disgruntled former small distributor. But, if you switch from a large distributor to a small distributor, the disgruntled former large distributor has an increased ability to harm your business and impair the operations of your new, smaller distributor.

As the discussion turned to the challenge of transitioning from indirect to direct in China, the key takeaway was to expect the unexpected. Your distributors may well be telling the truth when seemingly making excuses for underperformance, so do not be too hasty to make such a transition, or in his words, “wait until the pain is unbearable.”
Finally, it is important to bear in mind that investing in developing the capabilities of distributors does not and should not be conflated with retaining distributors. Taking a “tough love” approach has proven to be a trend among the highest growth companies. Investing in distributors to develop the capabilities you require should not prevent you from terminating relationships with distributors that are not meeting expectations, and a track record of doing so instills current and future partners with a higher expectation of accountability.

A structured, annual contract negotiation process builds a natural inflection point into the vendor/distributor relationship, which offers an opportunity to proactively evolve the relationship over time, or to bring the relationship to its conclusion with minimal loss of face.

2 Issues to Tackle When Operating a Business in India

1. Fragmentation:

Multinationals have to move out of the traditional Tier-1 cities in order to adapt to India’s unique urbanization trend:

The rise of manufacturing in rural India has led to robust job and wealth growth, which means a lot of the rural population, is not interested in moving to large-cities but instead, we can expect small villages to turn in to small towns, then big towns and eventually into large cities. This means that as a multinational- you will have to go to your end customers, and not the other way around- waiting for them to come to the traditional metro cities

Towns simply grow into densely populated cities, as opposed to a conventional migration of people from towns to cities

Expenditure on durable goods, education, consumer services (entertainment, transport, etc.), and fuel have grown faster than the average over the last 10 years

India distribution

2.  Infrastructure Issues:

India’s consistent underinvestment in infrastructure, lack of regulatory reforms, and generally unstructured style of conducting business adds an additional layer of complexity for multinationals operating in the country:

Stay tuned for the next blog-post on distributor sophistication in India and FSG’s assessment criteria to identity gaps in your channel strategy



As Multinationals Plan for Growth in Brazil, Profitability is Key

FSG recently surveyed our clients and expert advisors regarding their expectations for their businesses in Brazil over the next 5-10 years, and the results reflect two important trends: cost-consciousness and path-dependency. For many years now, companies have invested in Brazil and been content with robust top-line growth. However, in the wake of the financial crisis, as the US and Eurozone markets have struggled and China is currently experiencing a slowdown, many multinationals are running out of patience. Increasingly, top-line growth in Brazil is not sufficient, and our clients are concerned with cutting costs and improving operational efficiency so as to improve their bottom-line performance.

As they do so, they remain cognizant of the potential for government action to address specific constraints—while many of our clients are skeptical about the true impact reforms will have, our view is that government actions will help mitigate the impact of some constraints, most notably infrastructure and access to financing, while failing to address others, due in large part to domestic politics. This variation is impacting our clients’ strategic plans in quite interesting ways.

For example, while companies continue to equate geographic expansion in the Northeast and Center-West with growth potential, they are primarily planning for product-led growth over the near term, due to the logistical costs associated with expanding to lesser-penetrated regions where infrastructure is poor or non-existent. It should be noted that a zero-sum approach is neither evident nor expected. FSG clients are not discounting geographic expansion, but many executives are being forced by cost concerns to make trade-offs, and this often results in short-term concerns dictating strategic priorities.

Over the medium-to-long term, we do expect that push and pull factors, including market saturation and the need to serve existing accounts will continue to drive expansion, and we also expect infrastructure reforms to decrease the marginal costs associated with geographic expansion, making this approach much more feasible from a cost-benefit perspective. Of critical importance are external urgency drivers, including the 2014 World Cup and 2016 Olympic Games, which help raise the stakes and motivate the government to engage the private sector in infrastructure projects.

As executives plan for growth in Brazil, their decisions are increasingly motivated by the need to ensure the growth they deliver is profitable. Trends worth tracking in light of this paradigm shift are those that promise to tilt the balance down the road in favor of outcomes that may not be feasible from a cost-benefit perspective at present.

Gerardo’s Cautionary Tale: Pharmaceutical Companies and Distributors in Brazil

Brazil Flag

Last week I interviewed Gerardo Mendoza, one of Frontier Strategy Group’s Expert Advisors.  Gerardo is originally from Mexico, and also spent some time working in Argentina, before landing in Brazil where he has been an entrepreneur and business advisor for the last fourteen years.  He has become a specialist on corporate tax concerns and the healthcare industry, but this post will be about neither of those themes, per se.  Instead, I want to discuss a trap that Gerardo has seen pharmaceutical companies fall into in Brazil.  This trap is a cautionary tale, because it could easily become a problem for companies in other countries and other industries.

Before I go further, since this is my first post on the FSG blog, let me also introduce myself.  My name is Dan Kornfield, and I spend my time interacting with clients and working with them to uncover useful perspectives on and solutions to common management challenges they face in emerging markets.  I tackle these challenges primarily from a thematic rather than geographic angle.  Specifically, I serve as FSG’s Director of Strategic Research.

One of the areas where I believe FSG is doing truly groundbreaking work is on “channel management,” which is business jargon for managing sales channels, or the variety of ways a company gets its products to end customers.  For many global businesses operating in emerging markets, the most common sales channel is to operate through distributors. In fact, a great deal of business in emerging markets would come to a screeching halt if distributors stopped offering their services.

Distributors are intermediary third party companies that serve as a sales organization (and usually logistics provider as well) for their clients, the producers.  Unlike wholesalers, transactional links in the value chain that simply purchase based on bulk discount and then resell, distributors become active agents for their business partners.  Some distributors work for one company, but most work for several at once.  Some companies have one distributor authorized to operate in a country or region, and others have many.

Distributors represent the producer client’s brand, and take its products to end customers more efficiently and/or more effectively than the client believes they could accomplish by themselves.  Sometimes, distributors are also hired by a company to avoid hassle, or, whether they know it or not, to take on risks that the producer would rather not assume.  For example, a company recently told me they employ a distributor to sell to the Mexican government, because they do not want to have to deal with all the paperwork.

Regardless of industry (e.g. consumer goods, healthcare, heavy industrial, or technology and telecom), about 94% of our clients rely at least partially on distributors, and just over 50% of our clients’ sales volume is brought in through these “indirect” (distribution) channels.

Okay, enough background.  Now back to Gerardo and his cautionary tale.

He explained that many pharmaceutical companies in Brazil have relied too heavily on distributors.  The distributors have grown up to become indispensable partners.  And as the market has grown, distributors have undergone a flurry of M&A activity amongst themselves.  Now some pharmaceutical companies have to reach their end customers through distributors that have larger annual revenues than their clients, and they gain that revenue from a more diversified set of partnerships.  This has led, and is continuing to lead, to a significant imbalance of power in the producer-distributor relationship.

At the end of the day, this means that it is hard for pharmaceutical manufacturers to be able to offer enough sales volume to really matter to some of the major distributors.  Now the only way they can gain preferential time and attention from their own third party agents is to pay them more – at the risk of beginning a margin-conceding arms race with other companies that employ the same distributor.  The alternative is to exit the distributor relationship and, if there are no good alternatives, to shift to operating their own direct sales force.  Now that the market is both complex and well developed, the easiest way to “go direct” would be to acquire some existing distributors.  Unfortunately, many of the good targets have already been gobbled up.

Gerardo believes pharmaceutical companies in Brazil waited far too long to make their move.  If they had diversified earlier into more of a hybrid model, employing distributors while simultaneously developing their own formidable sales force, they would be better off and less drastically dependent.  They also should have had their eyes on acquisition targets earlier, before the distribution market became more consolidated on someone else’s terms.

If you are operating in a fast-growing emerging market country, this story could happen to you.  In your team meeting this month, ask your team members whether they are concerned about overdependence and the potential for consolidation in the distribution space.  You’ve heard the warning that your value chain is only as strong as its weakest link.  But what happens when one of the links in your value chain becomes stronger than you are? That, too, is a problem.


3 Key Objectives of Chinese Government Healthcare Spending

In the latest installment of China’s 5-year plan, the government laid out a series of initiatives that will make China one of the largest pharmaceutical markets in the world.  China’s pharmaceutical market is expected to grow from $46 billion in 2009 to $178 billion in 2019, and this massive growth is largely being driven by the ongoing healthcare reforms.

These government initiatives are creating massive opportunities for companies with their fingers on the pulse of these programs.  Here are three key government objectives and the impacts they are having on our clients:

1) Key Objective – To Provide Universal Healthcare Insurance

Under the healthcare reform, the government introduced two new basic healthcare insurance schemes, NRCMS and BMIUR, to expand coverage among the rural and the poor urban population, respectively.  In addition to a much larger population with access to health insurance, reimbursement rates have also increased; which is likely the cause of higher per capita spending on medical examination and treatment in hospitals countrywide.

2) Key Objective – To Improve Healthcare Services at Grassroots Level

As of February 2012, around 2,200 county hospitals and 33,000 primary healthcare institutions have been renovated as part of the healthcare reform, with approximately 70% of township hospitals and 85% of community health centers having been upgraded.  In 2010, 627 new hospitals were set up in China, and because of improved spending on healthcare facilities, about 70% of counties have at least one hospital at the secondary level-A.  With all of this new construction, there has been a sharp uptick in utilization and demand for diagnostics and examinations.

3) Key Objective – Public Hospital Reform

Introduction of reforms in the public hospital system has been the toughest challenge for the Chinese government; the government’s reform plan includes separation of ownership and management and a gradual elimination of drug margins.  This has led to the government announcing policies that promote private sector investment in hospitals.  Specifically, the tendering process is now much more in the hands of individual hospitals and lower-tier clinical facilities, which could be a boon for healthcare companies that are able to leverage their geographic reach and local knowledge into a competitive edge during this process.

India’s Recovery – 5 Areas to Watch

Companies should monitor the following areas to determine where India is headed:

1.       Interest Rate Cuts – One of the reasons we saw a small uptick in growth is because interest rates were cut in April which definitely impacted Q2 numbers. We need to see if the central bank is going to cut the interest rate again – if it does then we can expect growth to be higher than 5.5% for H2 2012

2.       Inflation – While headline and non-food inflation have fallen, retail (and food) inflation remain at stubbornly high levels for now. That is one of the reasons the central bank has been hesitant to cut any rates. Food inflation is a structural issue in India – a supply side issue caused by lack of infrastructure that leads to about 30-40% of all fruits and vegetables to rot in inadequate storage facilities- so until this is completely fixed – cutting interest rates is not really going to do much good

3.       Parliamentary Debates on Reform – This is extremely important. We need the politicians to begin to restart conversations on the many bills that are surrounding several of the reforms (including land-reform, tax reform, multibrand reform) etc. A new corruption scandal has not led to any real debate taking place in the parliament which means that true reforms are likely to be delayed further – so we can’t expect a full recovery until that happens

4.       Exports – While the rupee has fallen in value, so has demand from the west – so we need to understand whether or not exports are truly doing better – and for that – we need to wait for more detailed numbers. If export picks up, there might be some small relief but one has to keep in mind that India’s GDP is mostly based on domestic consumption (almost 60% of it)

5.      Monsoon – If monsoons turn out to be horrible – we will see the agricultural sector suffer and that will have a further negative impact on the growth figures

Overall I would say that since the GDP growth for H1 is around 5.4%, these are some of the things that need to happen:

1.       In order to meet the government target of 6.7% growth = India needs Q3 and Q4 to see growth of 8% – I highly doubt this will happen

2.       In order to meet the central bank target of 6.5% growth = India needs Q3 and Q4 to see growth of 7.6% – tough but possible

3.       In order to meet the FSG target of 6.3% growth = India needs Q3 and Q4 to see growth of 7.2% – tough but possible

Is the worst over? Assuming nothing changes from now until December, I personally expect India to see growth of 5.3-6% for the year so Q3-Q4 numbers need to be in the range of 5.8-6.3% – so yes they might be better but still VERY weak (given that a year ago, we saw GDP grow at 9%)


Expert Post: China and the BRICs

Frontier Strategy Group Expert Adviser, David Wolf recently wrote the following on his Silicon Hutong blog:

While the Fourth BRICS (Brazil, Russia, India, China, and South Africa) summit was nearly three months ago, the meta-message that is emerging from the aftermath is that these countries do not yet form anything resembling a bloc of interests.

Ruchita Beri’s short piece (linked above) is guardedly optimistic about the grouping, but if you read between the lines you can almost feel the divergence of interests that is pulling this grouping apart. Beri, a senior researcher at India’s Institute for Defence Studies and Analyses, gently suggests that China is part of the problem.

“While the BRICS grouping does provide an opportunity for each member to play an important role on the global stage, one of the challenges that it faces is cohesiveness. Take the issue of the BRICS development bank. While it is indeed a laudable initiative, the challenge lies in aligning the differing interests of the member countries. Moreover, other members of the grouping are wary of China’s domination over the bank given that China holds very large foreign exchange reserves ($ 3 trillion).”

All of this serves to underscore the real elephant in the room, which is the fact that while some of the BRICS might trust each other, most are having a hard time trusting China. As it considers its soft power challenges, China also needs to see that being a trustworthy player in the global system would do a lot toward making it influential (rather than disruptive) in such international groupings, and in turn toward making those groupings influential.

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