Emerging Markets Insights

Executives in high-risk markets should use Walmart’s troubles in Mexico to educate corporate headquarters of the difficulties of achieving high growth targets while abiding by FCPA standards in emerging markets. While Walmex’s growth was seen as one of the major success stories in emerging markets retail, we now know that it was fueled by business practices that created significant legal and reputational risk for the company

For those who have done significant business in Mexico, the bribery allegations should not come as a major surprise, nor that skirting FCPA compliance has become more difficult. Almost two-thirds of Frontier Strategy Group’s Latin America clients reported that achieving FCPA compliance has become more difficult over the past few years, with over 65% of our clients considering Mexico one of the most challenging markets in which to remain compliant, behind only Brazil and Venezuela. Locally empowered managers violating FCPA standards were the major force behind Walmart’s troubles, and FSG’s board of on-the-ground experts  considers this kind of violation to be one of the most common ways multinationals run afoul of regulations in Latin America.

FSG does not expect the situation to get better over the next few years, and companies need to prepare accordingly. Vigilance is necessary, and companies should create clear incentives and develop cultures supportive of ethics compliance and sanctions for violations, along with regular reporting of compliance practices in each business unit. However, this scandal represents an opportunity. It is particularly important for executives to communicate to corporate headquarters why growth targets must come with appropriate resources to understand and mitigate the accompanying risks, and this is best achieved by resourcing effectively government engagement efforts.

*Antonio Martinez, Analyst – Latin America contributed to this piece

Share/Bookmark

Frontier Strategy Group’s clients are revising growth forecasts for Latin America’s major economies upwards as the outlook for the global economy begins to stabilize. Growth leaders are emerging in the Andean region, and we expect that Chile, Colombia, and Peru will contend for the highest growth rate in Latin America in 2012. Strong fundamentals are keeping the Mexican economy remarkably stable while Brazil continues to miss the mark. Finally Argentina and Venezuela’s risk profile is increasing significantly, forcing MNCs to reconsider whether the potential rewards warrant the blood, sweat, and tears.

For a more detailed insight on key trends in Latin America, here are the analyst headlines for our key markets:

• Argentina: The nationalization of YPF has become the clearest indication of the Fernandez Administration’s hostility to investor concerns
• Brazil: The Brazilian government remains committed to revitalizing the economy, but it has not yet had a discernible impact on industry
• Chile: Strengthening domestic demand, higher copper prices and an improving international outlook point to continued strength for Chile’s economy
• Colombia: Strong growth in an uncertain global environment is forcing Colombia to deal with an appreciating currency and rising wages
• Mexico: Economic prospects appear to be stabilizing, but drug war violence sustains tension
• Peru: Growing pains in spite of robust consumer spending
• Venezuela: Chávez looks to foreign patronage to offset the deleterious effects of economic domination by decree

*Melissa Pegus, Senior Analyst – Latin America contributed to this piece

Share/Bookmark

MNCs that invested in Mexico in 2011 saw their bets pay off and have set high targets for sales growth in Mexico in 2012. High top-line performance will be augmented by Mexico’s superior profitability relative to high-cost Brazil. Companies that avoided dependence on Brazilian growth will continue to be rewarded throughout 2012 as increasing attention turns to Mexico.

Trend

Mexico is outpacing Brazil as a source for growth for MNCs

• In 2011, FSG clients saw average sales growth in Mexico of 21%, compared to 13% for Brazil
• Despite an expected deceleration of growth in 2012, FSG clients expect sales growth in Mexico to slightly outpace sales growth in Brazil

Expansion in the manufacturing sector was a leading force for growth in 2011

• Current projections expect growth in industrial production to remain in the 5%-6% range in 2012 despite growing external economic uncertainty
• Industrial production is increasingly destined for domestic markets

Drivers

Continued confidence in Mexico’s policy direction and domestic economic outlook is driving further investment across industries

• Producer confidence increased in January 2012, with producers citing a growing belief that this is the time to invest
• President Calderón promulgated a new law on public-private partnerships that should boost  private-sector investments through 2012 and beyond

Capital investments are driving growth for manufacturers

• Mexican companies’ investments in capital  goods increased by 6.7% YoY in November, with machinery and equipment posting a double-digit increase

Share/Bookmark

Latin America continues to look strong as 2012 gets rolling. Brazil’s growth remains subdued, but stimulus efforts are beginning to have an effect, and Mexico continuing to spend heavily in the run-up to the July presidential elections. Meanwhile Peru and Colombia continue to perform well despite a volatile international environment.

• Argentina: Risks to multinationals are growing as Argentina doubles down on trade restrictions in response to deteriorating economic fundamentals
• Brazil: Stimulus efforts are beginning to take effect, but Brazil is not out of the woods yet as industrial output continues to stall
• Chile: Chile is poised to weather global economic volatility with strong macroeconomic fundamentals and a sovereign wealth fund
• Colombia: Retailers and manufacturers remain confident as the economy continues to grow, buoyed by strong investment and stable commodity prices
• Costa Rica: Fragile public finances and a weakening economy have led the government to raise taxes, imperiling future foreign direct investment
• Dominican Republic: Economic decline in Europe and new immigration laws will have adverse effects on the tourism, agriculture, and mining industries
• Ecuador: Government spending and stable commodity prices will support growth in 2012, but overexposure to oil continues to present risks
• Mexico: Better-than-expected US growth has not stopped government authorities from pursuing stimulative policies to boost consumer spending
• Panama: An increasingly unpopular Martinelli administration will face a cooling but still high-performing economy in 2012
• Paraguay: Paraguay is developing a two-track economy with consumption thriving as exports falter
• Peru: President Humala is doubling down on his centrist, pro-business policies by pushing out leftists from key government posts
• Uruguay: Uruguay is at the mercy of economic developments in Argentina and Brazil, with current trends pointing to a slowdown in 2012
• Venezuela: Chávez’s erratic decision-making indicates an increasingly toxic business environment for MNCs

Share/Bookmark

2011 year-end growth figures and new forecasts for 2012 demonstrate continued, but slower, growth, and the emergence of new risks and opportunities in LATAM. Brazil’s growth will subdued, by recent standards, and Argentina is preparing for a potentially painful economic restructuring. While larger regional economies slow, robust Chile, Peru, and Colombia increase in relative importance.

• Argentina: High inflation and a yawning budget deficit are forcing Argentina to lower spending, but trade and capital restrictions remain in place
• Brazil: Brazil faces a rapidly slowing economy, and government authorities are pushing for monetary easing and higher government spending
• Chile: The Piñera administration faces political and economic headwinds going into 2012 but Chile’s fundamentals continue to shine
• Colombia: Growing recognition of the long-term potential of the Colombian economy is quickly eclipsing investor fears of violence and instability
• Costa Rica: Fragile public finances and a weakening economy have led the government to raise taxes, imperiling future foreign direct investment
• Dominican Republic: Economic decline in Europe and new immigration laws will have adverse effects on the tourism, agriculture, and mining industries
• Ecuador: Government spending and stable commodity prices will support growth in 2012, but overexposure to oil continues to present risks
• Mexico: Mexico enters 2012 with confidence earned from economic resilience and hopes for a smooth political transition in July
• Panama: Panama’s economy boosted by trade agreement with the US, but political uncertainty clouds the prospects for Martinelli’s reform agenda
• Paraguay: Contrary to previous expectations, Paraguay will see lackluster growth due to weakening external demand and supply shocks at home
• Peru: Protests are hurting President Humala’s political standing, but the economy remains strong despite growing political uncertainty
• Uruguay: Uruguay is at the mercy of economic developments in Argentina and Brazil, with current trends pointing to a slowdown in 2012
• Venezuela: New socialist legislation makes it harder to turn a profit and easier to run afoul of the law in Venezuela

Share/Bookmark

Multinationals can count on increased consumer spending as the evolution of the Mexican economy toward higher value manufacturing supports a more resilient and prosperous Mexican middle class. Companies servicing the automobile and heavy machinery sectors are set to benefit the most from the continued diversification of the Mexican economy.

Share/Bookmark

Country and regional heads at Frontier Strategy Group client companies are increasingly turning their attention to their government engagement function, and for good reason. It is evident that government decisions often hold the key to significant risks and opportunities, from regulatory issues to government sales, that can deeply impact the bottom line.

Clients express that they are wrestling with a variety of questions when it comes to running successful government engagement functions. These questions can be broken down into three principle challenges:

• Ensure the company invests the right amount in government engagement. MNCs struggle to quantify the function’s contribution to business objectives, which often leads to a crisis-response approach to investment.
• Generate positive engagement when government actors are initially unreceptive. This is particularly challenging because governments typically hold all the power in any given interaction and the panoply of government actor interests is much more diverse and complex than the typical business partner’s interest in increasing profitability.
• Capitalize on the abilities of third parties without putting the company at risk. This is particularly challenging because the same reasons that lead government engagement offices to turn to third parties – lack of internal staff presence on the ground, expertise, or connectedness – are the very elements that make it difficult to monitor third parties and make sure they are not engaging in wasteful or unethical practices on one’s behalf.

In response to these challenges, the government engagement function often resorts to a reactive, problem-solving approach. However, Frontier Strategy Group’s cross-industry research reveals that to succeed, the government engagement function should reframe traditional ROI evaluations to embrace the broader goals of government engagement, thus creating a proactive decision framework. This new ROI approach applies to each of the three major challenges companies face:

• Justify Your Investment – First understand how to tailor your investments to the realities presented by each country’s business and political environment. Then size up the “R” in ROI by taking a value at stake approach to determining which issues the government engagement function should prioritize, well in advance of the development of serious problems.
• Earn Your Influence – Make sure you time the “I” well in ROI. Provide direct value to key contacts in government before you need their assistance, for instance by offering research on a topic where your company has expertise or by partnering to help a government sector operate more efficiently. Build political support by building domestic companies into your supply chain.
• Discipline Your Delegates – Do not take short cuts with third parties. A low “I” does not guarantee high ROI if the “R” turns out to be negative. If you decide to hire a consultant, lobbying agency, or legal firm, you must first invest in sufficient due diligence to be sure they will not indirectly involve you in a scandal by association with other clients, or by hiring unauthorized fourth parties. Second, invest in helping third parties to really understand your industry so that they can better serve you.

Share/Bookmark

The recent headlines out of Mexico paint a seemingly dichotomous picture: violence is at an all-time high, yet multinationals continue to pour money into the country, with over $22 billion in foreign direct investment expected this year. The implication is that the knock-on effect to multinationals from the government’s war on the drug cartels has been slight. However, this interpretation of the facts belies the impact that violence-induced migration is beginning to have on many multinationals in the country. Recently, while in Mexico City, we heard over and over again of the many ways in which violence is changing demographic realities as workers and consumers move away from areas plagued by high levels of cartel activity.

As Calderón’s war against the cartels drags on, violence-induced migration is accelerating, creating a new set of challenges for multinationals. States with the highest levels of violence, such as Chihuahua, Sinaloa, and Guerrero, are seeing a net loss of citizens to more peaceful states like Querétaro and Hidalgo. According to Frontier Strategy Group Expert Advisor Leon Kraig, “many companies are starting to feel the impact of white collar flight from Monterrey” finding themselves unable to find entry- and mid- level managers. “Asking employees with families to move there is very difficult, and many based in Monterrey are asking to be transferred. Companies looking at alternative locations are primarily considering Mexico City, or possibly Guadalajara or Querétaro”, says Kraig.

In addition to tightening the labor market, violence is also changing the behavior of consumer markets. It is estimated that 230,000 people have been displaced in Mexico due to cartel violence, a tragedy that is shifting the demographic composition of many cities. Additionally, consumption patterns are changing as many individuals grow reluctant to frequent public venues such as restaurants and markets that could be targeted by cartels. According to a senior executive of a major global alcohol distiller, “Nobody is going out to bars and restaurants at night, so our business is suffering significantly in Monterrey, because consumers don’t compensate by entertaining more at home.”

One of the major drivers behind the decision of many Mexicans to relocate away from violent areas is the government’s lack of any viable near-term solution for dealing with the cartels. Indeed, violence has steadily increased with each new phase of the government’s war on organized crime, with the number of homicides growing by 15% year-on-year during the first half of 2011 alone. Given that only long-term efforts to strengthen judicial and police institutions are likely to have any major impact on the security situation, an adjustment to the government’s current strategy is unlikely over the near term. Many Mexicans therefore feel unable to wait out the increased violence as they have previously.

As the violence in Mexico continues, multinationals should expect to see skilled labor markets in the northern parts of the country tighten, driving up costs for companies seeking to efficiently manage their manufacturing operations. Additionally, B2C companies must keep an eye on how the violence is affecting demographic trends and consumption patterns. It is our belief that the companies that can adapt their strategies to these changing dynamics will see the least impact from continued violence.

Share/Bookmark

Fear over a stalling global economy stalks the region as volatility returns to the local bolsas. Frontier Strategy Group expects the overall impact of a slowdown to be smaller than in 2008 as Latin America has grown less reliant on global trade flows than other regions. Mexico has the most to fear, given its dependence on the US economy, while Brazil and Colombia could actually benefit from a currency depreciating financial flight to quality.

Share/Bookmark