MNC Insight: Five things I learned during my 10-day visit to Dubai

I met with more than a dozen Dubai-based senior executives from multinational companies across several sectors. Five important issues emerged during our conversations:

1. Improving performance in Africa is the focus of MEA strategic planning 

During my visit to Dubai, 70% of the companies that I met were focused on improving their performance in Africa. Interestingly, most of the companies use Dubai as a hub for Sub-Saharan Africa. The UAE is already an established regional hub for the Middle East, because of the advanced commercial infrastructure, air travel links to rest of the world (Gulf flights can reach 2/3 of world’s population in 8 hours), access to skilled, albeit expensive expatriate labor, and relative ease of anticipating local costs.

2. MNCs are frustrated increasingly by the procurement process in Saudi Arabia 

Many executives cited an extended and unclear procurement process as an obstacle to business growth. There are new procedures and staff in many ministries, in part to ensure compliance, and this has led to more delays in the approval process. SAGIA, Saudi Arabia’s investment agency, recently announced a new fast-track option for processing foreign investor applications and I will investigate how it is being implemented during my upcoming visit to the market.

3. Executives are still mystified by MENA’s frontier markets, particularly Algeria and Iraq

In Algeria, companies often work through a local partner, but have underperformed due to a difficult operating environment. Many are watching whether President Abdelaziz Bouteflika’s fourth term will usher in an era of growth or support stagnation. In Iraq, most companies do not have enough info to navigate the market appropriately and find it difficult to make the case for resources given dramatic headlines that appear in Western news outlets every day.

4. Investment in Iran is still a taboo topic for many despite the market’s huge potential

Iran has the 2nd largest population in MENA and among the largest oil and gas reserves in the world. Yet the market opportunity still seems too far off for many MNCs, especially those with US headquarters. Interestingly, I met with a consumer-oriented Danish company that is trying to get expansion plans approved by their board. The executives are worried about rising competition from American companies if a nuclear deal is reached in July.

5. Companies are not worried enough about MENA’s vulnerability to a Chinese slowdown

China’s growth trajectory was not a concern for many executives until I connected the dots to the overall health of MENA economies. The Middle East supplies nearly 50% of China’s oil. Strong Chinese demand drove an oil price surge that increased GDP in GCC countries by $1 trillion between 2003 and 2013. In addition, 15% of MENA exports go to China and Chinese-based companies are major foreign investors in the region. As a result, executives need to factor into their strategic plans how a slowdown in China (below 7% annual growth) would hurt economic activity in MENA.

Five Political Events that will Impact your MENA Business in 2014

My last post focused on an overlooked topic in the MENA region: business opportunity. This post covers a more popular regional theme: political risk. MNCs must prepare for how the following political events could impact their MENA business performance in order to be successful in 2014:

1.   The next round of Iran nuclear talks beginning on February 18

  • Why it matters: A deal would lead to the opening of MENA’s largest untapped market, while failed talks would shake business and consumer confidence throughout the region.
  • Political context: It is unclear whether a final deal involving Iran’s nuclear program can be reached this year. Decades of an uncoordinated international sanctions policy would be difficult to roll back even with a final agreement, particularly if the process is made into a campaign issue ahead of US congressional elections later this year. 
  • Business impact: Companies without a local presence should manage expectations regarding the pace of market entry if a final nuclear deal is reached; the sanction rollback process could take quite a long time and economic recovery will take longer. Established companies would have a head start against rapidly rising competition, but do not expect an immediate easing of restrictions on critical business activities like repatriating funds.

2.   Algeria’s presidential election, which is scheduled for April 17  

  • Why it matters: Algeria could become a major FDI destination if critical economic reforms are implemented after the election.
  • Political context: Companies should monitor whether President Abdelaziz Bouteflika announces that he will run for a fourth term. While the ruling National Liberation Front (FLN) could field another candidate who would win, Bouteflika’s absence from the election would be seen as a shakeup in the political order, leading to political uncertainty.
  • Business impact: If President Bouteflika decides to run for a fourth term, it could signify his desire to usher in a new economic era that would enshrine his legacy. Economic reforms are badly needed, particularly to ease the process for foreign investment and market entry. Some economic reforms could be aimed at encouraging local production in important sectors such as pharmaceuticals, as the government seeks to reduce its import bill and reorient spending toward local investment.

 3.   The Iraqi parliamentary election, which is scheduled for April 30

  • Why it matters: An election accompanied by significant violence would lead to another year of high business costs and frequent transportation disruptions. However, a modestly successful election could encourage stability and boost substantial business potential.
  • Political context: Politically disaffected Sunnis (and some Shiites) are not motivated to seek change through the ballot box, because they feel excluded from the political process. Low voter turnout and significant violence would further undermine political cohesion and fuel ongoing instability. On the other hand, if the federal government and Sunni tribal leaders cooperate to combat militants in the Anbar province, this could act as a building block to ease tensions ahead of the election.
  • Business impact: An election that is widely seen as a failure will lead to more violence and necessitate companies to ensure contingency plans protect staff and local partners. On the other hand, if the election is seen as a modest success, it could slow down the momentum of ongoing violence. Companies would be in a better position to establish a foothold to build market share and to expand geographically with a sustained improvement to political stability.

 4.   The expiration of the 6-year term of Lebanese President Michel Suleiman in May

  • Why it matters: A new government must be agreed upon before President Suleiman’s departure from office or a worsening security situation would hurt business locally and across the Middle East.
  • Political context: To limit instability, it is critical that a new government is formed before the expiration of President Michel Suleiman’s six-year term in May. Without a functioning government, it has been difficult for Lebanon to contain rising instability since mid-2013. Last Saturday’s car bombing in Hermel, which killed four and injured 30, is the latest example of spill over from the Syrian civil war. The deteriorating security situation cannot be improved without a new government.
  • Business impact: Companies should brace for escalating violence, especially if there is no move towards political consensus. The volatile environment will continue to undermine consumer confidence, depress foreign investment, and raise the cost of doing business. Regionally, ongoing instability contributes to rising competition in the stable GCC region. In addition, if Lebanon becomes more enveloped in the Syria conflict, it threatens to disrupt transportation across the Middle East given the integral role played by the Port of Beirut for accessing nearby markets.

 5.   The announcement of any new Saudi labor regulations during 2014

  • Why it matters: Senior executives rely heavily on the Saudi market for overall MENA growth. Tighter labor regulations could slow down business enough to threaten MENA performance targets in 2014.
  • Political context: The government could tighten labor regulations without more private sector hiring of Saudi nationals, which increased only 4.6% between 2010 and 2012. The labor market must absorb 100,000 Saudi graduates per year and the government is willing to accept short-term economic pain in exchange for a long-term rebalancing of the job market.  Official figures indicate that Saudi Arabia has deported up to 1.25 million of 9 million foreign workers since 2013.
  • Business impact: As a result of the imbalance created by the mass deportations of foreign workers, some construction firms are struggling with higher costs and worker shortages. As a result, banks must deal with an increase in late payments and non-performing loans. More stringent labor regulations would exacerbate this situation and lead to tighter credit conditions, undermining consumer spending and business activity in 2014.

Syrian Civil War: Wait-and-See Approach Will Hurt MNCs in the Middle East

Syria

(This post is adapted from FSG’s report on how the Syrian Civil War impacts the MENA business climate. The report is part of FSG’s monthly series on managing volatility in the MENA region and is available for FSG clients here.)

Seasoned Middle East executives are confident in steady sales growth rates regardless of sensational news headlines from the region. Companies that overreact to the region’s latest developments risk falling behind aggressive competition, especially from the Gulf and Turkey. However, Western multinational companies should avoid following the lead of their governments that are taking a wait-and-see approach on Syria.

Companies must adjust business plans for the Levant region and surrounding markets as the Syrian Civil War will not end anytime soon. Fighting has already led to more than 70,000 deaths, one million refugees, and two million internally displaced in Syria. The conflict will increasingly spill over Syria’s borders and hurt economic and political stability in Iraq, Jordan, Lebanon, Israel, and Turkey.

Planning ahead allows companies to weather short-term instability, while still positioning for long-term growth in the Middle East. FSG suggests that businesses consider taking actions across core functions:

  • Human Resources: Mitigate risk for staff and local partners located in areas that are most vulnerable to spillover from Syrian fighting: Anbar province, Iraq; Jordanian-Syrian border areas; Tripoli, Lebanon; Bekaa Valley, Lebanon; southern Lebanon; northern Israel; and southeastern Turkey. Designate alternative locations for offices, outline emergency plans regarding whether employees should come to the office, and set up IT capabilities to allow people to work remotely.
  • Logistics: Reorient shipping routes through Lebanon’s Port of Beirut and Jordan’s Port of Aqaba until at least 2015. Syrian ports are not viable supply chain options for transiting goods to other parts of the Levant, Eastern Mediterranean, Iraq, and Europe. Regionally, prepare for increased insurance rates and longer transportation times for the duration of the Syrian Civil War, which could last years without any major change in the environment, such as an international intervention.
  • Sales: Reassess sales targets for your businesses in Iraq, Jordan, and Lebanon. The Syrian Civil War represents an immediate threat to economic stability in Jordan and Lebanon and political stability in Iraq. Emphasize a market share-driven strategy to position for long-term growth after political turbulence associated with the Syrian Civil War subsides. Your business can focus on a profitability-driven strategy in relatively stable and economically vibrant markets in the Gulf Cooperation Council like Saudi Arabia, Qatar, and the UAE.
  • Marketing: Utilize social media tools to establish customer loyalty, recruit local talent, and reach new customer segments in the region. Even if the corporate office wants expansion plans to be put on hold, this is an effective way to maintain and create new relationships without the cost of a strong physical presence on the ground.
  • Partners: Establish relationships with Syrian-run businesses that moved operations to nearby countries. These businesses will be positioned to reenter the market after the cessation of fighting. Egypt is an attractive destination for Syrian businesses looking to take advantage of low labor costs, reasonable cost of living, and the local textile industry infrastructure. Jordan is a natural destination for Syrian-run tourism companies that focus on the broader MENA region. Lebanon’s multi-communal society is attractive to Christian businessmen who fled Syrian cities like Aleppo, Damascus, and Homs.

 

Surprise Israeli election results: It’s the economy, stupid

Israel

Israel’s surprising 2013 general election results weaken Prime Minister Benjamin Netanyahu’s political power, which has wider ramifications on the economic and political landscapes in Israel, the region, and beyond. The election results reduce the likelihood of an Israeli strike on Iranian nuclear facilities, assuming the governing coalition moves toward the center. This could lead to lower global oil prices, because it would help reduce a key risk to MENA regional stability in the short term.

A pre-election poll by Ha’aretz Daily explains some of the underlying factors that influenced the surprise gains for leftist and centrist parties. Only 10% of Israeli voters ranked Iran’s nuclear program as the most important issue that they were considering, while nearly 50% cited socioeconomic issues as their top concern. Security issues remain important, but companies should expect the next government to prioritize addressing economic issues like high cost of living, income inequality, the budget deficit, and social benefits for ultra-religious groups.

Netanyahu and the Knesset will be under pressure to rebalance the Israeli economy, while following through on campaign promises to not raise taxes. One consequence could be tax hikes on large companies rather than Israeli citizens to raise government revenue. To address a widening budget deficit, Israel’s central bank is calling for tax hikes and significant cuts to the state budget for education, healthcare, infrastructure, and defense. The central bank governor also warned that failing to raise taxes and cut the budget will result in significantly higher budget deficits for several years.

 

Assessing distribution partners in the Middle East and North Africa

Despite economic and political instability, the Middle East and North Africa (MENA)’s economies will continue to expand, offering both opportunities and risks. In the current business landscape, effective distributor management is a critical element to capitalizing on opportunities and mitigating risks in MENA.

Local partners can provide a buffer to operational risks in order to assuage the corporate center, which might be concerned about some of the more volatile markets. Local partners can also provide critical capabilities like market insight and value-added services, which help companies to capture growth opportunities that might otherwise be out of reach.

More than two-thirds of FSG clients that were polled said they rely on distributors to reach their customers in MENA. In addition, nearly 70% plan to expand their local presence during the next three years and distributors will play a critical role in this process.

Companies that are assessing new partners should vet the prospective distributors based on considerations that are unique to the MENA region:

MENA Distribution

 

Opportunities for MNCs in the Middle East & North Africa

MENA

 

The Middle East and North Africa’s shifting environment is making it more difficult for companies to justify investment. Several events are fueling the perception of MENA’s instability. Economic and political transitions in Egypt, Libya, and Tunisia are giving pause to foreign investors who are taking a wait-and-see approach to their entry and expansion strategies. There are serious concerns that Syria’s devastating civil war will increasingly undermine stability in neighboring markets, including Iraq, Jordan, and Lebanon. Other threats to stability, such as the fallout from a deepening eurozone crisis and the specter of a conflict involving Iran, keep corporate offices jittery about regional investment.

Despite a challenging environment, huge opportunities exist for companies operating in MENA. The MENA region’s resilient economy is expected to continue expanding steadily through 2013 and beyond. The region’s youth population has reached 200 million and it will grow significantly during the next two decades when MENA’s total population approaches 500 million. An estimated US$100 billion per year is needed for infrastructure investment to sustain growth rates and boost economic competitiveness. 

EMEA executives have a difficult time making the case for MENA, even though other regions in EMEA also have challenges. Economic growth in Central and Eastern Europe is slowing rapidly. Sub-Saharan Africa remains very risky operationally. Spending power in wealthy GCC countries is nearly 50% higher than in Central and Eastern Europe. MENA’s GDP will surpass US$4 trillion by 2015, which will be 2.5 times larger than Sub-Saharan Africa.

Even if your corporate office is not thinking about MENA investment, others are focusing on the high-reward markets. Companies will be fighting for a smaller piece of the pie due to rising competition. In a recent FSG survey of leading companies, more than 65% plan to increase their current presence in MENA markets during the next 1 to 3 years. Nearly one-third of surveyed companies expect to enter at least one new MENA market within the next 3 years.

 

5 Signposts to Monitor for Investing in Egypt

Foreign companies have reason for cautious optimism in Egypt after President Morsi’s stunning consolidation of power last month. Monitor economic and political signposts to anticipate the investment climate’s trajectory. If Egypt can achieve the first two signposts below by late 2012 and the other signposts by early 2013, then companies can accelerate plans to expand investment.

1. Egypt secures US$4.8 billion IMF loan: This would signal the government’s ability to prioritize economic challenges. The World Bank (US$200 million) Qatari (US$2 billion) loans have built confidence already

2. A new constitution by year-end: Non-Islamists may feel pressure to compromise on the constitution, because Morsi can appoint a new body if there is no consensus. However, a national referendum is meant to ensure the constitution is a balanced document

3. Orderly currency devaluation: An IMF loan would provide positive momentum for more funds from multilaterals, Qatar, Saudi Arabia, and the US. This would position the central bank to manage an orderly currency devaluation, potentially phased over two to three quarters

4. Morsi transfers legislative power: Elections are expected 3 months after a new constitution is adopted and a power transfer to a newly-elected legislature is critical to demonstrate that decision-making will be transparent

5. President Morsi builds consensus: Morsi must convince skeptics that his agenda does not only benefit the Muslim Brotherhood. He is appointing independent figures to several posts as a result

Growing Opportunities Behind Turkey’s Soft Landing

Turkey Economy

Turkey is on a clear slowdown trajectory. Both the consumer and the business sectors are seeing a gradual deceleration of growth, and GDP expanded by only 3.2% in Q1 2012, compared with last year’s annual growth of 8.5%. We expect Turkey’s slowdown to continue through the end of the year as the eurozone crisis continues to depress export demand while high inflation, a weakening currency, and more expensive consumer credit undermine consumer demand.

However, this slowdown should not lead multinationals to consider Turkey a declining opportunity. In fact, now is a critical time for companies to invest in positioning themselves for the post-crisis opportunity in the market.

While Turkey is slowing, it is still weathering the eurozone crisis better than most of Central and Eastern Europe. With strong demographic fundamentals, growing investment, a diversified economy, and increasing importance as a regional hub, Turkey offers long-term opportunity that promises a relatively fast recovery once the eurozone crisis is back on a path of growth.

More importantly, we’re seeing growing investor interest in the market. Cash-rich multinationals, many of them European, are taking advantage of the weak lira to make cheaper investments in setting up or expanding their local presence, including through local manufacturing. A reflection of this trend was healthy growth in FDI at US$6.5 billion in the first five months of 2012.

Turkey’s government is aggressively working to attract foreign investment, in particular in local manufacturing. Its recently-announced incentive program has attracted substantial interest from multinationals, with over 270 applications for incentives already submitted.

This trend of increased investment in the economy, however, does not just signal multinationals’ continued confidence in the Turkish market as well as growing opportunity for B2B companies. It will also contribute to growing competition on the Turkish market, already one of the most competitive emerging markets globally. Companies caught off guard will see growing competition on price from both local companies and multinationals with a local presence undermine their profitability and restrict their ability to take advantage of the opportunity in Turkey. For companies committed to the market, this is the right time to invest in Turkey.

Saudi Arabia: Uncovering Opportunities Outside of Jeddah and Riyadh

Saudi

Photo: Regional cement demand demonstrates opportunity across Saudi Arabia

The Saudi government is spending more than US$300 billion on major infrastructure projects through 2014. Development projects are dispersed throughout the country to create jobs, raise the standard of living, and attract foreign investment in less-developed areas. As a result, companies should no longer expect to capture the full potential of the Saudi market if they are only based in tier 1 cities like Dammam, Jeddah, and Riyadh. Expanding outside of Saudi’s major cities allows companies to reach more customers in the country’s population centers, where major public investment is targeted. Government funds will support rapid growth and these cities are likely to grow faster than the core markets, because they are starting from a lower base.

Concentrate on western Saudi Arabia in the medium term

The Saudis are pouring in money to develop various cities in the western region, which accounts for nearly 40% of construction activity through next year.  Public expenditure is driven by education, healthcare, housing demand, and religious tourism in the region. The spending trends are attracting foreign investment to Rabigh, Mecca, and Medina.

  • Rabigh: importance is tied directly to the construction of nearby King Abdullah Economic City (KAEC), which is already attracting investments from major foreign multinationals like pharmaceutical company Sanofi and chocolate manufacturer Mars. Both companies plan to invest at least US$60 million in manufacturing facilities. Rajhi Steel is building a US$4 billion heavy steel complex as part of KAEC.   The plant will have a capacity of 1.8 million tons per year and will play an important role in future development in the city and region.

 

  • Medina: benefits from infrastructure development related to religious tourism and construction plans for Knowledge Economic City (KEC). CBH Real Estate Development plans to build a shopping mall in Medina with an initial budget of US$530 million to accommodate the growing demand for retail space due to religious tourism. The Saudi government has allotted US$8 billion for Medina’s Knowledge Economic City, which is expected to be completed in 2020.

 

  • Mecca: religious tourism drives infrastructure development. An estimated US$40 billion will have to be spent in Mecca within the next decade to meet rising demand for hotel accommodations. The number of pilgrims is expected to double to 13.8 million by 2019, requiring 82,000 rooms. There are currently an estimated 50,000 rooms in Mecca.

Frontier and service cities offer long-term opportunities

The Saudi government aims to develop the country’s north and south in order to raise the standard of living and promote stability. Government spending priorities provide companies with opportunities in frontier cities as a result. Expanding into frontier cities such as Hail and Jizan is a way to capture long-term ROI with an Economic City being built in each location. Buraydah is becoming increasingly important as a trade corridor for Riyadh, which will continue to attract government investment in public sector and IT projects.

  • Buraydah: location means it will play a critical part in the US$5 billion North-South Railway. The rail project is meant to connect the northern mineral-rich region with Riyadh via Buraydah. The national budget allocates US$183 million to establish and equip hospitals in Qassim Province. Much of the money will be directed to Buraydah due to the city’s role as commercial center of the province. Al Baik Food Systems, a Saudi-based fast food restaurant chain, has announced plans to open two outlets in Buraydah by 2014.

  • Hail: attracts investment as part of the country’s strategy to increase industrial activity in the north. Alfanar Construction Company is upgrading the Hail -2 Power Plant to extend electrical capacity. The US$120 million project was delayed by a year, but it is expected to be completed this year. Saudi Arabia’s Health Ministry approved US$400 million in projects in Hail Province. The new projects include the establishment of two 300-bed hospitals with a total cost of more than US$140 million.

  • Jizan: development is tied to the government’s desire to create jobs and increase the standard of living in the southern region. Bids are set to be accepted next quarter for King Abdullah Bin Abdulaziz Airport, which will be an important component of future development in Jizan and the rest of the southern region. After several delays, KBR Inc. is building a refinery in Jizan for Saudi Aramco. The facility will refine up to 400,000 barrels of oil per day when it is completed in 2015.

 

5 Ways to Adapt Your Business to the Arab Spring

The Arab Spring has ushered in a new era for the Middle East and North Africa region. Foreign companies must adapt to a changing local environment or risk falling behind competition. Companies can take practical steps to mitigate risks and capture opportunities across the region.

1. Vet local partners with an eye toward the stigma of previous regimes

Be mindful of which local companies built their success on connections with previous regimes. Some are likely to be targeted by anti-corruption initiatives as new governments seek to demonstrate progress with economic and political reforms. In Libya and Tunisia, companies will want to disentangle from partners with close ties to the previous regimes. The same will be true of Egypt in the long term. 

2. Consider price sensitivity in the medium term to solidify long-term customer loyalty

Ongoing instability involving oil-producing countries will place upward pressure on commodity prices, hurting consumers in import-dependent economies. Companies should pursue special pricing initiatives to be accompanied by advertising campaigns to express solidarity with the people.

3. Maintain relationships with experienced bureaucrats and key embassy staff in transitioning markets

The bureaucratic cores of most governments will stay in place. Senior executives should establish close relationships with career bureaucrats that handle product registration, taxation, and tariffs. Ambassadors and staff can assist companies in reaching out to local government officials.

4. Contemplate opportunistic M&As or resetting expectations with local partners

Assets are trading at extremely low valuations. They look even cheaper when currency devaluations are factored in for markets like Egypt. Now may be the time to shop for companies and deepen your presence in the region. Weakened market conditions can help companies reset contracts to drive efficiency gains in the short term.

5. Build robust contingency plans to mitigate risks and capitalize on opportunities

Escalating violence in Syria raises the threat of spillover in Iraq and Lebanon, and a clash between the Egyptian military and Muslim Brotherhood would set a dangerous precedent for the region. Companies that take an informed approach to contingency planning for these types of events will preserve resources, while mitigating risks and maximizing upside opportunities. Multinational companies with plans in place will be positioned to gain market share while competitors scramble to respond.