Escalation in Crimea: Impact on MNCs Operating in Western Europe

As MNC executives responsible for Western Europe dissect the events unfolding in Ukraine’s Crimea region, they will fall under more pressure to digest mounting media news and interpret current events’ impact on their business. To address the localized impact of increasing hostilities in Crimea, our latest podcast, introduced in the preceding blog post, focuses on the factors that will impact multinationals’ Ukraine and Russia business regardless of the scenario that unfolds in Ukraine’s Crimea region.

However, the impact of Ukraine’s crisis is extending to the regional level, and could impact European recovery. Executives should act now to consider how the following possible impacts will affect their ability to meet targets in 2014:

  • Any disruption in gas lines will push up prices in Europe. A Gazprom (Russia) decision to cease gas flow to Ukraine would disrupt gas flows to Europe, which only has 18 days of gas reserves and easily could be outlasted by a political crisis. Decreased gas flows would thus increase energy prices and hurt any chance of recovery as consumers focus on inelastic energy costs and away from elastic purchases of goods and services. Europe is Russia’s largest export market, creating disincentives for a gas cutoff that would leave a large hole in the government budget. The Russian government, however, has often put political concerns ahead of economic ones
  • Germany could be the worst hit. Most of Germany’s gas supply flows directly through Ukraine, and constitutes about one-third of its energy mix. German consumers also suffer from the highest electricity prices in Europe, meaning that the country’s exposure to increased energy prices would force the government to abandon its new energy rebalancing policies in favor of keeping prices manageable for its citizens and industry. The result would be increased short-term energy costs and a return to government deficit. Furthermore, Germany’s reliance on exports means that lower demand due to regional volatility would reduce its prospects for outperforming the eurozone in 2014
  • Even European bank exposure to Ukraine could reduce lending activity in Western Europe. While the Ukrainian credit market is almost entirely dominated by local players ─ only Raiffesen of Austria is heavily exposed ─ the European banking system is so sensitive that one bad bank could accelerate the credit contraction already taking place in Europe
  • Continued crisis in Ukraine could disrupt supply chains, which would increase costs. Companies should consider what disrupted supply chains would mean for getting their products to market, and include distributors in the conversation to gain local knowledge and buy-in, and ensure adherence to any contingency plans

Now is the time for executives to build contingency plans, particularly focusing on what increased activity in Ukraine would mean for pricing. Companies that are able to course correct strategic plans and allow for increased costs will be better-equipped to address regional volatility, meet their 2014 targets, and gain market share.

Escalation in Crimea: What it Means for MNCs

With all eyes on Ukraine after Russia threatened military action, MNC executives are under more pressure than ever to rise above the media noise and assess what current events mean for their business. Even though the situation is evolving by the minute, executives’ time is better spent focusing on the factors that will affect their business under any scenario, rather than trying to decipher the multiple directions in which the crisis may evolve.

In our latest podcast (client portal) on Ukraine and Russia, we highlight what executives should focus on:

  • Companies need to have contingency plans for both Russia and Ukraine; any existing plans likely need to be revised in light of events during the weekend
  • Under any scenario, Ukraine is in for significant economic pain in the short term. Targets and plans should reflect that. Pricing may also need to be adjusted
  • Managing corporate’s perceptions of the situation is critical given the flood of media coverage on Ukraine. Executives need to control the narrative on Ukraine and Russia with HQ to ensure that their business is well-positioned to take advantage of any opportunities that the crisis may present
  • 2014 Russia plans need to be revised. Russia is likely to underperform in what was already a poor economic environment. Companies should in particular make sure they have a plan in place to respond to the currency depreciation which threatens to hurt both revenues and profits this year

For a detailed discussion on these and other steps executives should take in response to tensions between Ukraine and Russia, listen to FSG’s podcast (client link) and read our report (client only) on how to protect your Ukraine business from the worst fallout from the crisis. You can download the podcast here (public) or subscribe to our Emerging Markets Podcast Series.

Russia’s Hidden Trend: Regional Slowdown with Significant Implications

Russia slashed its long-term growth target this week, admitting that its economic slowdown is a trend that is here to stay for the next several years.

While the reasons for the slowdown have been discussed extensively, one topic has remained overlooked – the slowdown is not playing out uniformly across Russia’s geography. This has significant implications for multinationals, the majority of which are not planning to pull out of Russia, but are instead looking to allocate their resources more efficiently and to capture growth niches on a segment and geographical level.

To help our clients prioritize Russia’s geographic opportunity, we analyzed the economic health of the country’s regions. We found massive region-level variations in performance. More importantly, we found that the slowdown has been much more pronounced across many regions than the headline numbers indicate – a sign that next year’s outlook could deteriorate further.

Three trends stand out:

Trend #1: Pockets of growth are driven by one-off factors

  • Relatively fast growth in the Far East, Southern, and North Caucasus federal districts is driven by one-off projects, such as the Sochi Olympics, and federal government subsidies

Trend #2: Leading federal districts are underperforming

  • Traditional engines of economic growth, such as the Central and Urals federal districts, are stagnating because of depressed investment by large industrial enterprises in their regions

Trend #3: Slower growth is geographically widespread

  • In every federal district, there are at least several regions that are underperforming significantly, indicating that the economic slump is not isolated to a particular part of the country

The map below (click map to enlarge) summarizes our assessment of the economic health of Russia’s regions so far in 2013. We analyzed regional trends in the consumer and business sector, as well as among the increasingly-indebted regional governments, to find that demand in Russia is being driven by pockets of high growth that are geographically dispersed. This is likely to increase costs for companies looking to capture all growth pockets, and will push more multinationals to prioritize only a small number of regions, which are increasingly likely to outperform the rest. As a consequence, we are likely to see more multinationals focus on profitability and cost optimization of their local operations, rather than on making the kind of large investments that could help jump-start the country’s economy.

FSG Index for General Health of Russia's Regions

 

FSG clients can access the full report here.

Memo to EMEA and LATAM regional heads: time to pick up the phone and chat

Struggling to Combat Slowing Growth and Rising Costs in Key BRICS Markets?

A conversation with your regional counterpart in EMEA, LATAM, or APAC can help you understand the common structural factors driving lackluster growth and help you re-set corporate expectations for growth in 2014

BRIC deceleration

2013 has been a difficult year for the BRICs—economic growth has decelerated across the board due to the confluence of external headwinds and domestic inefficiencies, while the political will to push for necessary structural reforms has proven elusive.

For emerging markets executives seeking to respond to slowing growth in key BRICS markets, cross-regional conversations can be valuable for issue diagnosis and strategy development. The premise of the argument here is a simple one: common problems can and ought to be identified, so that viable strategies for driving profitable growth given less favorable medium-term prospects for the BRICs can be replicated and applied across regions.

I’ve been ruminating about Brazil’s slowdown and potential for recuperation in 2014 for several quarters now, while my EMEA colleague, Martina Bozadzhieva, has been doing the same with respect to Russia.  However,  it wasn’t until we had an opportunity to sit down together and discuss the dynamics driving Brazil and Russia that we learned how much these two seemingly disparate markets have in common.

Listen to our podcast below for a quick recap of the structural factors driving lackluster growth in Brazil and Russia, and get a cross-regional perspective on strategies for managing corporate expectations and improving bottom-line performance across the BRICS.

Download the podcast or access the entire FSG iTunes library here

Russia beyond the headlines: A vibrant start-up environment

Although negative publicity seems to dominate Western coverage of Russia, the country offers many exciting growth stories. Evan Burfield, founder of 1776, a technology start-up incubator based in Washington, DC, shared impressions from his latest trip to Moscow with FSG. In Russia, he met with start-up entrepreneurs, angel investors, and government officials to discover that a community of exciting, ambitious, Western-style technology start-ups has appeared in the country during the past few years. Below, we highlight a few of Evan’s insights from his trip.

Russia has a vibrant start-up community and it looks very much like the one in the West

Surprisingly to many observers, Russia has a growing community of start-ups that would be very much at home in Silicon Valley. One reason for this is that many Russian high-tech start-ups were set up by Russians educated in the West or with experience working in top global consulting companies such as Booz Allen Hamilton, McKinsey, and others. Some Russian emigrants living in West have also returned to Russia to take advantage of the huge growth potential that the country offers.

As a result, you find in Russia the same trends in start-up development as in other countries – big data, education, consumer web, etc. Some Russian companies are cloning Western business models, but are striving to be global players and to expand into markets beyond Russia.

But the sources of start-up capital are different 

Russian startups are supported by an angel community composed of prominent investors whose roots are often in building successful businesses during the 1990s tech sector boom, for example companies such as Russian search-engine Yandex. However, many investors also come from more traditional industries such oil and gas. They may not see stable investment opportunities in their current industries and look to instead invest in what they increasingly see as the next-generation wave of Russian startups.

Russian start-ups face unique challenges

In the U.S., capital and start-ups are readily available and the challenge lies in selecting the right ideas. In Russia, capital is abundant, but high-quality ideas and entrepreneurs are more difficult to find.

One of the reasons for this difference is the shortage of mentors in Russia. Most of the big Russian businesses are in more traditional industries, which means that the pool of successful tech entrepreneurs is small. Local mentors with experience are highly sought after, but are few and far between.

The Russian government both supports and obstructs local start-ups

The Russian government seeks to support start-ups, especially in the technology industry. The most well-known example of this is the high-tech innovation hub of Skolkovo.

On the other hand, start-ups in Russia struggle with administrative issues such as being able to post several years of losses without arising the suspicion of the tax authorities, and the generally very high level of taxation. This makes it critical for them to establish good relationships with the authorities to ensure sustainable growth.

Corruption is less of a problem than is commonly perceived. The burdensome regulatory environment is a much bigger challenge for Russian start-ups. This underlines the attractiveness of special projects such as Skolkovo, which offer reduced red tape and tax breaks.

Exciting opportunities exist for investors with a more balanced view of Russia

There is no doubt that there is a massive misunderstanding of Russia in the US investor community. There is a Western perception of the inherent element of criminality and corruption in all Russian business. But at the same time, this doesn’t mean that there are no sophisticated, Western-style aspects of the Russian economy. In fact, the two exist in parallel.  For example, Russian government rhetoric against the US is also combined with strong interest in and support for collaboration in technology. There is huge demand for start-up engagement on the side of the Russian government as well as from the private business community.  This creates significant opportunities for those investors who are willing to look beyond the headlines on Russia.

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Evan Burfield is a cofounder of 1776, driven by his passionate belief in entrepreneurship as the engine for solving the major problems facing America and the world today—from education to energy efficiency.

Evan became an entrepreneur in 1996 when he founded netDecide, shortly after graduating from the Thomas Jefferson High School for Science and Technology. Before he turned 25, he built netDecide into the leading provider of enterprise wealth management solutions for top tier financial service firms. After netDecide, Evan served as the Director of Strategy and Technology for Oakwood Global Finance, where he led the London-based private equity firm’s analyses of new global markets, new business models in financial services, and data-driven investment strategies. In 2006, Evan returned to Washington, D.C. to found Synteractive, a consulting firm that builds innovative social apps for startups, corporations, and government agencies.

Evan holds Bachelor’s and Master’s degrees in Philosophy, Politics and Economics from the University of Oxford. While at Oxford, he won the Webb Medley prize for outstanding work on the effects of organizational incentives on knowledge sharing. Evan currently serves on the Board of the Rothermere American Institute at Oxford, dedicated to the study of American history and politics.

Emerging Markets Opportunity Not Over

Currency-Volatility-Global-Performance-DriversRecent reversals in capital flows caused large and sudden currency devaluations, faster than many emerging markets expected or could manage. As a result, many market commentators have called this end of the emerging markets opportunity. That statement couldn’t be further from the truth. While companies should always expect challenges in emerging markets, the changing environment will also create a new set of opportunities.

FSG identified four ways companies can capture growth in this shifting environment:

  1. Leverage home-currency strength to win share back from emerging markets–based competition
  2. Double down on local production to reduce production costs
  3. Use balance sheet strength to earn financing margins
  4. Reassess customer segmentation to identify local customer “winners”

FSG looks at these strategies and the drivers of the changing global environment in our 2014 Global Performance Drivers report, now available for FSG clients.

What happened?

Capital flows reversed because of push and pull factors.  As the US economy continues to improve, the Federal Reserve is expected to reduce bond purchases, changing the risk-return payoff for portfolio investors, “pulling” capital out of emerging markets.  We also see slowing growth in emerging markets “pushing” capital to developed markets.  The outflow of capital is more concerning for countries like Turkey, Poland, and Ukraine, which have high levels of short-term external debt. Countries fitting this profile may run into short-term funding challenges that could drive up local interest rates, or in the worst case cause temporary liquidity problems. Other countries like India and Indonesia may now struggle with inflation as currencies decrease faster than is manageable, driving up costs for consumers.

Podcast: Russia, Belarus and Kazakhstan Customs Union | Expert Interview

PODCAST

The Customs Union between Russia, Belarus, and Kazakhstan increasingly attracts the attention of multinationals interested in expanding their presence in the CIS. In this podcast, FSG interviews Alexander Rogan, CEO of Russia Supply Chain and FSG Expert Advisor on the practical implications of the Customs Union for companies looking to transport goods across the CIS, as well as the opportunities that the Union creates for companies investing in the region.

Click here to download the podcast or alternatively access the FSG iTunes podcast library here.

________________________________________________________________

Alex RoganAlexander Rogan is the CEO of Russia Supply Chain, a series of publications and a consultancy. He previously worked as Managing Director at Priority Freight CIS, a logistics and supply chain company with offices in the EU, UK, and CIS. Mr. Rogan has 28 years of experience in global logistics and currently works in Russia, Kazakhstan, and the Former Soviet Union. Mr. Rogan has also served as Managing Director of AJR Logistics, which provides inbound/outbound logistics in Russia. He has wide-ranging expertise in managing distribution in Russia. He was also the Russian editor for Logistics Leaders and published Russia’s Automotive Supply Chain magazine.

Alexander is available to FSG clients for private consultation – please reach out to your account manager to schedule a meeting. 

PODCAST: Managing Compliance in Russia

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

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

Protecting Your Business in Russia From Corruption

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

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

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

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

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

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

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

 

Emerging Market View: What Our Analysts Are Reading – 3/1/2013

Many of this week’s US headlines primarily focused on the the imminent United States government sequestration.  In addition to following those developments, our research talent kept an eye on headlines pertaining to emerging markets, too.  Below are some headlines with FSG research analyst commentary:

Bloomberg News reported that Emerging Stocks Erase Weekly Gain on China, Commodities:

“Today’s headlines highlight the US budget sequester’s ripple effect on emerging-market growth. That could incrementally diminish the opportunities for MNCs in some EMs, but it doesn’t change the fundamentals. We are more concerned that US-based MNCs will react to economic mismanagement at home by remaining overly risk-averse abroad, allowing local competitors to capture yet more market share.”
- Joel Whitaker, Senior Vice President and Head of Global Research

The Wall Street Journal’s Deal Journal blog posted Doubts Over Returns Hit Fundraising in China:

“Look beyond headline GDP to gauge China’s economic performance. Look at corporate profits in China and return of PE investment is a good indicator.”
- Shijie Chen, Research Practice Leader for Asia Pacific

From Reuters - Brazil may use imports to curb inflation:

“Offhand comments by Brazil’s finance minister raise the possibility that the country could drop import tariffs in sectors and on goods where local producers have been raising prices aggressively. This would be a 180 turn from years past, when Brazil raised tariffs on imported goods in industries impacted by cheaper imports due to a strong currency.”
- Clinton Carter, Director of Research for Latin America

And lastly, another article from Reuters - Russia says central bank independence not at risk:

As CEE governments struggle to boost growth without increasing fiscal deficits, they are increasingly pushing regional central banks to cut interest rates, even at the expense of undermining the banks’ independence. This is a trend to watch in 2013, especially in Russia where reduced central bank autonomy could significantly undermine investor confidence.”
- Martina Bozadzhieva, Senior Analyst for Central and Eastern Europe