Emerging Markets Insights

Peace talks between the Turkey and the PKK, a Kurdish militant organization, are making the biggest progress seen in decades in resolving Turkey’s difficult relationship with its Kurdish population. Although many roadblocks to the successful completion of the process remain, the peace talks warrant multinationals’ attention as they could create increased investment opportunities. The process is already supporting Turkish stocks and ratings agencies are speaking about its potential to bring Turkey to investment-grade status.

Here are some of the implications of successful peace talks for multinationals operating in Turkey:

• Access to new customers – Improved physical security in southeastern Turkey will lead to decreased shipping and insurance costs for getting goods to customers in the region
• Increased private investment – Despite generous government incentives, companies have shied away from investing in the region due to security concerns. Private investment will begin to pick up as companies gain confidence that the ceasefire will hold. Private investment will be led by Turkish players who have deeper regional knowledge and who will be more aggressive in seizing investment opportunities. Multinationals should ensure that they monitor competitor activity in the region to avoid losing market share
• Attractive export hub – Producing in southeastern Turkey could provide avenues for exporting into northern Iraq, GCC, and the Levant. Companies looking to leverage Turkey’s regional hub position may be able to use southeastern Turkey as a cheap production and sales hub
• Branding opportunity – Companies looking to capture market share among the Kurdish population can use the peace process to position their products as part of a historic, positive change happening in Turkish society, especially among young people

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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.

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Are joint ventures an outdated strategy for growing in the Turkish market?

The answer is increasingly yes.

Joint ventures were a preferred strategy for multinationals looking to enter the Turkish market, often by partnering with Turkey’s powerful conglomerates, in the 1980s and 1990s. Since then, however, Turkey’s operating environment has seen significant improvements – macroeconomic stabilization, strong economic growth, investor-friendly government policies, growing adoption of EU standards, and, importantly, an increasing number of multinationals that are setting up a direct presence in the market. Simply put, it’s a lot easier for multinationals looking to scale their presence in the market today to go hybrid or direct than it was a decade or two ago. As a result, multinationals in Turkey increasingly prefer to maintain full control over their local business and go at it alone instead of navigating the challenges of partnering with local companies.

Are joint ventures in Turkey dead then? Not quite. We find that forming a joint venture can still be a successful strategy for scaling in the market, and it is a particularly good fit for companies that are looking to expand but are unable or unwilling to commit significant up-front investment to it. Multinationals in this position will find that Turkey’s conglomerates, as well as big local players, and even other multinationals with a significant presence on the ground could give them access to the manufacturing facilities, distribution networks, capital, as well as government connections and market know-how that will allow them to rapidly expand.

As a result, joint ventures are increasingly becoming a niche strategy, one among many that multinationals can implement to effectively scale their business in the market while maintaining profitability.

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Going direct is not always the best strategy in Turkey

Companies looking to scale their presence in Turkey often assume that a transition to a fully direct presence in the market is the most logical next step as they seek to grow. However, this is not always the case. Instead, for many companies across industries, a hybrid presence is a more cost-effective way to cover the market.

What makes hybrid an attractive option for companies looking to grow their presence in Turkey?

First, Turkish distributors are relatively cheap. Turkish distributor margins are 23% lower than the global average distributor margins, according to FSG’s annual growth benchmarking survey. For companies selling low-margin products to numerous, geographically dispersed customers, working through a distributor could be the most cost-effective strategy to cover those markets.

Second, Turkish distributors can offer multinational companies access to markets that are difficult and/or costly to cover via a direct sales force. This is particularly true for Turkey’s traditional market – bazaars, open-air markets, individual merchants. The traditional market is heavily driven by relationships and having a local distributor with strong connections on the ground can make or break your access to this market.

Finally, multinationals in some industries, such as consumer goods, can find distributors with enough capabilities to be strategic partners. Because of the well-developed consumer market in Turkey, there is a wide supply of distributors who have the geographic coverage, networks, and capabilities to effectively cover the market.

Despite these advantages of working with Turkish distributors, companies often still need a direct presence to ensure the high quality customer support and technical expertise that higher-end or more technologically sophisticated products require. Multinationals who work with corporate or large business clients also find that a direct presence is the best way to serve these types of clients.

As a result, a hybrid model based on segmenting the market and selecting the right channel to cover each segment is often the most cost-effective strategy of scaling your presence in Turkey.

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With the eurozone falling into recession and most of CEE following closely behind, multinationals increasingly look to Turkey as a growth engine for their EMEA business. However, growing competition on the Turkish market means that companies need to build scale into their Turkish business to maintain profitability. One strategy a growing number of multinationals are pursuing is leveraging Turkey as a regional hub. In fact, Frontier Strategy Group’s research finds that companies that based their regional hub in Turkey improve their profitability well above the global average for their company.

Why are these companies doing so well? Basing a regional hub in Turkey has two benefits: cost savings and customer access. Turkey’s geographic position as a hub, its extensive trade agreements with countries in the region, and strong infrastructural and cultural linkages to the Middle East, North Africa, Balkans and Central Asia regions, offer global multinationals access to over 1 billion potential customers.

However, Turkey’s main attraction are the cost savings companies can realize when locating a hub there. Turkey’s large and growing domestic market, with 75 million customers and a vibrant business sector, makes the country a viable alternative even to established hubs in places such as Dubai. The size of Turkey’s market is complemented by the country’s large skilled, and relatively cheap labor force that allows companies to build a sales hub, to manufacture, and even to conduct R&D activities locally. Finally, Turkey’s favorable investment climate means that companies can confidently make the large, long-term investments that are required when setting up a regional hub.

Leading global multinationals are already benefiting from the opportunity to hub in Turkey. Some companies have selected Turkey as a hub for the larger EMEA region, for example The Coca Cola Company, manages more than 90 markets from its Istanbul regional headquarters. Other companies use Turkey as a regional sub-hub managing a limited number of smaller regional markets. For example, Pepsi, Adobe, Huawei all manage 10-20 regional markets from Turkey. Illustrating this trend, global multinationals such as Sanofi and GlaxoSmithKline both relocated their regional headquarters from Dubai to Turkey in the past 6 months. More companies will no doubt follow.

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While Turkey is one of EMEA’s most attractive growth markets, MNCs face significant challenges in building a profitable business there. According to Frontier Strategy Group’s clients, strong local competition is one of the biggest obstacles to growth in Turkey. MNCs can improve their profitability and boost their performance in Turkey by leveraging increased scale to cut costs and create economies of scale.

FSG’s research shows that scale leads to improved profitability in Turkey at a higher rate than it does in the BRIC markets. One way in which MNCs can take advantage of this is through M&A. The M&A market in Turkey is particularly favorable due to the weak lira, the slowdown of the economy which is depressing valuations for export-oriented local players, as well as the upcoming introduction of Turkey’s new commercial code which will improve transparency and strengthen shareholders rights. As competition for the best assets from private equity funds intensifies, MNCs will have a limited opportunity to take advantage of this favorable environment and reap the benefits of improved profitability in Turkey.

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If you are not going direct in Turkey, then you are likely missing out on a tremendous opportunity for your business. In our latest research on the market opportunity in Turkey, Frontier Strategy Group identified three questions you should ask about the state of your operations in Turkey:

1. Turkey’s M&A market is ripe for acquisitions, but MNCs increasingly have to compete with private equity funds for the best assets. How is your company leveraging acquisitions to grow its presence in the Turkish market?
2. MNCs leveraging Turkey as a regional sales hub are 9% more profitable in Turkey than the global average for their company. How is your company taking advantage of Turkey’s growing position as a regional hub?
3. Turkish distributors are 23% cheaper as a percentage of profit margins than the global average. How effective is your company at leveraging distributors to increase market penetration in Turkey?

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Turkey had a strong 2011, with GDP growth exceeding 8% for the year. However, we expect a noticeable slowdown in 2012 to 1.7% YoY. The main drivers of the slowdown are weakening industrial production as eurozone demand for Turkish exports slows, tightening credit conditions in the eurozone, and rising inflation in Turkey. These factors will come together to put downward pressure both on business and consumer demand and will affect multinational companies across a wide variety of sectors.

However, Turkey has consistently surprised on the upside over the past several months, and a very gradual slowdown of the economy in 2012 is becoming increasingly likely. What is more, as the Turkish lira remains relatively weak, the exchange rate will favor companies exporting from Turkey and will partly offset the declin in export demand from the eurozone. We expect Turkish growth to accelerate once again in 2013 as the effect of the eurozone crisis wears off and Turkey’s current account deficit narrows, improving market confidence in the country’s economic stability.

Meanwhile, 2012 is a year of opportunity for companies looking to invest on the Turkish market. With tighter credit conditions and low export demand putting pressure on the local companies’ financial stability, a weak currency, and lower investment from the eurozone, MNCs will have more targets to choose from for M&A this year, at a lower cost of investment, and facing weaker external competition for priority targets. With the market expected to rebound next year, companies that invest in Turkey this year will find themselves positioned for stronger growth in 2013 and beyond.

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The outlook for Central and Eastern Europe is getting gloomier by the day as the eurozone crisis is weakening regional economies. While there is a significant level of volatility and uncertainty around the eurozone’s performance in 2012, there are several clear trends that will impact MNC performance in CEE this year:

• 2012 GDP growth projections are low across the region and will be revised further down
• Decreasing exports will hurt local producers
• Tight lending will limit local companies’ ability to make investments and will dampen consumer demand
• Austerity measures across the region will slow government and consumer spending but will ease inflation
• Local currencies will remain volatile and weak against the dollar

MNCs should plan to adapt their product portfolios, purchasing policies, and partner relationships to respond to weaker demand and tighter lending conditions in CEE.

However, not all CEE markets will fare the same – some will be impacted more than others (see table).

This creates opportunities for MNCs that pay attention to the nuances of the different regional economies and zero in on the markets that will outperform the rest of the region. The two most obvious ones are Poland and Turkey. In Poland, resilient domestic demand will sustain growth despite the negative impact of slowing export demand. Turkey will definitely see a slowdown this year, but its macroeconomic fundamentals remain solid and the country offers excellent opportunities for long-term growth.  Both countries are presently experiencing currency depreciation, creating opportunities for cheap investment and acquisition of attractive local assets at a discount.

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Trend

• Turkey’s economy is growing at a slower pace than it did in H1 2011, a trend that will become more pronounced through 2012

Drivers

• Demand for Turkish exports is slowing as the sovereign debt crisis drives recession in the eurozone, Turkey’s most important trade partner
• The Central Bank of Turkey is tightening credit conditions to stem the depreciation of the Turkish lira. This will slow both consumer and retail credit growth in 2012 and will contribute to slower GDP growth for the year

FSG View

• B2B demand from Turkish customers is decelerating, but the pace of the slowdown will depend on customers’ target markets:
  • Turkish companies exporting to EU markets are most exposed in 2012 because of the slowdown of demand from European markets
  • Turkish companies exporting to fast-growing Middle Eastern and African markets, as well as domestic FMCG companies, will be the least affected by the slowdown because demand from these markets is less dependent on EU demand
• MNCs should monitor growth projections for the euro zone and Turkish Central Bank actions as leading indicators of the slowdown in Turkish economic growth for 2012
• Even though its growth is slowing, Turkey will remain one of the most attractive markets in CEE

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