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International Business
HEID
Simon J. Evenettwww.evenett.com
2
This Afternoon's Material
• The Emerging Markets:• Towards a realistic assessment of the profitability of
operating in emerging markets. • "The Emerging Giants": The overseas expansion strategies
of firms from developing countries (Topic 5)– BCG and Khanna/Palepu reports.– Kumar's advice on fighting low cost rivals.
• Firm strategies and Financial Crises (Topic 6).
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Risks
Six sources of Profits from operations in emerging markets
Volume
Margin
Knowledge/ resources
Uncertainty/ risk
Competitive advantage:
•Costs
•Differentiation
Industry attractiveness/ leverage5
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Simchi-Levi (2008) simulation of an actual US consumer company sourcing patterns with $200/barrel oil
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Politics.
• Degree of political stability tends to be more in the extremes in developing countries:
– some more stable (entrenched dictators).– some more volatile (revolution, civil war in the extreme
cases).• Graft and corruption.
– “Competitive” versus “Monopoly” corruption.• Policies towards business (see also next slide.)
– Broad changes in emphasis over time.– Role of business in policymaking.
Need to write off some of your investment in Egypt?
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Entries in this table report how much faster trend profit growth must be forever so as to make up the profit reduction or loss experienced during a regime's overthrow.
Source: Aggarwal and Evenett, Harvard Business Review Blog, 2010.
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Why are the BRICs different from other developing economies?
• Implications of their “size”: refers not just to economic
might, but to geographic and population size too.
1. Federalism: Baron’s 4I’s.
2. Have clearer goals for FDI and clout to back this up.
3. Large home market prompts activist industrial policy.
– Can be a source of new rivals (more soon!).
4. Prospect of even larger home market and large
populations encourages BRICs to participate in global
“rule making.”
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Key points to take away
• Volume, cost, and risk predictions are often the weakest links in firm plans for expansion into emerging markets.
• Improving these assessments is possible using:– better data (now more readily available for those who
know where to look)– tougher questioning of assumptions (especially as they
relate to locational advantages, such as low costs)– scenario planning (to assess how sensitive a strategy is to
major changes in the business and political landscape.)• Don't be overwhelmed by the information available on
emerging markets—use your favourite strategy tool to identify which factors really matter and make sure you know everything important about those factors.
The Emerging Giants:
Overseas Expansion by Leading Firms from Emerging Markets
Simon J. Evenettwww.evenett.com
Content of this presentation1. Findings of the BCG study.
– Strategies of the “challengers” from emerging markets.– Potential responses by rich country “incumbents”.
2. Digging deeper into the sources of competitive advantage of the emerging giants.
– The three sources identified by Khanna and Palepu.– Demystifying the competitive threat from emerging giants.
3. Kumar analysis of How To Fight Off Low Cost Rivals.– Pre-requisites for successful differentiation based
strategies.– Dual strategies to cope with cost-based competition.
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BCG 100 New Global Challengers• Goal of study was to identify the firms from emerging markets
most likely to challenge incumbents in the West.– Use of a previous study by GE.
• Over 3000 firms from 14 emerging markets were assessed according to the following three criteria and the 100 firms that best met them were designated “challengers”:
1. Company must truly be from an emerging market—not a JV with a Western firm or a subsidiary of the latter.
2. 2006 revenues should exceed US$1bn—or rapidly approaching US$1bn.
3. Evaluation of “globalization credentials” of each firm e.g. number of owned subsidiaries abroad, sales networks, manufacturing facilities etc.
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Principal sectors of Challengers
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1714 14
21
0
510
1520
25
3035
40
Industrialgoods
Resourceextraction
Consumerdurables
Food,beverages
andcosmetics
Other
Nu
mb
er o
f C
hal
len
ger
s
Nationality of Challengers
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20
13
7 6
13
0
5
10
15
20
25
30
35
40
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China India Brazil Mexico Russia Other (9nations)
Nu
mb
er o
f ch
alle
ng
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Performance metrics of ChallengersCountry Number
of challengers
Average revenues, $bn 2006
CAGR revenues
2004-2006
Operating profit
margin 2006
TSR 2002-2007
China 41 14.5 26 14 27.7
India 20 3.9 31 16 38.2
Brazil 13 9.8 35 25 44.5
Mexico 7 9.5 29 18 39.5
Russia 6 29.7 41 24 44.3
The operating margins of Challengers are much higher than Western rivals
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14
87
0
2
4
6
8
10
12
14
16
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BCG 100 S&P 500 Nikkei Dax
Ave
rag
e o
per
atin
g m
arg
in (
%),
200
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Other key characteristics of challengers performance
• Challengers as large customers in their own right: BCG estimates that the 100 challengers will buy US$500bn in 2007.
– US$310-330bn raw materials and energy.– US$80-100bn parts and components.– US$65-80bn services.
• Challengers spend little on R&D but this is changing: Of the 48 challengers that report R&D data, total spending grew 16 percent between 2004-2006.
• Challengers have engaged in aggressive M&A activity: 72 transactions completed in 2006; 48% in emerging markets.
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Growth is the rationale for Challengers’ overseas expansion
• “For the great majority (90) of the BCG 100, access to new growth and profit pools is the overriding rationale for going global. These companies have realized that being big in their home markets is not enough to ensure their long-term viability. They must move abroad in order to continue growing and to attain a scale that will enable them to compete with other global players.”
• What alarm bells should go off when you read this statement? Hint: How would Ghemawat react to this argument?
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Other rationales for Challengers’ overseas expansion
1. Developing complementary skills e.g. R&D expertise.
2. Acquiring intangible assets, such as brands.
3. Experimenting with new business models.
4. Securing long term access to natural resources (relates to 10 challengers only.)
• These four additional rationales build on the established low cost advantage of the challengers.
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Mapping the Challengers’ rationales to Ghemawat’s framework
Economic profit (value)
Volume
Margin
Knowledge/ resources
Uncertainty/ risk
Competitive advantage:
•Costs
•Differentiation
Industry attractiveness/ leverage
√
√
X
X
√
X
Ends and Means of the Challengers’ overseas expansion
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Ends Means (no. of challengers)
• Volume growth• Developing
complementary skills e.g. R&D expertise.
• Acquiring intangible assets, such as brands.
• Experimenting with new business models.
• Securing long term access to natural resources (relates to 10 challengers only.)
• "Taking existing brands global" (29).•"Turning existing engineering skills into global innovation" (20).•"Assuming global category leadership" (14).•"Monetizing home base’s natural resources" (17).•Rolling out “new” business models to multiple markets (10).
Hurdles facing the Challengers’ overseas expansion
1. Limits of cost-based competition—all call into question sustainability of current challengers’ strategies.
• The cheap labor of emerging markets are available to Western multinationals; potential counter-attack.
• Rising energy and commodity prices.
• Task: How to create and sustain a cost differential based on other factors, not just labor costs.
• Combining IPR and services with products reduces the relative importance of manufacturing costs.
• Growing sophistication of customer demand in emerging markets requires product redesign, puts premium on customer knowledge, brand recognition, and different employee skill set.
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Hurdles facing the Challengers’ overseas expansion (2)
2. Difficulties moving beyond cost-based competition• Investing in R&D: where, with whom, and with what staff?• Brand development:
• Organic: taking local brands international.• Acquisition: acquiring brands in other locales or acquiring
global brands.• To what extent is the brand uniquely identified with a
nation or location of production? From Thursday’s New York Times, a comment on Tata’s acquisition of Jaguar and Land Rover: “I don’t think you can build Jags in India and retain the customer base” (a third of which are British.)
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Hurdles facing the Challengers’ overseas expansion (3)
3. Possible over-reliance on expansion through M&A.• Traditional concerns: paying the right price and post-
merger integration.• Going from revenue growth may obscure analysis of true
value-added from the acquisition.• If rationale is to acquire “missing pieces” then question
must arise as to whether M&A is the cheapest and most effective means to that end.
• Risk of nationalistic backlash in acquiring country (e.g. CNOOC, Arcelor-Mittal, Dubai Ports.)
4. Addressing talent shortages—dangers of playing the nationalism card.
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Hurdles facing the Challengers’ overseas expansion (4)
5. The double-edged nature of receiving state backing.• Many Challengers have received active backing of their
governments. This is not just in China (where one state commission controls 155 companies) but elsewhere (e.g. Embrarer in Brazil).
• Challengers may receive financial support from the state as an active investor, benefit from infrastructure improvements, cheaper energy, and exports promotion, and funds made available to invest in R&D and training.
• But what really matters (product development, intangible assets, talent) and chosen vehicle for much expansion (overseas M&A) state offers little direct help.
• And there is the stigma of state-influence that rivals can use in their non-market strategies.
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What makes the Challengers successful in home markets?
• Khanna and Palepu (HBR 2006) identify three reasons why challengers are profitable at home and often able to keep multinational entrants at bay.
• The starting point is to recognize that there are four tiers of markets in emerging markets (global, glocal, local, and bottom) and are plagued by “institutional voids”.
• Multinationals focus on global segment because it involves least product adaption, higher willingness to pay, less information needs, and fewer distribution costs than other segments.
– Underlying this insight are three factors that local firms in emerging markets exploit to ensure their profitability.
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Three factors underlie the competitive success of Challengers
1. Exploit knowledge of local product markets—adapt product offerings to specific characteristics of customers and the business climate at home.
2. Exploit knowledge of local markets for talent and capital.
3. Fill in legal and information-related institutional voids—often acting as intermediaries where information, cultural sensitivity, and connections are important.
• Notice the national specificity of all three factors—these factors condition at least in the near to medium term how these firms expand abroad and where they expand abroad.
• Where the challengers have come from defines in large part where they are going; understanding a challenger’s past then is central to any sensible analysis of these rivals.
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Kumar’s analysis of Fighting Low Cost Rivals
• This careful analysis is very useful for understanding the nature of low cost competition and the difficulties in pursuing product differentiation and other responses to it.
• First insight—What low cost rivals do well:
1. Focus on one or a few consumer segments.
2. Deliver a basic product (few thrills or add ons) better than rivals do.
3. Keep prices low by maintaining efficient operations that keep costs down.
• Low cost rivals not only appeal to a segment of the customer base that do not want to pay for extras—but also get customers to accept fewer benefits at lower prices. This is one element of their long term success.
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Kumar’s analysis of Fighting Low Cost Rivals (2)
• Second insight—Price wars without substantial cost reduction by incumbents is futile.
1. Higher cost structure makes strategy unprofitable, at least in short run.
2. Rarely drives low cost rival out of business (especially if the rival doesn’t face same performance pressures.)
• Third insight—The pre-reqs for a successful product differentiation strategy are much more onerous than many realize.
1. Combinations of differentiation tactics work better.
2. Customers must be persuaded to pay for benefits.
3. Cost control is still important—must deliver extra benefits at lowest possible cost.
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Kumar’s analysis of Fighting Low Cost Rivals (3)
• Fourth insight—Successful differentiation strategies can involve switching from selling products to selling customized solutions to clients’ problems.
1. Requires seller to understand customers’ needs—and this requires co-investment by customers which, in turn, raises switching costs.
2. Charging structure can shift from quantity of product supplied to value created by service.
• Fifth insight—Dual strategies (product differentiation and setting up a low-cost operation) only work if there are complementarities between the two approaches.
– Even so, some cannibalization of high-end product should be expected and factored in.
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Key points to take away on the Emerging Giants
1. Goal here has been to demystify the Emerging Giants:• Understanding what makes them successful at home• Figuring out their overseas expansion strategies.• Identifying the pros and cons of different responses to
their rise.2. What makes Emerging Giants competitive at home are
many national characteristics—not just cheap labor.• Those characteristics don’t necessarily offer the prospect
of success in many Western markets; but are probably better recipes for success in other emerging markets.
3. There are tangible options available to Western incumbents—these are not just defensive as the Emerging Giants could become important customers too.
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Firm Strategies and Financial Crises (Topic
6)
Professor Simon J. Evenett
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Contents of this presentation• Some comments on the second section of the
course.
• The different types of financial crises.• The effects of financial crises on host countries.• Causes of financial crises.• Contagion.• Corporate responses to financial crises in East Asia
and Latin America during 1997-2001.
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The Different Types of Financial Crisis
• Types of national financial crisis:1. Banking crisis.2. Currency crisis.3. Foreign debt crisis.
• Sovereign debt crisis.• Private sector debt crisis.
• More than one type of crisis can occur at the same time.
• National crises versus regional crises.
The Effects of Financial Crises
on Host Economies
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How do you begin to assess financial crises?
• Prevalence/Frequency.• Time for the economy to recover to its previous
growth path (“recovery time”).• Total output lost compared to prior growth path.
• What other factors are relevant for a multinational operating in a country affected by a crisis?
• The above indicators are macroeconomic in nature.
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Crises since 1975
Type of crisis Number in industrial
economies
Number in emerging markets
Currency crises
42 116
Banking crises 12 42
Currency and banking crises
6 26
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Recovery times differ across crises
Type of crisis Years to recover in industrial
economies
Years to recover in emerging markets
Currency crises 1.9 1.5
Banking crises 2.0 2.1
Currency and banking crises
5.8 2.6
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Lost output varies too
Type of crisis Output loss in industrial
economies
Output loss in emerging markets
Currency crises
3.1 4.8
Banking crises 5.0 7.9
Currency and banking crises
17.6 13.6
The Causes of Financial Crises
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Getting ready to explain financial crises.
• See Haggard reading on East Asian financial crisis—which I will refer to here.
• Always ask yourself: what precisely am I trying to explain?• Relevant because financial crises differ and so what you
have to explain differs too.1. Banking crisis:2. Currency crisis:3. Sovereign debt crisis:4. Private insolvency crisis:5. Combinations of the above:
• Example: The Thai crisis in 1997.
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Different explanations for financial crises.
• “Fundamentalists.”– Balance of payment problems—loss in reserves and
unsustainable pegs.– Critics—including “rational panics.”
• “Internationalists”.• “Neo-fundamentalists.”
– Moral Hazard.– Industrial policy.– Importance of corporate “capture” of financial
liberalisation.
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Predicting currency crises• Two types of errors.• At best there are a series of warning signs:
– Ratio of short term foreign borrowings to currency reserves.
– Real estate and stock market booms. – Falling export prices, rising import prices. – Rising interest rates in industrialised economies.
• Key point: single indicators do a poor job of predicting crises. What matters is when several indicators point in the same direction.
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Contagion: spreading crises
• Examples:– East Asian financial crisis.– Argentine crisis in 2001-2002.
• Mechanisms:– Trade channel: exports, imports, and devaluations.– Perceived commonalities in institutional structure.– Portfolio rebalancing.
Corporate Responses to Financial Crises
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Getting the questions right
• What responses did firms take before, during, and after the financial crisis?
• What opportunities arose because of the crisis?• What previous opportunities closed because of the crisis?• What logic, if any, drove those responses?
– Is there any evidence of forward thinking?• What are the lessons for planning for the different types of
financial crisis?
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Stepping back…so as not to lose sight of the big picture.
• What would the strategy tools you’ve been exposed to imply about firm planning for a financial crisis?
• Take Baron’s approach to Integrated Strategy:– In what ways, if at all, has the financial crisis affected
each of the five forces facing the firm?– In what ways, if at all, has the financial crisis affected
each of the 4I’s that make up the non-market environment?
• The “interests” involved may markedly change.• There is a tendency for sharp swings in policies
towards business: from liberalization through to backlash.
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Planning corporate responses to crises
Dimensions Crisis country Neighboring countries
Issues Response Issues Response
Sales
Relations with buyers and distributors
Relations with suppliers
Financing operations
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Crises and corporate strategy• Before a crisis:
– Make sure someone is following the warning signs (including hints from the IMF and World Bank.)
– Take pre-emptive steps.• During a crisis:
– Must form realistic expectations about impact on the market and non-market environment in the crisis economy.
– Must consider the impact on subsidiary’s operation along many dimensions
– Must consider impact on neighbouring economies: contagion.
