August 14, 2011 4:50 pm

Compelling reasons to increase engagement

Multinational companies cannot afford to ignore emerging markets. Nor can they afford to ignore the difficulties involved.

With about half of global economic output now coming from emerging markets, multinationals have been right to increase their investments in these countries so that they now generate about 20 per cent of revenues from the developing world compared with 10 per cent 20 years ago.

The so-called Bric economies alone – Brazil, Russia, India and China – will add about $12,000bn to the world economy over the next decade, double the US and the eurozone combined, says Jim O’Neill of Goldman Sachs, coiner of the Brics concept. That leaves multinationals little choice about expanding their emerging market investments. Those that do not will cede vital ground to their rivals from the developed world and, increasingly, from emerging economies headed by China, India, Russia and Brazil.

Neville Isdell, head of the Investment Climate Facility, an Africa-focused investment promotion forum, and a former chief executive of Coca Cola, the US soft drinks group says: “I hear this question ‘How do you stop China?’ You don’t. You get in there.This will be the largest economy in the world”.

But, as this two-day Financial Times series will show, companies investing in emerging economies face multiple challenges. Broadly speaking these divide into two: challenges from local companies, be they competitors or partners; and challenges arising from the general business environment, ranging from corrupt customs officials and untransparent courts to strikes.

Without doubt, the most significant development is the emergence of big local companies ready to deal with western and Japanese multinationals on their own terms.

In the past, these were often minerals-based groups, usually state-backed and often state-owned, such as Russia’s Gazprom, Petrobras of Brazil, and Cnooc, the Chinese oil group.

Today, alongside these resources majors, emerging markets are fostering future multinationals in manufacturing, such as Huawei and ZTE, the Chinese companies that rank among the world’s top five telecoms equipment makers, Tata, the Indian grouping that controls Jaguar Land Rover, the British vehicles group, and the Brazilian-led Anheuser-Busch InBev and South Africa’s SABMiller, the world’s largest brewers.

In services and finance, emerging markets companies are further behind, but they are certainly in the race in terms of size if not global reach. For example, three of the world’s top 10 banks in tier one capital terms are Chinese.

Some western companies complain their emerging market rivals – notably Chinese – benefit from unfair advantages, including restrictions on foreign access to their markets (especially in public procurement) and cheap state-driven finance.

Chinese executives retort that western companies are moaning because they are facing for the first time real competition from emerging market challengers.

This is not true, given the earlier emergence of Japanese and South Korean global companies. But this time the scale of the challenge is much larger.

Even when there is truth in the protectionist arguments, developed world multinationals cannot afford to rely on political counter-measures. History suggests they should instead address weaknesses and focus on strengths – as the US and European carmakers belatedly did in response to the rise of the Japanese car industry.

In a report last month, Boston Consulting Group argued that the only way for established multinationals to fight back was “by shifting their businesses to developing markets and focusing on services in which they hold a competitive lead”.

What about investors? Should they back multinationals or emerging market rivals? A Goldman Sachs report earlier this year argued that developed world multinationals were a good bet, with 50 selected groups having outperformed the S&P 500 index over five years.

But over 10 years, emerging markets have greatly outperformed developed world multinationals with emerging market exposure: the FTSE index of multinationals with 30 per cent or more revenues from outside their home turf has returned about 30 per cent in the past decade, compared with a 260 per cent gain in the MSCI emerging markets index.

The traditional response to this disparity is to say that emerging markets come with bigger risks. But the bigger they grow, the more stable their economies and the more successful their companies, the less this applies.

And the more compelling the reasons for established multinationals to increase their engagement – whatever the difficulties.

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