Strategies for Investing in Developing Markets
Posted by | Fuld & Company
The global economy is in transition, not so much as the result of fluctuating superpower politics, but more so as the quiet byproduct of shifting investment in emerging economies. We are at the end of supersized returns previously found in Brazil, Russia, India, China, and South Africa (BRICS), foreign direct investment constants since 2001 that have in recent years become increasingly fragile economies. Their era as primary centers for investment has been replaced by a “Frontier Era,” a period marked by a concentration on economies scattered throughout Africa and Asia. A dramatic shift as hundreds of millions of dollars in foreign direct investment will swing from the pockets of one group to new, emerging markets.
The key to successfully navigating this shift and making strategic decisions about where to pursue new ventures is finding reliable data and conducting exhaustive analysis on relevant external factors. Sounds like routine business. But given the nature of frontier economies, and considering the chauvinistic if not nationalist rhetoric espoused by many political leaders, successful investment will require new skills. This transition will kick risk management into new levels of intensity.
All Eyes on Africa and Southeast Asia
Companies looking abroad for high returns may find the answer in frontier economies. These nations, as defined by Aldo Musacchai and Eric Werker in the Harvard Business Review, are countries at an early stage of economic and
political development, characterized by weak legal systems, heavy corruption, low human development, and significant political turmoil. Despite these negatives, as Musacchai and Werker found, 19 of the 25 economies forecast to grow the fastest over the next five years are frontier countries.
- Democratic Republic of the Congo
- Cote d’Ivoire
- Kenya and others
Commercial Investment has Begun
Leading market participants in a variety of industries are already generating foreign direct investment (FDI) in several of these economies. The hospitality sector has moved aggressively to capture growth, Accor Hotels made a significant investment in a single frontier economy by financing fifty hotels in Angola. The total occupancy of 6,200 rooms demonstrates the company’s commitment to Angola’s economy as well as its diversification strategy, complementing its European assets with deals in new growth markets. Facing increasing competition and low growth rates across Europe, where the bulk of its portfolio is located, Accor saw investing in Angola as a way to establish a first mover advantage in a market with considerable upside potential. Accor now has the largest hospitality asset base in Africa and anticipates doubling its footprint on the continent by the end of 2017. The company is also planning to open another thirty hotels throughout sub-Saharan Africa by 2020, targeting the Democratic Republic of the Congo and Cote d’Ivoire. As growth slows in the U.S., EU, and Asia Pacific, hospitality firms are looking to frontier economies in Africa for new revenue. Africa is the second most populous continent with a population in 2016 of 1.2 billion people, 41 percent of whom are under the age of 15. The forecast is for exponential growth.
While frontier economies offer enticing returns, they are also imbued with risks that are initially impervious and continually challenging to navigate. Discerning the risks present in frontier economies is exceedingly confounding given the nascent nature of the nations, the lack of economic experience in-country, the potential instability of governments, and the security problems of every nature. The list can be expanded for any specific market, industry, nation, or investment.
Gathering data in these environments, for instance, can be thwarted by not only cultural and language differences, but by national, tribal, or personal loyalty. Safety is a fear at the personal level and security of business operations can be threatened by both organized terrorist groups or opportunistic criminals. Additionally, with corruption as a factor, interaction with government representatives presents constant uncertainty. Therefore, the data needed to establish and operate a successful business or make a capital investment is often initially unobtainable.
While operating, and investing in these frontier economies poses substantial risks, companies can increase their chances for success through robust preparation and contingency planning. Gathering key data not only about the nation-state but about how one’s specific company fits into the national ecosystem is the obvious start, to be done prior to an entry decision. Notably, this data gathering must exceed the typical due diligence completed for routine investments in developed economies. Elements discounted in other situations must be emphasized here: security, corruption, government stability, rule of law.
The means through which companies obtain this information must necessarily be expanded. The risk management, facility security, logistics, and investment staff of U.S.-based corporations do not have the requisite skills to obtain information about key factors of frontier nations. Complementing the team with external firms experienced in such exploration and sophisticated enough to operate without jeopardizing the opportunity or client brand is a critical aspect of managing the risk.
Most critically, companies need to develop a lucid understanding of the complete set of unique risks posed within each country and analyze how these dynamics, including competition, infrastructure, government, and regulation, challenge their operations. A survey by Ernst & Young found that only two-thirds of companies complete a formal risk assessment when entering a foreign market, many of which are less than comprehensive. Understandable given that risk assessment is not a core competency of operating companies, but unforgiveable in that a shareholder’s money is put at risk when there are risk management experts to help.
However, as we work with clients to develop risk-based market entry, product launch, and investment strategies in risky frontier economies, we emphasize the need for an inclusive and ongoing risk assessment, and find that the rate of success is abundantly higher the more robust that assessment is. Those companies that make minimal or superficial efforts, or do not challenge the internal biases or routine processes that often hinder corporate initiatives, fall subject to the unique, and often malignant, risks present in each market.