Special Report: Emerging markets

There is no starker example of the risks associated with doing business in emerging markets than the current civil unrest ongoing in Kyrgyzstan. This tiny central Asian state shot to the world’s attention in April when popular discontent with the ruling powers boiled over into bloody revolution. Already there are concerns that the “people’s government”, which has seized power, could immediately begin nationalising in key mining, telecoms and other infrastructure sectors.

Despite these risks, or perhaps because of them, the rewards for doing business in emerging markets are simply too great for companies to pass up. The emerging middle class in places like China and India represent a goldmine of new customers and lower wages mean cheaper production costs. In 2000, developing countries were home to 56% of the global middle class, but by 2030 that figure is expected to reach 93%. China and India alone will account for two-thirds of the expansion, with China contributing 52% of the increase and India 12%, according to a McKinsey projection. The expectation is of the nearly 700m new middle class by 2030 that nearly 350m will be from China. Even this startling figure could be an underestimation. The McKinsey projection is based on a conservative assumption of 6.5% GDP growth for China. But growth in China has been averaging between 10% and 11% since 2006.

Nevertheless, accompanying this huge potential are significant downside risks. Companies investing in emerging markets should be reviewing their risk management systems to ensure they have adequate protection in place.

Reputation

One of the principal threats of doing business in exotic parts of the world, where the rules of engagement are likely to be different than back home, is becoming embroiled in an ethical scandal. One issue over which multinationals have come to blows with environmental and human rights groups is through investing in palm oil plantations.

Large scale palm oil plantations in Indonesia are blamed for the destruction of ancient forests, high carbon dioxide emissions and land grabs from indigenous people. Yet many food, consumer goods and cosmetics companies use palm oil in their products. Companies that do not exercise strict due diligence over their partners to ensure they are sourcing oil from sustainable sources could run into problems, says Anthony Skinner, a principal analyst at global risks specialist, Maplecroft. The challenge for companies and institutions that already have tarnished reputations is how to recover public confidence and improve their brand standing. Skinner says UK environmental activists filed a complaint against a Singapore-based agricultural group Wilmar International alleging that two of its plantations were involved in land rights conflicts and illegal logging—and this led to the World Bank suspending funding to palm oil projects. It is clearly not enough to simply assume that a supply chain provider is acting responsibly.

Bribery

Bribery appears to be common practice in many emerging markets, indeed some firms can find it hard to go about their business without paying bribes. But law enforcers are cracking down on the habit, in the conviction that bribery distorts markets and harms consumers.

German carmaker Daimler AG is among the recent recipients of a regulatory sting. Daimler agreed to pay a fine totalling $185m to US authorities in April to settle allegations that it was repeatedly paying bribes to secure business in Asia, Africa, Eastern Europe and the Middle East. The authorities claimed that Daimler used bribes to boost sales in places like Russia, China, Vietnam, Nigeria, Hungary, Latvia, Croatia, and Bosnia.

“It is no exaggeration to describe corruption and bribe-paying at Daimler as a standard business practice,” said Robert Khuzami, director of the SEC’s Division of Enforcement. “The financial and reputational costs incurred by Daimler as a result are a lesson that should be studied closely by all companies.” But preventing bribes can be hard particularly when the practice has become embedded in corporate culture. Cheryl Scarboro, chief of the Security and Exchange Commission’s Foreign Corrupt Practices Act Unit, explained: “The bribery was so pervasive in Daimler’s decentralised corporate structure that it extended outside of the sales organisation to internal audit, legal, and finance departments. These departments should have caught and stopped the illegal sales practices, but instead they permitted or were directly involved in the company’s bribery practices.”

Furthermore, it may no longer be the case that US authorities are the sternest watchdogs; European authorities are also cracking down on corruption. The UK recently enacted a new bribery law designed to toughen up existing, admittedly lax, regulation. It means companies should be reviewing their bribery law compliance programmes to ensure they have responsible and effective controls in place. The new rules are explored further in this special report.

Expropriation

Restrictive trade tariffs and protectionist measures are a popular move by emerging market rulers to claw back some of the profits from multinationals, which are often seen as plunderers in their host countries. A recent example of this occurred when the UK decided to drill for oil off the Falkland Islands, over which it claims sovereignty and which could be resting on as much as 60bn barrels of oil.

A decree from Argentina’s president Cristina Fernandez stated that ships transiting Argentine waters en route to the Falkland Islands must obtain a permit. The foreign minister said Argentina aimed to make it “difficult and costly” for oil explorers in the islands. Efforts to disrupt operations began in February when Argentina detained the Thor Leader cargo ship, suspected of transporting drilling equipment to UK oil companies in the Falklands. But Argentina’s weak military capability means that efforts to disrupt drilling are unlikely to stretch beyond diplomatic and legal objections, according to analysts.

It is no longer good enough for companies with operations in emerging markets to just work with a local partner and hope everything turns out OK. As our special report will show, there is no shortcut for properly analysing individual countries and putting in place the structures and people to mitigate the risks.