Get it right, or stay at home: Managing risk in challenging markets

Author: Jamie Hepburn

As developed market growth stalls, fast-growth emerging markets can offer potentially higher rewards. But businesses can also face heightened political risks, which may manifest themselves in a variety of operational and reputational risks. A close understanding of local politics is therefore crucial — not only in shaping strategy, but also in informing practical operational decisions.

Nearly 60% of the business leaders taking part in PwC’s latest Annual Global CEO Survey said that emerging markets are now more important to their company’s future than developed markets.1

The path to Brazil, China and India is well trodden. Now emerging from the shadow of the BRICs is a second tier of smaller but increasingly dynamic markets such as Turkey, Indonesia, Nigeria, Kenya and Vietnam. There is also a further rung of ‘frontier markets’ — those that have up until recently had little involvement from multinational businesses. Iraq, Afghanistan, Libya and Myanmar are just some of the countries that are moving onto the radar of senior executives.

Apart from their commercial potential, the other factor that connects these markets is a range of challenging risks to doing business there. Broadly speaking, the country risks incorporate elements of political, reputational, operational and physical risk, with the political risk underscoring the other three.

Investors in Southeast Asia might worry about how to manage relations with Vietnam’s authoritarian government or how to contend with Indonesia’s weak infrastructure. In Kenya, political upheaval and social unrest in the run-up to next year’s elections could be a concern. In Nigeria, the upsurge in violence in the North associated with Islamist militants could increase the risk to staff deployed there.

Understanding the country risks before investing in a new market is clearly a vital part of any entry strategy. In this article, we outline a broad framework to help your board think about the relevant issues. The aim is to allow you to gain early-mover advantages, while at the same time helping to identify and manage hidden or unforeseen risks.

Libya: Potential for pitfalls in political transition

Post-Gadhafi Libya offers a range of investment opportunities in infrastructure (estimated at some $200bn over 10 years2), hydrocarbons, the financial services sector, and services such as health and education. If you are thinking of investing, the central challenge is how to get a grip on the political dynamics of the transition process and how to position your business for future opportunities.

Key dilemmas include how to develop productive relationships when the individuals in ministerial positions will change. What impact will Gadhafi’s legacy have — for example, how will the country deal with those deemed to ‘have blood on their hands’: those who benefitted from Gadhafi’s rule and those businesses that were associated with them?

What kind of profile should your business adopt? The answers lie in regular monitoring and assessment of the political situation, careful selection of Libyan associates and, not least, patience. Mapping the new political landscape and conducting due diligence on business counterparts (a challenge given the paucity of reliable sources) will be an important part of that process.

There are also logistical challenges. These include how to obtain visas, how to enter the country (overland from Egypt or Tunisia, or by intermittent air services), how to find secure accommodation with functioning business facilities and how to ensure the security of staff. Although the security situation remains fragile and prone to sudden deterioration, new entrants have been able to establish workable operating procedures in the country.

 

Assessing emerging market risk

There are a number of frameworks for analysing a country before potential entry. They typically cover politics, the economy, society, technology, infrastructure, the environment, legal and regulatory issues, geography and security. In addition, awareness of a country’s history and culture is crucial to understanding a new market, albeit an area that is often overlooked. Scenario planning can also be a good way to anticipate what future trends might emerge, as well as their impact and their probability.

Whatever risks are identified, they typically come down to two main types of risk:

  • Reputational risk: This applies equally in developed economies, but can be especially acute in emerging markets. It stems largely from a failure to manage the typically higher and more varied operational risks present in these markets. It also reflects rising global standards for corporate behaviour and governance, particularly with respect to anti-bribery legislation. Involvement — unwitting or otherwise — with governments that are authoritarian, corrupt or involved in human rights abuses, for example, presents a significant risk to the values that many multinational businesses seek to uphold.
  • Operational risk: This, too, is a broad term, but encompasses issues that might affect the day-to-day viability of working in the new market and its profitability. These might include political instability; weak policy, legal and regulatory frameworks; graft and petty corruption; poor educational standards; low-quality working practices; and militant trade unionism, to name just a few. Physical risk to staff and assets can also be significant, whether associated with political instability, conflict, terrorism or crime. Post-conflict environments such as Iraq and Libya all require varying degrees of physical security support.

Understanding the political context

For both types of risk, understanding the political context and how it affects the business (or could do so in the future) is vital. This is as true for developed markets as it is for emerging ones. But the relationship between politics and business in emerging markets is often closer — in many cases, political power is synonymous with the control of resources. Patronage and the concentration of power in the hands of a small number of individuals or families, many of whom may have close connections to the government, can create an environment in which nepotism and corruption can flourish.

Moreover, authoritarianism, weak governance, corruption, regional divides, sectarianism, separatism and fractious relations with neighbours can all add to the complexity of an unfamiliar working environment. Many of these issues may not be immediately apparent to an outsider but can create a range of risks to business — from the physical threat to staff to decisions on legislation and the threat of outright expropriation of private assets. Recent examples include the Argentine government’s nationalisation of Spanish energy company Repsol’s stake in YPF, and Zimbabwe’s new mining regulation, which requires foreign mining companies to hand over a 51% stake in their shares to local designated entities.3

A thorough initial assessment and regular monitoring is needed. Seeking local views can help, but equally the perspectives of a local associate may not be entirely objective, so it is important to seek a range of input, both local and external, and for the business to make its own judgement on the balance of risk and reward. The nature of the business, and the way it is likely to be perceived in the local context, will need to be a fundamental part of the assessment and will help to determine strategy.

Myanmar: 2015 elections will be the true test of reforms

Myanmar has long been ‘out of bounds’ because of its poor human rights record and broad sanctions against the ruling regime. Over the past year, however, the military-backed civilian administration has driven forward an ambitious reform agenda. Political prisoners have been freed; peace deals with many of the country’s separatists groups have been signed; and the opposition National League for Democracy, led by democracy campaigner Aung San Suu Kyi, won by a landslide in by-elections held in April 2012.

Economic reform is also on the agenda. In April 2012, the government floated the currency, unifying the hugely overvalued official rate of the kyat with the black market rate. The U.S., EU and others are moving quickly to re-establish diplomatic relations and ease sanctions to encourage further progress. Interest among businesses has taken off.

But the transformation is far from complete. The military, which has run the country for decades, remains in overall control. Democratic space is limited — only 7% of seats were contested in the April by-elections. The drive for liberalisation may owe as much to self-interest among the ruling elite as an ideological shift, suggesting a real risk of crony capitalism emerging. The capacity of the pervasive state bureaucracy to facilitate change is also likely to be severely limited. The real test of the reforms may not come until 2015, when three-quarters of the seats in parliament will be contested.

As a result, if your company is looking to enter the market, you will need to establish a clear picture of the political landscape. Given the closed and guarded nature of the country’s elite, establishing sources of political intelligence and a meaningful assessment will be difficult. Providing adequate safeguards against corruption will also be a significant challenge.

 

Failing to prepare is preparing to fail

So what are the practical considerations and how can they be addressed? Engagement in a new market demands political understanding and mechanisms to make sure this informs strategic and tactical decisions at all levels of the organisation.

At the strategic level, this framework appraisal, governance and decision making would help your business to judge how to approach a country whose politics are divided by sectarian, religious or ethnic differences. Strategic decisions — over company profile, for example — might also have tactical consequences for the behaviour and security of staff on the ground.

At the tactical level, considerations might include what part of town a company’s office should be located in and who should be employed to guard it. Other issues would include whom to engage with locally and how to make sure they have no past political or criminal associations that might pose a reputational risk.

Whatever risks are identified, they are best viewed holistically, rather than in isolation. Your business will need to develop a clear risk appetite and weigh the opportunity against the cost of risk mitigation, which can be expensive. A risk review board with participation from senior management — typically the project engagement leader and representatives of strategy, security, risk, human resources, legal counsel and strategic communications — will help to ensure the right level and scope of appraisal oversight. The exact make-up of this body will vary from one organisation to another, but ensuring it is an integral part of the business strategy is vital. Failure to establish a thorough assessment and ongoing risk-monitoring process is simply preparing the venture to fail.

Risk review board agenda

  • A formal and comprehensive country risk assessment
  • What are the political context and drivers?
  • Seek a range of views
  • Challenge the country risk assessment
  • Is there a process for ongoing risk monitoring?
  • Has thorough due diligence been carried out on business partners?
  • Is there a strategy to manage identified risks?
  • What is the public profile of the business in the new market?
  • If there is a physical risk to staff, how can it be mitigated?

Getting it right the first time

Recent corporate history is littered with examples of companies that have failed to appreciate the intricacies of a new market, particularly local politics, and have come unstuck as a result. Careful preparation ahead of entry and ongoing monitoring of operations in new markets can help to manage the risks and, crucially, respond quickly and effectively if threats to the business do materialise.






1 1,250 CEOs from 60 countries were polled at the end of 2011 as part of PwC’s 15th Annual Global CEO Survey, published on 25.01.12
2 Research and Markets – Libya Infrastructure Report 2012
(http://www.researchandmarkets.com/reports/2077125/libya_infrastructure_report_2012violence)
3 Mining Review, 10.03.11