Achieving business success in emerging markets has increasingly become a key factor for multinational corporations (MNCs) worldwide seeking new growth opportunities and greater global supply chain efficiency. There is little question as to why this is happening: Over the past decade and a half, the average growth rate of GDP in real terms for emerging markets has been twice that of the advanced countries, and this secular trend shows no sign of abating.
Yet surprisingly few corporate executives, whether from MNCs from the ‘North’ — the EU, U.S. and other mature, industrialized economies — or MNCs from the ‘South’ — the BRICS (Brazil, Russia, India, China and South Africa*) and other developing countries — realize this fundamental shift is underway. While the lion’s share of international investment and trade with the emerging markets of the South still originates from the North — more than 90% of stock of inward foreign direct investment (FDI) in emerging markets was made by Northern firms1 — new flows of such commerce are increasingly coming into emerging markets from the South itself. In fact, ‘South-South’ trade now accounts for a sizeable 20% of all global trade, and one-third of FDI outward flows originating from the South go to the South.
What are the competitive implications of this shift in global investment and trade flows, and how will it affect corporate strategic decisions?
The rapid increase in South-South investment and trade is not a recent phenomenon but dates back several decades and is due to several factors. Firms from emerging markets have intensified interest in integrating into global commerce in order to harness new trade and investment opportunities within emerging markets. This stems, in part, from regional or bilateral trade/investment agreements, as well as the desire to capitalize on the growth of new middle-class populations and employee talent in emerging markets not being served by MNCs from the ‘North’. The gap has opened up because Northern firms are charging prices for their products and services that are higher than these markets can bear; they are ill-informed about the existence of such opportunities; or they perceive these markets as too risky.
In any event, the growth of South-South commerce creates a challenging environment for Northern firms seeking to buoy growth, while at the same time providing opportunities for maturing Southern MNCs to rival and potentially surpass their Northern competitors. Thus advanced country multinationals are facing a host of new risks and opportunities as they aim to compete not only with their longstanding rivals in the North, but also with emerging world-class MNCs from the South.
First and foremost, Northern firms seeking to compete in this new environment need to consider more closely both the benefits and costs of engaging in commerce in emerging markets. Too often, perceptions of risk in these markets are being overstated and the opportunities are being understated. This is not to suggest that this is the case in all emerging markets; it is quite the contrary. Indeed, there are cases where the perceived investment risks are significantly understated and remain so because of a herd investment mentality.
The rise and growing maturity of multinationals from the South present opportunities for Northern firms to capitalize on new trade-offs while investing in emerging markets. For example, multinationals from the North can benefit from joint-ventures with lower-cost Southern partners who have developing country experience versus potentially greater exposure to reputational and intellectual-property protection risks. Of course, recipient emerging market countries face analogous trade-offs — such as taking advantage of lower costs in procurement from Southern firms versus improving governance, product and environmental quality standards, which can serve to improve the success rate of entry by Northern firms.
Indeed, one of the major risks that Northern firms face through the increased presence of Southern competitors is the outright loss of bids, as companies from other emerging markets can leverage lower-cost products and inputs, lower margin requirements and heavy government support in the form of below-market rate debt and other financing agreements with active Ex-Im banks.
For example, countries dominated by state-owned enterprises (SOEs) often use government agencies to direct money to favoured industries and work closely with their SOEs abroad to help ensure their success, often mixing diplomatic missions with business. Northern companies do not tend to benefit from such state-sponsored advantages, and should they seek to compete with local governments in such deals, they can often run into serious allegations of violations of anti-corruption laws and policies in their home markets. This can lead to significant reputational damage as well as material financial losses. Furthermore, Southern firms often can take on less-than-bankable projects due to interest rate subsidies and other state guarantees. Should Northern firms seek to compete, they can face serious medium-term challenges in projects that become uneconomic with the smallest hike in market rates or commodity prices, creating substantial revenue risk for such projects. As such, Northern firms are in need of new and creative forms of financing projects in emerging markets.
Recommendations for Northern firms:
To manoeuvre successfully through new market trends and Southern competition, Northern multinationals must develop and implement creative growth strategies, and develop new and innovative forms of partnership, financing arrangements and product development.
Recommendations for Southern firms:
Despite the risks involved, emerging markets continue to represent a major opportunity for multinational companies, both from the North and the South. Southern firms should continue to act through shared experiences and commitment to similar objectives and should leverage opportunities for regional integration. Northern firms should embrace new partnering and financing options and be early movers in new markets in order to stay competitive. Overall, partnerships between Northern and Southern firms offer mutually beneficial solutions and should be pursued by both sides.