International Business

1. International Business HEID Simon J. Evenett www.evenett.com

2. This Afternoon's Material • Feedback on First Analytical Assignment. • Preparation for Second Analytical Assignment. • The Emerging Markets: • Towards a realistic assessment of the profitability of operating in emerging markets. • "The Emerging Giants": The overseas expansion strategies of firms from developing countries. • BCG and Khanna/Palepu reports. • Kumar's advice on fighting low cost rivals.

3. Feedback on the First Analytical Assignment

4. The Learning Challenges of this assignment • The Question: In what ways, if at all, will the potential reform of Europe's "social models" affect the strategies of firms located in Western Europe and their domestic and international competitiveness? Use corporate examples from selected industries and countries to support your argument. • Ultimately this assignment is an example of how to determine the effect of a change in the business environment upon firm strategies. • So the principal learning challenge is to demonstrate proficiency in applying corporate strategy tools, taking account of the relevant sectoral and legal circumstances.

5. How I would have done this assignment • Figure out what the European Social Models are and which policies were most important. • Be clear about the direction of the policy change and which government unit is responsible for reform. • Use each major strategic framework or analytical tool (such as supply and demand curves) to possible changes in firm choices. • Think through impact on corporate performance of different reform scenarios. • Identify important caveats; think through value-added of your analysis compared to existing analyses. • Begin write up of paper.

6. Steps 1 and 2 • The policies relevant to the European Social Models are: • Employment protection legislation (EPL). • Unemployment insurance (UB). • Non-wage labour taxes (for pensions, UB, and other elements of welfare state.) • Specifics of reform: • Move toward Anglo Saxon model from....? • Move toward Nordic model from....? • Reform of UB and EPL is at national level—creates potential for multiple reform scenarios.

7. Step 3: Relevant Analytical Tools • Supply and Demand analysis. • Porter’s Five Forces plus his wisdom! • Ghemawat’s Added Value Score card plus his wisdom! • Baron’s 4I’s.

8. Turning fixed costs into variable costs—outsourcing, relaxing employment laws etc MS: high variable costs P P2 MS: low variable costs P1 MD Q2 Q1 Q

9. Turning fixed costs into variable costs—the effects of liberalising rigid employment laws MC: high variable costs P MC: low variable costs Old MS P1 MD Q1 Q

10. Liberalising EPL will alter cost structure, pricing, and market shares. MC: high variable costs P New MS MC: low variable costs P2 Old MS P1 MD Q1 Q2 Q

11. Porter’s Five Forces • Threats to profitability: • Picky customers. • More demanding suppliers. • New substitutes. • New entrants/rivals. • Increased rivalry. • Use this list to ask what EPL relaxation and UB cuts would do to the potency of each threat and the choices available to managers? • Have the relative importance of the threat changed? Have the options for dealing with those threats changed? Are the proposed responses distinctive?

12. Using Ghemawat’s six sources of profit: Impact of EPL and UB reform on... 1 Volume • Competitive advantage: • Costs • Differentiation 2 Economic profit (value) Margin 3 Industry attractiveness/ leverage 5 Uncertainty/ risk 4 6 Knowledge/ resources

13. Using Baron’s 4I’s to assess potential non-market responses to the reforms

14. Other factors relevant in the readings • Apparent willingness of German unions to negotiate secret deals to improve productivity and to accept low pay increases. • How important is formal EPL reform then to German companies? • Willingness of VW to set labour standards above that covered in German EPL legislation. • How important is formal EPL reform then to some German companies? • Ability of Continental European companies to adapt their innovation systems to long-term employment contracts (Caspar and Whitley paper.) • Will EPL reform change form of innovation pursued? • Will EPL reform affect incentives of employees to make relationship-specific investments?

15. Implications of changing UB and non-wage labour taxes • UB as a floor to wages for low skilled workers. • Minimum wage legislation has similar effect. • Implications for recruitment and motivation of such workers. • Options available to firms: wage cut or seek productivity increase? • Effects of non-wage labour taxes on: • unit costs. • degree of mechanisation of plants.

16. Step 4: Implications for corporate performance • National nature of reform implies that firms in same sector in same country face same policy changes—but does that mean performance changes must be the same in the short and long term? • Depends on whether reform is unilateral, coordinated, or sequential. Some options: • e.g. France reforms but German does not. • e.g. France reforms then Germany reforms. • e.g. Continental countries reform together. • Specific characteristics of sector or firm being considered. e.g. Burberrys.

17. Step 5: Identifying value-added from your analysis. • The analysis conducted above might lead you to conclude: • Impact of EPL and UB reform on managerial choices goes far beyond shedding surplus staff. • Impact of EPL and UB reform could be adverse for some firms (identify circumstances); the presumption that all firms gain from these reform is wrong. • Some firms may find their strategies and rivals unaffected by EPL and UB reform (state examples.) • Then state Caveats: point out factors not considered in your analysis. e.g. did not consider macroeconomic consequences (in particular for consumer spending) of employees facing greater employment uncertainty.

18. Possible flawed presumptions in some papers • Presumption that flexibility is always good—is commitment always bad? • Presumption that fast adjustment is always desirable. • Presumption that investing to raise efficiency is always desirable. • Presumption that the existing labour force must be changed—what’s wrong with it and didn’t firms’ choose their workers in the first place? • Apparent unwillingness to examine how firms coped with tough EPL laws and, in some cases, thrived—Would EPL reform undermine a recipe for success?

19. Excessive use of vague terms • Try to write the second assignment without referring to the following vague words or terms: • Leveraging. • Competitiveness. • Flexible, flexibility. • Strategic response, strategic investment, strategic decision... • Better position to compete in... • Embrace. • Strengthen. • Avoid using adverbs and the like. e.g. “increasingly impact”

20. Suggestions for the second analytical assignment. • Use this opportunity to demonstrate that you have mastered one or more strategy tool learnt during your Masters courses. • Use the strategy tool creatively and comprehensively. Make sure you identify and evaluate many potential choices that a firm can make. Follow Ghemawat’s advice on applying strategy tools. • Use a strategy tool to help organise your write up. • When it comes to writing up the assignment, follow the guidelines for the first assignment. • Write as precisely and specifically as possible. • Ask yourself if the introduction and conclusion of your paper are self-explanatory. • Could someone who has never heard of the assignment understand what your analysis is about, why the analysis is important, and what your findings are and why they are significant? If not, then the ideas have not been well communicated.

21. The Changing Business Climate in Emerging Markets Simon J. Evenett

22. What features of Emerging Markets really matter? Those that affect profits. 1 Volume Six sources of Profits from operations in emerging markets • Competitive advantage: • Costs • Differentiation 2 Margin 3 Industry attractiveness/ leverage 5 Uncertainty/ risk 4 6 Knowledge/ resources

23. Volume: A realistic assessment 1 Volume Six sources of Profits from operations in emerging markets • Competitive advantage: • Costs • Differentiation Margin Industry attractiveness/ leverage Uncertainty/ risk Knowledge/ resources

24. Assessing Market Size • Measures of market size should take into account: • Distribution of income, not just average income per head. • "Threshold effects." • Rural-urban distribution of population (geography). • Age distribution. • Income from remittances. • B2C versus B2B.

28. Costs: A realistic assessment Volume Six sources of Profits from operations in emerging markets • Competitive advantage: • Costs • Differentiation 2 Margin Industry attractiveness/ leverage Uncertainty/ risk Knowledge/ resources

31. Accurate assessment of costs. • Full accounting of relevant costs. • Excessive focus on wages and labour costs. • Always ask yourself: why are costs in this location so low? • View current prices are the market’s verdict on a location. • Are you missing something? • Durability again. Will the low costs last? For how long? • What financial inducements are available? • From the host country. • From others.

32. Risks Volume Six sources of Profits from operations in emerging markets • Competitive advantage: • Costs • Differentiation Margin Industry attractiveness/ leverage 5 Uncertainty/ risk Knowledge/ resources

33. Simchi-Levi (2008) simulation of an actual US consumer company sourcing patterns with $200/barrel oil

34. Politics. • Degree of political stability tends to be more in the extremes in developing countries: • some more stable (entrenched dictators). • some more volatile (revolution, civil war in the extreme cases). • Graft and corruption. • “Competitive” versus “Monopoly” corruption. • Policies towards business (see also next slide.) • Broad changes in emphasis over time. • Role of business in policymaking.

35. Need to write off some of your investment in Egypt? Entries in this table report how much faster trend profit growth must be forever so as to make up the profit reduction or loss experienced during a regime's overthrow. Source: Aggarwal and Evenett, Harvard Business Review Blog, 2010.

36. Why are the BRICs different from other developing economies? • Implications of their “size”: refers not just to economic might, but to geographic and population size too. • Federalism: Baron’s 4I’s. • Have clearer goals for FDI and clout to back this up. • Large home market prompts activist industrial policy. • Can be a source of new rivals (more soon!). • Prospect of even larger home market and large populations encourages BRICs to participate in global “rule making.”

37. Key points to take away • Volume, cost, and risk predictions are often the weakest links in firm plans for expansion into emerging markets. • Improving these assessments is possible using: • better data (now more readily available for those who know where to look) • tougher questioning of assumptions (especially as they relate to locational advantages, such as low costs) • scenario planning (to assess how sensitive a strategy is to major changes in the business and political landscape.) • Don't be overwhelmed by the information available on emerging markets—use your favourite strategy tool to identify which factors really matter and make sure you know everything important about those factors.

38. The Emerging Giants: Overseas Expansion by Leading Firms from Emerging Markets Simon J. Evenett www.evenett.com

39. Content of this presentation • Findings of the BCG study. • Strategies of the “challengers” from emerging markets. • Potential responses by rich country “incumbents”. • Digging deeper into the sources of competitive advantage of the emerging giants. • The three sources identified by Khanna and Palepu. • Demystifying the competitive threat from emerging giants. • Kumar analysis of How To Fight Off Low Cost Rivals. • Pre-requisites for successful differentiation based strategies. • Dual strategies to cope with cost-based competition.

40. BCG 100 New Global Challengers • Goal of study was to identify the firms from emerging markets most likely to challenge incumbents in the West. • Use of a previous study by GE. • Over 3000 firms from 14 emerging markets were assessed according to the following three criteria and the 100 firms that best met them were designated “challengers”: • Company must truly be from an emerging market—not a JV with a Western firm or a subsidiary of the latter. • 2006 revenues should exceed US$1bn—or rapidly approaching US$1bn. • Evaluation of “globalization credentials” of each firm e.g. number of owned subsidiaries abroad, sales networks, manufacturing facilities etc. 40

41. Principal sectors of Challengers

42. Nationality of Challengers

43. Performance metrics of Challengers

44. The operating margins of Challengers are much higher than Western rivals

45. Other key characteristics of challengers performance • Challengers as large customers in their own right: BCG estimates that the 100 challengers will buy US$500bn in 2007. • US$310-330bn raw materials and energy. • US$80-100bn parts and components. • US$65-80bn services. • Challengers spend little on R&D but this is changing: Of the 48 challengers that report R&D data, total spending grew 16 percent between 2004-2006. • Challengers have engaged in aggressive M&A activity: 72 transactions completed in 2006; 48% in emerging markets. 45

46. Growth is the rationale for Challengers’ overseas expansion “For the great majority (90) of the BCG 100, access to new growth and profit pools is the overriding rationale for going global. These companies have realized that being big in their home markets is not enough to ensure their long-term viability. They must move abroad in order to continue growing and to attain a scale that will enable them to compete with other global players.” What alarm bells should go off when you read this statement? Hint: How would Ghemawat react to this argument? 46

47. Other rationales for Challengers’ overseas expansion • Developing complementary skills e.g. R&D expertise. • Acquiring intangible assets, such as brands. • Experimenting with new business models. • Securing long term access to natural resources (relates to 10 challengers only.) • These four additional rationales build on the established low cost advantage of the challengers. 47

48. Mapping the Challengers’ rationales to Ghemawat’s framework √ Volume • Competitive advantage: • Costs • Differentiation X Economic profit (value) Margin √ Industry attractiveness/ leverage X Uncertainty/ risk X √ Knowledge/ resources

49. Ends and Means of the Challengers’ overseas expansion 49

50. Hurdles facing the Challengers’ overseas expansion • Limits of cost-based competition—all call into question sustainability of current challengers’ strategies. • The cheap labor of emerging markets are available to Western multinationals; potential counter-attack. • Rising energy and commodity prices. • Task: How to create and sustain a cost differential based on other factors, not just labor costs. • Combining IPR and services with products reduces the relative importance of manufacturing costs. • Growing sophistication of customer demand in emerging markets requires product redesign, puts premium on customer knowledge, brand recognition, and different employee skill set. 50