When two worlds meet how high growth market companies are changing international business

It examines the growing international footprint of companies based in fast-growing emerging markets and the ways in which firms from Western Europe and North America are responding to a

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HELPING YOUR BUSINESS GROW INTERNATIONALLY

WHEN TWO WORLDS MEET: HOW HIGH-GROWTH MARKET COMPANIES ARE CHANGING INTERNATIONAL BUSINESS

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About the report

When two worlds meet: How high-growth market

companies are changing international business is a

UK Trade & Investment (UKTI) report commissioned

from the Economist Intelligence Unit It examines the

growing international footprint of companies based

in fast-growing emerging markets and the ways in

which firms from Western Europe and North America

are responding to a phenomenon that is redefining

the global economy The report also assesses the

risks and opportunities that lie ahead for Western

economies and their companies

As part of the research for this report, the Economist

Intelligence Unit conducted a survey in August 2011

of 459 executives from companies based in Europe

and North America The respondents are from a

range of industries and they represent companies of

varying sizes One-half of the respondents are C-level

executives or board members

All graphs and tables in this report are from

the Economist Intelligence Unit’s survey unless

otherwise stated

The EIU also conducted in-depth interviews with senior executives from companies in Europe, North America and high-growth markets as well as with independent experts We are particularly grateful to the following for agreeing to share their insights for this study:

■ Ferdinando Beccalli-Falco – President and Chief Executive Officer, GE Europe and North Asia

■ Lewis Booth – Chief Financial Officer, Ford Motor Company

■ Ishaat Hussain – Chief Financial Officer, Tata Sons

■ Gareth Jenkins – Managing Director, FSG Tool & Die

■ Zafer Kurtul – Chief Executive Officer, Sabanci Holding

■ Rainer Ohler – Senior Vice President, Airbus

■ Karl P Sauvant – Executive Director, Vale Columbia Center on Sustainable International Investment at Columbia University

■ Oliver Seidl – Chief Executive Officer, Loewe AG

■ Santiago Fernandez Valbuena – Chief Executive Officer, Telefonica Latin America, and until recently, Chief Strategy Officer, Telefonica SA

■ Maarten Wetselaar, Executive Vice President (Finance), Upstream International, Royal Dutch Shell Plc

■ Yuan Xiaolin, Head of Chairman’s Office, Volvo Car Corporation

EXECUTIVE SUMMARY

With their increasing numbers and growing ambition,

multinational corporations (MNCs) based in

high-growth markets – emerging economies growing at

above average rates – are at the forefront of forces

helping the global economy to recover from the

financial crisis of 2008 and the subsequent recession

The rise of this new kind of MNC represents either

an unprecedented challenge or an opportunity for

companies based in the developed but low-growth

economies of Western Europe and North America

Firms rooted in emerging and mature markets may

be quite different entities today but their futures

are likely to be increasingly intertwined, either as

partners or as competitors

The “new” MNCs already account for an increasing

share of outflows of foreign direct investment

(FDI) In 2010 these flows reached a record high

of US$377 billion, up 21 per cent on 2009, and

amounted to a 29 per cent share of the global total

for FDI compared with 15 per cent in 2007 At the

same time, almost one-half of developed countries’

investments of US$970 billion in 2010 went to

developing countries, compared with 30 per cent

in 2007, according to the 2011 World Investment

Report from the United Nations Conference on

Trade and Development (UNCTAD)1

Confidence among European and North American

firms may be fragile after the global economic

downturn but they are sitting on nearly US$5 trillion

of cash that is ready for investment, according to

UNCTAD Research for this report suggests that

Western firms are pursuing a variety of strategies to

deal with their new challengers on the global stage

Some are sharpening their competitive edge while

others are exploring partnership options The report

points to increased investment flows not only from

developed to developing economies, and vice versa,

but also from one developing economy to another

The main findings of the report include the following:

European and North American companies see the rise of high-growth market companies on the global stage more as an opportunity than a threatSeven out of 10 respondents in the survey for this report see expansion by companies based in high-growth markets as beneficial for their own firms

43 per cent cite improved access to emerging markets

as the main benefit of doing business with high-growth market MNCs; 35 per cent of Western executives expect this new force in world trade to stimulate demand for their own products and services, while others view partnership opportunities as a way to reduce operating costs A significant minority of respondents also see foreign investment by high-growth companies boosting economic growth, employment and consumer choice

in developed markets A much smaller proportion cite greater volatility, higher unemployment and loss of control over strategic assets as the biggest risks posed

to developed markets by the expansion of high-growth market MNCs

The growing international footprint of high-growth market companies is making the competitive landscape more challenging for European and North American firms

A majority of survey respondents admit competition

is becoming increasingly intense, more so in emerging markets than in their home or developed markets Nearly one-half of executives agree it will become harder for Western firms to compete on price, pointing to lower labour costs as the main competitive advantage of high-growth market MNCs A similar number of respondents also believe that developed market firms are underestimating the competitive challenge from high-growth market companies As Santiago Fernandez Valbuena, the CEO of Telefonica Latin America and until recently the Spanish

telecommunications provider’s chief strategy officer, points out: “The newcomers represent a threat in the competitive sense; they’re very competent, they ask all the right questions and their prices are unbeatable.”

Western firms see their edge in technology and

innovation as their greatest competitive advantage

Companies in Western Europe and North America

are responding to the new competition by investing

in innovation across all aspects of their operations:

from their business model and supply chain to

their marketing and product portfolio While more

European survey respondents than North American

ones think the way forward lies in innovation, a

greater number of manufacturers than

service-providers favour innovation as a path to growth

“The fundamental way to respond is to stay ahead

of the curve,” says Ferdinando Beccalli-Falco,

president and CEO for GE in Europe and North Asia

A majority of survey respondents also think Western

firms can add the greatest value in any partnership

with their advanced technology and their expertise

in business strategy

Mergers and acquisitions are likely to replace

partnerships and joint ventures as the favoured

form of FDI by high-growth market companies

North American and European executives anticipate

a flurry of cross-border merger activity after an initial

period of collaboration or partnership with their

emerging challengers Currently at least two out of

five Western firms are likely to be doing business

with or partnering with companies based in

high-growth markets Over the next 12 months, while the

global economic outlook remains uncertain, survey

respondents see high-growth market MNCs opting

for lower-risk options such as join ventures, equity

swaps or franchising and outsourcing agreements

as the preferred route for international expansion

However, Western executives expect high-growth

market companies to pursue growth primarily

through M&A thereafter

Risk aversion in Western economies is likely to help high-growth market FDI flow more and more into the developing world

One-half of European and North American executives see protectionist barriers going up in their home markets, not least as a result of their governments coming under increasing pressure to shore up their weak economies and shield local businesses

A majority of survey respondents also admit their companies have little appetite to significantly increase their risk exposure by doing business with their high-growth market rivals, involving as it does overcoming differences in culture and corporate governance standards That, along with the relatively better growth opportunities and untapped resources

in developing economies, is likely to make growth market MNCs favour emerging markets as

high-an investment destination

The global economy is at a historic crossroads Much

of Western Europe and North America continues to

be mired in the economic downturn triggered by the financial crisis of 2008 Meanwhile, many developing economies have been growing robustly, becoming in the process important engines of globalisation The International Monetary Fund talks of a two-speed global recovery at best: earlier this year it forecast 2.5 per cent growth in advanced economies for 2011 and 6.5 per cent in emerging or developing economies

It may well now bring forward the date when the latter account for more than half of global output (in terms

of purchasing power parity) from its projected 2013 According to Min Zhu, deputy managing director

at the IMF, recent structural changes in developing economies support the three key drivers of growth:

“The labour force is growing at a rapid pace and populations are urbanising, investment is growing with support from ample foreign capital and productivity is increasing as production moves

up the value-added chain.”2

On current trends, he adds, annual global output will more than double in two decades from US$78 trillion

to US$176 trillion (at today’s prices), with three-fifths

of that extra output coming from emerging

or developing economies

The most influential of the developing economies known collectively as the BRICs – Brazil, Russia, India and China – are increasingly shifting the emphasis of economic policy towards domestic consumption as tens of millions in these developing giants are lifted out of poverty

1 INTRODUCTION

FDI outflows from developing and transition economies:

the value and their share in global FDI outflows, 2000-2010

Source: UNCTAD

The Boston Consulting Group, a management

consultancy, forecasts that the middle class in rapidly

developing or high-growth economies will account

for 30 per cent of the global population by 2020

and 50 per cent by 2030.3

It is hardly surprising, therefore, that in 2010

developing economies absorbed the major chunk

(53 per cent) of FDI flows for the first time, according

to UNCTAD They also accounted for 29 per cent of

global FDI outflows in 2010 – doubling their share

from 2007 – with China (including Hong Kong)

investing more overseas than either Germany or

France China, in the process, overtook Japan for

the first time in terms of FDI outflows

Annual global output will more than double

in two decades from

US$78 trillion to US$176 trillion.

According to UNCTAD’s Global Investment Trend

Monitor No.6 published in April 2011, developing

economies are increasingly important investors in the

international arena This is particularly true for East

and South-East Asia, where outward FDI from Hong

Kong, China, South Korea, Taiwan and Malaysia rose

by more than 20 per cent from 2007 to 2010

MNCs driving this surge in investment after the

financial crisis are hungry for access to new markets

and basic materials, as well as new skills and

technology In the Financial Times’s 2007 list of the

world’s 500 biggest companies by capitalisation, China

– excluding Hong Kong – shared eighth place, with

eight companies in the list In the 2011 list, China was

in fourth position, with 27 companies, behind the US,

UK and Japan Other BRIC countries have also moved

up the rankings: India has 14 companies in the 2011

list, compared to eight in 2007; Brazil is up to 12 from

seven and Russia now has 11 companies in the list

compared to nine in 2007

“Companies in China and India are not cheap toy producers anymore but have the capability to produce high-technology goods and services,” says

Mr Beccalli-Falco of GE “It’s got to the point where what we call developing countries are not really developing countries any more; they’re developed.” Karl P Sauvant, a former UNCTAD official who is now executive director of the Vale Columbia Center

on Sustainable International Investment in New York, says: “Outward FDI from emerging markets will grow significantly as their firms are subject

to the same pressures of globalisation as their developed country competitors.”

The rise of the “new kids on the block,” as Dr Sauvant

calls MNCs based in high-growth market economies,

has led to some headline-making acquisitions in

developed markets such as the purchase by India’s

Tata Group of revered British brands such as Tetley,

Corus and Jaguar Land Rover (JLR) – in sectors as

diverse as tea, steel and automobiles – all within

the past few years Tata is now Britain’s biggest

manufacturing company, and under its ownership,

JLR has invested in new products and innovation,

resulting in more jobs in Britain and handsome profits

for the previously ailing firm

Gareth Jenkins, managing director of FSG Tool

& Die, a small Welsh precision engineering

company that is also a supplier to JLR, says of the

newcomers: “There’s always a threat to everything

but, based on our experience thus far, I would

have no difficulty in viewing (the rise of

high-growth MNCs) very positively.” His attitude is

surprisingly common among respondents to the

survey, with as many as 70 per cent viewing the

phenomenon of high-growth market MNCs as a

positive development for developed economies

and their companies

This holds equally true for executives from both North America and Europe though, on the whole, American firms are more sanguine about the new competition This perhaps reflects the differences

in the competitive landscape and business culture

on both sides of the Atlantic However, within both groups around one-half of the respondents see greater FDI outflows from high-growth markets

as contributing to economic growth in Western economies and in their home markets

2 FDI FLOWS UPSTREAM

How might greater outbound FDI from high-growth markets benefit Western economies?

Select up to three

Will contribute to economic growth

Will add to consumer choice

Will help make developed world firms more competitive

Will provide more jobs Will make developed world economies less vulnerable to

economic shocks Will help reduce the debt burden of developed world economies

This poses no benefit to developed world economies

a positive development for developed economies

and their companies.

Growth in Western economies has been at a near standstill as the credit crisis of 2008, subsequent recession and an ongoing sovereign debt crisis have sapped business confidence and dampened consumer demand As companies from developed markets cope with a low-growth environment, those based in developing economies have set themselves ambitious double-digit growth targets Towards that end, with growth in their home markets also starting to cool down, many of them are aggressively expanding overseas via acquisitions, partnerships, joint ventures and greenfield projects For instance, in the largest overseas acquisition by a Chinese company so far this year, state-owned oil group Cnooc bought Canada’s Opti for US$2.1 billion.

Western manufacturers, proportionally, are benefiting more from the changing competitive landscape While

in comparison to the services sector they have suffered more during the recession in their home markets, almost one-half of manufacturing executives in the survey – compared with 29 per cent of respondents from services – say the rise of high-growth market firms has given their own companies a lifeline by, for instance, opening

up access to new markets Western manufacturers, in many cases, are becoming important cogs in the supply chain for high-growth market companies

The global civilian airliner market has long been dominated by Western firms but Russia’s United Aircraft Corporation is the new force to reckon with:

it aims to gain a sizeable market share with its Superjet

100 plane After a slow start, orders have started pouring in, not least because the Superjet 100 is up

to 15 per cent cheaper than the competition But to compete on quality, the Russian manufacturer has had

to rope in partners As a result, the Superjet 100 is now

50 per cent produced in Russia and 50 per cent abroad, with its engines produced jointly with France’s Snecma

What do you see as the main benefits for your company of partnering or engaging with a

high-growth market MNC? Select up to three.

Better access to emerging markets

Source of new business growth

General ability to reduce operating costs

Access to low-cost labour Better / cheaper access to raw materials and

resources Access to local skills/talent

Improved innovation, including so-called frugal

innovation Other, please specify None of the above

Don’t know

0 10 20 30 40 50 60 100

Tough times in their traditional markets are forcing

some European and North American companies to

think and act boldly Some established MNCs such

as Ford are responding to the economic slowdown

by not only slashing costs but also by investing in

innovation and new products and by expanding ever

more into emerging markets “In 2009, when we

started returning to positive cash flows, we turned

our sights on growth markets,” says Lewis Booth,

Ford’s chief financial officer, pointing to substantial

investments in China, India, South Africa and South

America “But we had already decided to continue to

invest in new products in the traditional parts of the

business We have no desire to handicap our existing

business just for the sake of growth markets.”

Ford, which posted a profit of US$5 billion in the first half of 2011, now plans to export India’s ‘Car

of the Year’, the Figo, from its plant in Chennai to

50 countries around the world Mr Booth says the company expects its worldwide sales to rise by

50 per cent over the next four or five years – and more than half that growth is expected to come from the Asia-Pacific region But Ford has also announced 7,000 new jobs in its North American units over the past two years, providing a fillip to US manufacturing

3 ADAPTING TO CHANGE

What is your company doing or planning to do in order to respond to increasing competition

from high-growth market MNCs? Select all that apply

40%

36%

35%

32%

25%

22%

18%

15%

1% 3%

3%

Investing in innovation, research and development

Introducing new products and services

Expanding into new markets Adapting our business strategy/operating model

Cutting costs Acquiring emerging-market competitors

Investing in brand development

Changing our business model

Other None of the above Don’t know

0 10 20 30 40 50 60 100

This self-renewal is the key driver among respondents

to regaining or sustaining competitiveness While two

in five survey respondents say their companies plan

to invest in innovation, research and development,

36 per cent will introduce new products and services,

35 per cent will expand into new markets and

32 per cent will adapt their business strategy

Rainer Ohler, senior vice-president for public affairs at the European aircraft manufacturer Airbus, says: “The way to stay ahead of the Chinese is to take them seriously but ensure it’s you with the cutting-edge technology.” GE’s Beccalli-Falco adds: “The fundamental way to respond is to stay ahead of the curve.”