Question

1. Why are the emerging markets important for global companies? What specific issues should global companies consider when they want to explore these markets? Share your rationale.

Answer 1

Before we delve deeper into institutional voids, it’s important to understand why companies often target the wrong countries or deploy inappropriate globalization strategies. Many corporations enter new lands because of senior managers’ personal experiences, family ties, gut feelings, or anecdotal evidence. Others follow key customers or rivals into emerging markets; the herd instinct is strong among multinationals. Biases, too, dog companies’ foreign investments. For instance, the reason U.S. companies preferred to do business with China rather than India for decades was probably because of America’s romance with China, first profiled in MIT political scientist Harold Isaacs’s work in the late 1950s. Isaacs pointed out that partly as a result of the work missionaries and scholars did in China in the 1800s, Americans became more familiar with China than with India.

Companies that choose new markets systematically often use tools like country portfolio analysis and political risk assessment, which chiefly focus on the potential profits from doing business in developing countries but leave out essential information about the soft infrastructures there. In December 2004, when the McKinsey Global Survey of Business Executives polled 9,750 senior managers on their priorities and concerns, 61% said that market size and growth drove their firms’ decisions to enter new countries. While 17% felt that political and economic stability was the most important factor in making those decisions, only 13% said that structural conditions (in other words, institutional contexts) mattered most.

Just how do companies estimate a nation’s potential? Executives usually analyze its GDP and per capita income growth rates, its population composition and growth rates, and its exchange rates and purchasing power parity indices (past, present, and projected). To complete the picture, managers consider the nation’s standing on the World Economic Forum’s Global Competitiveness Index, the World Bank’s governance indicators, and Transparency International’s corruption ratings; its weight in emerging market funds investments; and, perhaps, forecasts of its next political transition.

Such composite indices are no doubt useful, but companies should use them as the basis for drawing up strategies only when their home bases and target countries have comparable institutional contexts. For example, the United States and the United Kingdom have similar product, capital, and labor markets, with networks of skilled intermediaries and strong regulatory systems. The two nations share an Anglo-Saxon legal system as well. American companies can enter Britain comfortable in the knowledge that they will find competent market research firms, that they can count on English law to enforce agreements they sign with potential partners, and that retailers will be able to distribute products all over the country. Those are dangerous assumptions to make in an emerging market, where skilled intermediaries or contract-enforcing mechanisms are unlikely to be found. However, composite indices don’t flash warning signals to would-be entrants about the presence of institutional voids in emerging markets.

In fact, composite index–based analyses of developing countries conceal more than they reveal. (See the exhibit “The Trouble with Composite Indices.”) In 2003, Brazil, Russia, India, and China appeared similar on several indices. Yet despite the four countries’ comparable standings, the key success factors in each of those markets have turned out to be very different. For instance, in China and Russia, multinational retail chains and local retailers have expanded into the urban and semi-urban areas, whereas in Brazil, only a few global chains have set up shop in key urban centers. And in India, the government prohibited foreign direct investment in the retailing and real estate industries until February 2005, so mom-and-pop retailers dominate. Brazil, Russia, India, and China may all be big markets for multinational consumer product makers, but executives have to design unique distribution strategies for each market. That process must start with a thorough understanding of the differences between the countries’ market infrastructures. Those differences may make it more attractive for some businesses to enter, say, Brazil than India.