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Building a presence in today's growth markets: The experience of privately held companies

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It’s no wonder that privately held and midsize businesses in the United States, Europe, and elsewhere are looking abroad to grow — emerging markets are leading the world’s growth, presenting …

It’s no wonder that privately held and midsize businesses in the United States, Europe, and elsewhere are looking abroad to grow — emerging markets are leading the world’s growth, presenting significant opportunities for investors. In fact, the growth gap between emerging and fast-growing markets (EFGMs) and the world’s mature markets has never been wider. The countries outside North America, Western Europe, and Japan account for about only half of global GDP, but since 2007 have accounted for over $2 trillion worth of growth — far more than the $200 billion of the mature economies, according to Economist Intelligence Unit (EIU) figures.

At the same time, the risks of doing business in EFGMs are declining. Across a range of business risks — from inadequate infrastructure to hard-to-interpret laws and difficult-to-navigate bureaucracies — there are fewer uncertainties associated with doing business in most of those markets. The EIU’s Business Environment Index, which has tracked a detailed set of operational risks across 59 countries since 2002, shows sharp drops in risks pertaining to economic volatility, political instability, infrastructure (from ports and roads to broadband connections), and banking systems.

This paper, which draws from interviews and a survey of executives in privately held businesses in North America and Western Europe, explores how private companies are turning to emerging and fast-growing markets that, in the recession year of 2009, contributed to only half of the world’s GDP but accounted for all of its growth.

None of the executives interviewed for this research regret their decision to move into the EFGMs. All say that the more experience abroad they gain, the more the perceived risk of doing business there diminishes for them. And while their near-term impetus for investing away from home might be immediate growth via market penetration in countries with a rapidly expanding middle class, the executives we spoke with also expect to reap the longer term benefit of greater global competitiveness, with more opportunities to outsource and to develop a lower cost base as the world’s economic center of gravity moves to the south and east.

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  • 1. Building a presence in today’s growth markets The experience of privately held companiesOpportunities andchallenges in the BRICsand beyond
  • 2. Building a presence in today’s growth markets The experience of privately held companiesThe surveyThis publication was created in cooperation with the Economist Intelligence Unit(EIU). The f indings presented in the main report are based on a survey and analysisconducted in 2010 by the EIU on behalf of PwC. A total of 158 corporate chiefs,directors, and senior executives of non-f inancial private companies from aroundthe globe and across 17 industries participated in the survey. They representcompanies with annual revenue ranging from US$100 million to US$5 billion;58% of respondents work at f irms with annual revenue of US$500 million or more.Two-thirds of the respondents are either C-suite executives or board members.The interviewsIn addition to the survey, in-depth interviews with f ive executives were conductedfor this report. We thank the following individuals for their valuable contributions:Robert Koch, CEO, Koch Enterprises; Bill Kozyra, CEO, TI Automotive; Jochen Meissner,CEO, Goss International; Gus Ramirez, CEO, Husco International; and David Whittleton,COO, Arup Group.We also interviewed f ive PwC partners from around the globe, who shared theirinsights about the opportunities and challenges that private companies face inemerging and fast-growing markets: Humphrey Choi, China; Ray Headifen, Indonesia;Rama Krishna, India; Abelardo Macotela, Mexico; and Carlos Mendonça, Brazil.To the interviewees and the 158 individuals who participated in the survey,we extend our appreciation and gratitude.
  • 3. As little as several years ago, investing in more than is focused business-planning that’s tailored to each one foreign market at once was relatively uncommon submarket and administrative region; a blanket among our private-company clients. The norm was strategy won’t work. In this respect, midsize private to venture into a single country, typically in Western companies enjoy an important advantage over Europe, and test the waters there before moving their larger, better-resourced public counterparts: into a second country. Now we’re beginning to see faster, more-eff icient decision making. F lexibility a number of clients take a bolder approach, entering and agility are very helpful qualities to have when multiple markets simultaneously. Even for them, doing business in EFGMs. however, “testing the waters” remains a standard For these and other reasons discussed in the following approach, with companies often f irst setting up a sales Rich Stovsky pages, many private companies have been meeting off ice to feel things out before further committing with success in EFGMs. They are apt to only increase US Leader themselves in a particular country or region. Another their presence there in the coming years, given that Private Company Services popular route is to form a joint venture, sometimes EFGMs’ macroeconomic fundamentals now look health- via a company’s current network — for instance, by ier than those of the heavily indebted developed world. leveraging a distributor or supplier. This publication shares some of the stories of privateAt the turn of this new century, we saw only a handful It stands to reason, then, that of the 158 private- Joint ventures and other strategic alliances can be companies that are doing business in EFGMs, with CEOsof US private companies pursuing business abroad. company executives surveyed for this publication, particularly important for midsize private companies, describing how they’ve overcome challenges to suc-A decade later, that’s no longer the case. A signif icant all say they have or are considering establishing which generally lack the resources of large public cessfully establish themselves in those markets. It alsonumber of our private-company clients have an inter- operations in EFGMs. And while the desire to keep companies and therefore don’t have the luxury of shares the insights of PwC partners in Brazil, China,national presence these days or are seriously consider- manufacturing costs down is a key factor in why learning the ropes of a new market slowly. Regional India, Indonesia, and Mexico regarding what they viewing one. For some, it’s a way to control costs. For even private companies are going abroad, they are less partners who understand the local market and as the top opportunities and diff iculties for foreignmore, however, it’s a way to make up for lost revenue interested in making goods in EFGMs than they customs, as well as have good relationships with key businesses in their countries. I hope that this on-the-at home and a path to growth. are in selling them there. This shift in focus ref lects government off icials, can help mitigate the risks ground knowledge, coupled with the survey f indings how rising wages in EFGMs are not only making of doing business in an EFGM.Companies seeking growth abroad are setting their summarized in the pages to come, proves helpful new consumers out of the workers in those countries,sights on emerging and fast-growing markets (EFGMs), In especially large, complex markets such as China to you in plotting your company’s growth strategy for but also making those individuals more costly forwhere economic conditions are rebounding more and India, where there are many submarkets that the new decade and beyond. foreign manufacturers to employ.quickly than in mature markets. At present, the EFGM can vary widely in their differences — including tax, Sincerely,landscape is dominated by the BRICs — Brazil, Russia, Although rising consumerism abroad, coupled with regulatory, and legal differences from one regionIndia, and China — but a second tier of rapidly develop- sluggish growth at home, is the biggest impetus for to the next, as well as among municipalities — lever-ing economies, including Indonesia and Mexico, are private-company investment in EFGMs (82% of com- aging local expertise is particularly critical. So, too,catching up. panies surveyed cite market growth opportunities as the top reason for EFGM investment; 51% cite theWhile all of these markets have their share of chal- economic slowdown), there are other powerful mo-lenges — ranging from infrastructure to regulatory tivators as well. Some are negative, such as increaseduncertainty — private companies are increasingly competitive pressure in home markets (cited by 49% Revenue growth Internationally active US private companies consistentlyf inding that the rewards outweigh the risks. Our project higher revenue growth than their domestic-only peers. of companies surveyed). Others are positive, including All international marketersongoing research1 shows that US private businesses Emerging markets EFGMs’ lower cost base (45%) and access to other Domestic onlyoperating abroad — particularly those active inEFGMs — consistently project higher revenue growth nearby major markets (42%). Data derived from PwC’s quarterly Trendsetter Barometer Business Outlook surveys. * Emerging market data began to be collected in 2009. 14.3%than their domestic-only peers, as well as report An additional lure is the introduction of policy reforms 14% 13.6%higher gross-margin increases. They’re also planning aimed at creating friendlier business environments 12.9% 12.3% 12.3% 12.2%greater capital investment, operational spending, in EFGMs. Brazil, for instance, has implemented a sys- 12% 11.8%and M&A activity. tem to reduce the complexity of complying with 10.6% corporate tax rules, while Mexico looks poised to pass 10% 9.7% 9.6% 9.4% 9.4%1 PwC’s quarterly, survey-based Trendsetter Barometer Business Outlook anti-monopoly legislation in 2011. 8.5% 8.5%reports: http://www.barometersurveys.com/trendsetter 8% 7.9% 7.8% 7.7% 7.6% 7.5% 7.4% Meanwhile, private companies are growing more 6.8% adept at dealing with the challenges in EFGMs as their 6.1% 6% 5.5% exposure to those markets increases. Consequently, 4.9% 4.8% 4.5% EFGMs are beginning to appear less risky to many 4% of those companies. For instance, three-quarters of 2.1% private businesses investing (or planning to invest) 2% in just one or two EFGMs characterize China as * * * high-risk, whereas this view of China is held by only 10 10 10 09 09 09 09 08 08 08 41% of companies investing (or planning to invest) 20 20 20 20 20 20 20 20 20 20 3Q 2Q 1Q 4Q 3Q 2Q 1Q 4Q 3Q 2Q in f ive or more EFGMs.
  • 4. Table of contentsPreface 6Where private companies are goingThe BRICs and beyond 7Why are they going there?The successful experience so far 10The risk landscapeHow it’s changing 14Top risks when investing abroad 19What to do now 22Country snapshots 24Brazil 26China 34India 42Indonesia 50Mexico 58
  • 5. Preface Where private companies are goingIt’s no wonder that privately held and midsize businesses This paper, which draws from interviews and a survey The BRICs and beyondin the United States, Europe, and elsewhere are looking of executives in privately held businesses in North Americaabroad to grow — emerging markets are leading the world’s and Western Europe, explores how private companies aregrowth, presenting signif icant opportunities for investors. turning to emerging and fast-growing markets that, in theIn fact, the growth gap between emerging and fast-growing recession year of 2009, contributed to only half of themarkets (EFGMs) and the world’s mature markets has world’s GDP but accounted for all of its growth.2never been wider.1 The countries outside North America, None of the executives interviewed for this research regretWestern Europe, and Japan account for about only half their decision to move into the EFGMs. All say that theof global GDP, but since 2007 have accounted for over more experience abroad they gain, the more the perceived$2 trillion worth of growth — far more than the $200 bil- risk of doing business there diminishes for them. Andlion of the mature economies, according to Economist while their near-term impetus for investing away fromIntelligence Unit (EIU) f igures. home might be immediate growth via market penetrationAt the same time, the risks of doing business in EFGMs in countries with a rapidly expanding middle class, the Companies are going where demand is Among survey respondents, most com-are declining. Across a range of business risks — from executives we spoke with also expect to reap the longer- growing — and they are going there in large panies planning investments in the BRICsinadequate infrastructure to hard-to-interpret laws and term benef it of greater global competitiveness, with more numbers. All of the 158 survey participants already operate in those countries. Like-diff icult-to-navigate bureaucracies — there are fewer opportunities to outsource and to develop a lower cost have already moved to establish operations wise, companies investing in EFGMs suchuncertainties associated with doing business in most of base as the world’s economic center of gravity moves to the abroad or are planning to do so in the next as Mexico or Poland already have opera-those markets. The EIU’s Business Environment Index, south and east. three years. The most frequently mentioned tions there.which has tracked a detailed set of operational risks across destinations are the BRICs: Brazil, Russia,59 countries since 2002, shows sharp drops in risks 1 According to the International Monetary Fund, in 2008 the “emerging and India, and China. But the story of EFGM developing” category of countries accounted for 90% of the world’s growth;pertaining to economic volatility, political instability, ascendency is broader than just the BRICs: in 2009, when the mature economies shrank, these countries accounted for allinfrastructure (from ports and roads to broadband of the growth. Survey results suggest that six additionalconnections), and banking systems. 2 The rising economies of Asia, Latin America, Eastern Europe, the Middle East, markets — Mexico, South Korea, Turkey, and Africa—typically referred to as emerging markets—are described in this paper Poland, Indonesia, and South Africa — repre- as emerging and fast-growing markets (EFGMs). The commonly used distinction between emerging and mature economies still has considerable validity, especially sent the second wave of overseas investment. on a per-capita GDP basis. In this report, EFGMs encompass markets outside North America, Western Europe, Australasia, and Japan that are experiencing rapid development. Figure 1 Top targets for foreign 60% investment by private Who took the survey companies The survey, conducted by the Economist Intelligence Unit on behalf of PwC, was designed to discover why Q1: In which of these and how non-f inancial private companies are investing abroad. A total of 158 corporate chiefs, directors, 40% emerging and fast-growing and senior executives of non-f inancial private companies from around the world participated in the survey. markets are you doing or Two-thirds of the respondents are either C-suite executives (61%) or board members. They hail from considering doing business? companies either already operating in EFGMs or planning to establish operations there imminently. These (N = 158) f irms are mainly headquartered in Western Europe (47%) or North America (40%). They come from 20% across 17 industries and represent a range of company sizes, from US$100m to US$5bn in annual revenue; 58% of respondents work at f irms with annual revenue of US$500m or more. a a le nd t lic an a a nd y ea o a l a na zi yp ke bi in ric si si di ic hi ra ub or w hi la la ne us nt om ex In Eg r C Af i B C ai Po Tu K Ta ep ge R do M Th ol h h R Ar ut ut In C ch So So ze6 Private Company Services C Private Company Services 7
  • 6. BRICs: Average, highest, and lowest growth from 1999 to 2009 Figure 2 Country Average real economic Highest growth (year) Lowest growth (year) “Mexico’s ranking on the FDI Confidence Index rose in 2010, Where the growth is growth 1999–2009 despite Mexico’s heavy reliance on the fortunes of the US China 10.0% 14.2% (2007) 7.6% (1999) economy. Our many free trade agreements with fast-growing India 7.2% 9.6% (2007) 3.8% (2002) economies such as China, Turkey, South Korea, and Indonesia Russia 5.5% 10.0% (2000) -7.8% (2009) may help reduce that reliance.” Brazil 3.0% 6.1% (2007) -0.6% (2009) — Abelardo Macotela PwC Mexico Six most-cited non-BRIC EFGMs: Average, highest, and lowest growth from 1999 to 2009 Country Average real economic Highest growth (year) Lowest growth (year) growth 1999–2009 South Korea 4.8% 9.5% (1999) 0.2% (2009) Indonesia 4.7% 6.3% (2007) 0.8% (1999) Poland 4.0% 6.8% (2007) 1.2% (2001) South Africa 3.5% 5.6% (2006) -1.7% (2009) Real annual GDP rate 2005–2009 EFGM Mature Turkey 3.1% 9.4% (2004) -5.7% (2001) 12% Figure 3 Mexico 1.9% 6.0% (2000) -6.1% (2009) China Poorer markets Source: Economist Intelligence Unit are growing fast; richer and more 10% mature ones are not Nigeria The mature economies are For other EFGMs mentioned by survey To attract foreign direct investment India those with high levels of respondents — such as Chile, Colombia, and encourage local growth, each of these 8% Vietnam market capitalization and Egypt, South Africa, and Turkey — about countries has stepped up investment Peru Bahrain liquidity, and are defined half of the investments would be f irst- in infrastructure. Argentina here as the United States, time ventures. These may represent the 6% In a testament to well-directed policy- Indonesia Canada, Western Europe, most exciting EFGM opportunities, for Iran making in recent years, all have a reasonable Poland Japan, and Australia. Size the following reasons: Philippines track record of macroeconomic stability Israel Singapore of bubbles denotes 2009 With the exception of Chile, all have and rode out the global economic crisis fairly Brazil 4% nominal GDP, adjusted for sizeable working-age populations, as well as successfully. Even Turkey, which suffered Russia South Korea Kuwait inflation. The vertical axis Hong Kong children who will soon reach working age.3 from its exposure to export markets, is Thailand Australia is the compound annual Taiwan The largest non-BRIC country, Indonesia, rebounding strongly. real increase in GDP from Greece has 161 million people aged 15 to 64 years 2% 2005 to 2009. (The five-year Spain France Norway (and another 33 million below 15 years old, 3 Chile has a population of just under 17 million but is of Mexico Lithuania Canada compound annual growth growing interest to companies due to a well-publicized US soon to be of working age). Ukraine Portugal Germany rate was used because 2009, strong business climate and impending membership in the Organisation for Economic Co-operation and Develop- 0% a recession year, was atypi- All are diversif ied economies not overly Hungary ment (OECD). Italy Japan cal.) Per capita GDP is GDP reliant on commodities, which means per person, adjusted for freedom from the boom-and-bust economic inf lation. All figures are cycles that often characterize commodity- 2009 GDP per capita in USD -2% based on EIU data. based economies. 0K 10K 20K 30K 40K 50K 60K 70K 80K8 Private Company Services Private Company Services 9
  • 7. Why are they going there?The successful experience so far Market growth opportunities Figure 4 Bright prospects outside Economic slowdown in developed markets slow-growing, increas- Competitive pressures in your home market ingly competitive home markets are the main Outsourcing opportunities or lower cost base driver of private-company investments in EFGMs Closer proximity and access to other major markets Q6: Why has your company Better location to serve global clients invested in emerging and fast- Easier regulatory environment growing markets? (N=158) Better availability of talent Better access to natural resources While the pull is the lure of growth, the The need to follow competitors“Nearly three-quarters of India’s population push is the outlook at home. Burdened by aging populations, sticky wages, high A better environment for innovation resides in rural areas. There you have what cost structures, reluctant consumers, 100% 0% 100% remains a largely untapped consumer base.” deleveraging banks, and higher public debt Unimportant Important— Rama Krishna PwC India burdens, the mature economies appear to be stagnating. Stay and stagnate, or go and grow? For most executives, the answer is clear. To them, expanding abroad is Eighty-two percent of survey respondents increasingly viewed as a necessity, not just say that the opportunity to grow is highly an attractive option. important in driving their investment This shift in focus is evident in UK-head- Past three years Next three years Figure 5 decisions (see Figure 4). Despite the global quartered Arup Group, a building design Revenue growth downturn, companies’ performance and engineering f irm. Its COO, David Over 25% growth abroad beats domestic in EFGMs in recent years has been impres- Whittleton, admits that the company’s early growth — both now sive — and signif icantly better than that expansions abroad, which began with and in the future of their home markets. Ireland, were not necessarily part of a set 15% to 25% growth Q9&10: Over the past Eighty percent of respondents report aver- strategy. If the f irm won business in a coun- three years, what has been age annual revenue growth of more than try and saw the promise of more, it set up the average annual rate 5% in EFGMs in the past three years, while shop. But its approach to foreign investment 5% to 15% growth of revenue growth in your 40% enjoyed annual growth of more than has changed recently. The company has company’s home market? 15%. Performance is expected to improve identif ied Russia, for example, as a country (N=153) Outside your further over the next three years and sub- with market potential that demands a pres- 0% to 5% growth home market? What do you stantially outstrip that in companies’ home ence. Arup now employs roughly 75 people expect at home and abroad markets: 84% of survey-takers expect in Moscow and a similar number in St Pe- in the next three years? average annual revenue growth to exceed tersburg. It has also been looking at other Decrease (N=128) 5% in EFGMs where they have already leading EFGMs, expanding strongly in China invested; 57% expect revenues to grow (via Hong Kong), where it now employs 0% 15% 30% 45% 0% 15% 30% 45% more than 15% per year. roughly 600 workers. Home market Overseas market10 Private Company Services Private Company Services 11
  • 8. Private-company EFGM success stories Because competition from EFGM f irms will Private companies that have already invested Volume“Chinese businesses are no longer in the shadow continue to grow, extending beyond EFGMs in EFGMs have generally found it rewarding, Husco seeks preference from suppliers by being into mature markets, the opportunity to survey data show. Smaller companies can be just a big buyer. “We want to be important to [our of their foreign counterparts.” face these competitors early — and to learn as successful as their larger counterparts when suppliers],” says Mr Ramirez. “So we work very— Humphrey Choi PwC China from them — can be seen as an advantage. investing overseas — as the executives interviewed hard to have exclusive relationships.” Even when EFGM competitors have years of experience for this research demonstrate. They are often Husco’s suppliers sell to the industry as a whole, in low-cost manufacturing, strong local more nimble than bigger, public companies when Husco strives to remain at or near the head of the Global competitiveness knowledge, and the relationships to compete it comes to drawing on peer networks, enlisting line. In every case, says Mr Ramirez, “We want Greater global competitiveness is another strongly with their Western counterparts local advisors, and collaborating with local partners. to be number one or no worse than second so that clear benef it of investing abroad. Much in cheaper segments. As they move up the we get priority.” For example, when Koch Enterprises, a US-based of that competitiveness stems from oppor- value chain they will pursue expansion company that manufactures aluminum die-casting Support tunities to outsource in EFGMs and to through acquisition, in search not just of parts, sought to move into Brazil, it solicited recom- Husco has helped domestic Chinese companies get develop a lower cost base there. As Jochen market share but also of technology, know- mendations from its automotive customers and into the automotive components business. F irst, Meissner, CEO of Goss International, how, and established brands. For Western eventually acquired a struggling local f irm. Goss, it provides expertise: Although Husco doesn’t make a global printing and publishing company manufacturers, keys to competing success- meanwhile, started its operations in China by the parts itself, its executives know the processes based in the United States, notes, moving fully with these f irms include eff iciency, launch­ ng a joint venture with a Chinese f  rm, Shang- i i required to make them, as well as what capital into China helped Goss’s mature business strong supplier relationships, and the con- hai Electric, which is now Goss’s parent company. equipment is necessary. “It typically takes two or “lower the overall cost structure.” Goss’s stant quest for improvement (as in, for three years to take [new suppliers] up the learning experience highlights another benef it of instance, lean manufacturing processes). Nimbleness and leveraging relationships aren’t curve,” says Mr Ramirez. Second, Husco provides global expansion: visibility to the next useful simply in helping companies get an initial suff icient volume to ensure a viable business oppor- generation of global investors. The company foothold in EFGMs. They can also be helpful tunity for the local company. “The combination was bought out by Chinese investors after in coping with business challenges brought on of the two is critical,” says Mr Ramirez. establishing operations there. by success in those markets. Gus Ramirez, CEO of US-based Husco International, which provides Diversification The journey to greater global expansion components for off-road vehicles, relates his In cyclical markets, the drawbacks of a brittle also involves going up against a more global experience of meeting the challenge of rapid supply chain become apparent — as do the advan- group of competitors. A sizeable majority growth in China, where his f irm supplies a large tages of f lexibility. Husco has suppliers in Europe, (74%) of respondents say that subsidiaries Chinese equipment manufacturer: “The growth India, China, North America, and South America. of foreign multinationals are their main rates are just incredible,” he says. “The challenge Many have similar capabilities. If one stumbles, competitors in key EFGMs. Yet local compa- of staying on top of the demand is certainly unlike another can often take over. “That’s the game of nies and locally based multinationals that of any other country we have ever worked in.” manufacturing,” says Mr Ramirez. “You’re always are also cited as main competitors by large juggling. If one ball falls, you better be nimble minorities (49% and 42%, respectively). Husco meets the challenge by cultivating suppliers. enough to put another ball in the air.” At the moment, many companies still operate The recession of 2008 and 2009 created turmoil in a two-tier market, and local competition in the small universe of companies supplying criti- Building relationships is mainly at the cheaper end. Mr Meissner cal automotive components, with demand dropping F inally, suggests Mr Ramirez, it is diff icult for notes that in China, “We compete on two by as much as 80% in some cases. After pulling Westerners to overestimate the power of personal different levels. There is the so-called import back, many found it diff icult to f inance the ramping relationships in Asia. In North America he allows segment, where we face our traditional up of operations in response to renewed demand. his staff to manage supplier relationships. Not Japanese and German competitors. But there Luckily, Husco has experience in dealing with ex- in Asia: Every visit is spent paying personal calls is also a domestic segment, where we have treme market cycles: “We deal in a cyclical business on the owners and senior executives of as many a number of Chinese competitors.” in cyclical markets. We go down hard and come suppliers as possible. back hard,” says Mr Ramirez. “That’s the nature These factors don’t completely solve the problem of [the] industry.” of keeping up with demand in hot markets. To respond quickly to these f luctuations in But they do help Husco manage its business better demand, Husco focuses on four factors: when the company inevitably hits a snag.12 Private Company Services Private Company Services 13
  • 9. Ratings are on a scale of 0–100. Figure 6The risk landscape Positive change equates to decline in risk Change in EIU overall 10 business risk ratingsHow it’s changing for selected countries ea la e or or since 2002 ue K ap ez h ut ng n S So Ve Si U 0 ia a y nd l na a ge o y ce a zi ke an si di si ic an ra e hi ra la ne us In ex r m re om B C Po Tu e R do M er G Av R G In -10 Romania, Egypt, and Argentina wit- The risk-reward equation turns This decline in perceived risk is ref lected“Foreign investors are generally cautious about nessed the biggest declines. Macroeconomic more favorable with greater in the hurdle rates of TI Automotive, risk dropped as the economies of all three market exposure a British company headquartered in Detroit. Indonesia because of certain misconceptions countries became more robust. Financial While the actual level of risk in an EFGM According to TI Automotive CEO Bill Kozyra, out there. For example, I don’t think the security risk fell when Argentina’s banking sector may decline for a variety of reasons, the company used to require a higher inter- risk is as dire as it’s been made out. Overall, became stronger and more eff icient. Roma- a decrease in a company’s perception of risk nal rate of return in EFGMs — up to 35%, nia acceded to the EU in 2007 and has tends to hinge primarily on exposure. compared with 20% for a mature economy — Indonesia is pretty stable.” made progress in tackling corruption and The more EFGMs a company invests in, the to compensate for what it saw as higher— Ray Headifen PwC Indonesia regulatory convergence. And Egypt’s infra- more its ability to cope with risks grows, risk. Now the company considers a 20% rate structure — especially port facilities, air and hence the more comfortable its leaders of return in EFGMs suff icient. “In the last transport, and IT connectivity — improved become with taking the plunge into new two years,” he adds, “we’ve certainly had Risk and the ability to cope with risk are two signif icantly, cutting infrastructure risk. markets. For instance, 75% of companies more stability in countries such as India and different things. The more experience a com- investing or planning to invest in just one China in terms of volume growth, versus pany has in operating abroad, the better it Brazil, China, and Russia also pose less or two EFGMs see China as a market with Western Europe.” can mitigate the risks. That said, some oper- risk to foreign companies than they did high risk, compared with just 41% of ating environments are clearly riskier than eight years ago. (India’s risk rating hasn’t Arup’s Mr Whittleton also notes this narrow- companies investing or planning to invest others, and levels of risk change over time. changed.) All three countries have more- ing of the risk gap between EFGMs and in f ive or more markets. resilient governments and economies and more mature economies. And trends that Measuring the risk more-developed f inancial markets than are contributing to a lower level of risk of operating abroad they did in 2002. Brazil’s infrastructure has may present business opportunities. For Risk is a slippery concept to quantify even not kept up with its growth, while the example, as Indonesia’s government works when applied to prices, populations, and infrastructure of the other three countries to make the country more attractive to other things that can be counted. But the art was judged to have improved, especially foreign investors, observes Mr Whittleton, of quantifying qualitative risk concepts has in India and China. there’s a signif icant market developing developed rapidly as organizations like for the types of services the company offers. Transparency International (corruption), China’s risk rating improved signif i- the World Bank (ease of doing business), cantly in the category of legal and regulatory the United Nations Development Programme risk, particularly regarding speediness Percentage of executives who say that (quality of life), and Friends of the Earth and fairness of judicial processes and unfair investment in a country is “high risk” (ecological health) have taken on the task competitive practices. 100% Figure 7 of aggregating information in specif ic The more countries South Korea saw a slight increase categories and developing indices that show a company invests in, in risk. Its risk score was very low to start progress over time. the less likely executives with; the small increase mainly ref lects are to characterize key Since 2002, according to the ratings devel- the possibility of an economic downturn 50% EFGMs as “high risk” oped by the Economist Intelligence Unit, the resulting from the country’s extreme overall risk of operating in Brazil, Russia, export dependence. and China — and all but four of the coun- tries cited by survey respondents as destina- Russian Federation China Brazil India 0% tions for foreign operations — has fallen. Some of the declines in risk were dramatic. Number of countries in which company has invested: 1–2 countries 5 or more countries14 Private Company Services Private Company Services 15
  • 10. Deconstructing risk: Figure 8 shows the world’s major economies The EIU business risk framework plotted by operational risk (the horizontal Case study: TI Automotive Since 1982, the Economist Intelligence axis) versus the forecast compound annual Unit has maintained a set of operational risk real GDP growth rate from 2010 to 2015. indicators designed to quantify the risks to In general, the higher the operational risk, business prof itability across 180 countries. the higher the GDP growth. But some The overall score is an average of ten sub- countries (China and India in particular) scores, each of which is based on four to ten offer an extremely high rate of growth specif ic ratings (see Figure 9). The result is relative to the level of risk, while others a framework of risk indicators built up from (such as Italy, Portugal, and Japan) are far the specif ic to the general, and based on below the trendline. criteria that are clearly def ined and stable Figure 9 shows the hierarchy of risks over time. that make up the risk framework. About Although the risk scale theoretically runs one-third of the indicators are based on from zero to 100, no country receives quantitative data (e.g., crime statistics) and a score of zero or 100. This ref lects that are mostly drawn from recognized national even the least risky countries have some and international statistical sources. All risk, while riskiest countries could become make use of in-country experts who provide even more risky. (Switzerland is currently detailed, regular information on conditions judged to have the lowest risk, at 10, while within a country. Since companies in differ- Somalia is the highest, at 83.) ent industries pay attention to different risks, the indicators can be weighted to create a company-specif ic risk assessment. EFGM Mature Compound annual real GDP growth rate 2010–2015 Figure 8 A global supplier of automotive f luid systems Extensive and lengthy experience operating in Forecast real GDP India 9% that’s headquartered in Detroit (although incorpo- a market helps companies deal with the challenges China growth rate versus rated in the UK), TI Automotive employs some and manage the risks. For example, despite operational risk score 14,000 people in 27 countries. It relies on its close China’s reputation as a risky environment for intel- 8% for major economies, proximity to the auto companies’ assembly plants lectual property (IP), the company’s 25 years of Qatar 2010–2015 Vietnam around the world, as shipping costs are not eco- experience in China have convinced it that placing 7% Size of bubbles denotes nomical. It therefore operates in a number of its most valuable technology there does not put forecast nominal GDP EFGMs, in Asia, Latin America, Eastern Europe, the company at risk. Indonesia Nigeria in 2015. Forecast growth and Africa, including all four BRIC countries. TI Automotive has also made a point of employing Kazakhstan 6% is compound annual Bill Kozyra, TI Automotive’s CEO, says that the only local staff to manage its foreign operations, Chile Malaysia Turkey Kenya real increase in GDP. The Kuwait Egypt main diff iculty in working in EFGMs is that which helps navigate any obstacles. “Our president operational risk score Singapore Brazil 5% different regulatory frameworks can change the of [operations in] China is a Chinese national,” is the simple average of Thailand economics and execution of strategic initiatives. notes Mr Kozyra. “His whole management team are Hong Kong Russia 10 sub-scores covering Romania The real issues are the amount of regulation, Chinese nationals. We don’t have any Westerners Taiwan Poland South 4% security, political stability, Korea Mexico Pakistan the clarity and complexity of regulations, the running our business for us. The same is true [of our government effective- diff iculties of compliance, and executives’ lack operations] pretty much all over the world.” Australia ness, legal and regulatory of familiarity with regulation in different kinds Sweden Germany 3% environment, macroeco- While China and India are TI Automotive’s fastest- of economic systems. US Iran nomic risk, foreign trade growing markets, establishing the company in Finland Venezuela and payments, financial For example, in China, where TI Automotive has those countries has not come overnight — it began 2% Netherlands markets, tax policies, the 12 manufacturing facilities, the process of f inding operating there 30 years ago. “You have to be Japan labor market, and infra- land is a major issue. Land must be rented from patient and plant seeds, and develop them over Italy 1% structure (see Figure 9). the Chinese government, and “there’s a long lead decades,” says Mr Kozyra. All figures are based on time,” Mr Kozyra says. He estimates that it takes Portugal EIU data. roughly three years to set up a factory in China, EIU operational risk score 2010–2015 (higher is riskier) 0% compared with a year in Mexico. 10 20 30 40 50 60 70 8016 Private Company Services Private Company Services 17
  • 11. Figure 9 Risk indicators in the EIU’s operational risk Risk indicators Sub-components of risk indicators Top risks when Security risk – Armed conflict – Violent crime framework – Terrorism – Violent demonstrations –  ostility to foreigners/ H – Organized crime – Kidnapping/extortion investing abroad private property Political stability risk – Social unrest – Excessive executive authority – Disorderly transfers – International tensions – Opposition stance Government – Policy formulation – Corruption effectiveness risk – Quality of bureaucracy –  ccountability of public A –  xcessive bureaucracy/ E officials Any move to a new business environ- Of course, risks are not uniform across red tape – Human rights – Vested interests/cronyism ment involves risks. This is not an issue countries. Different countries present dif- just with investments in EFGMs. When ferent risk prof iles. Figure 10 shows how the Brazilian meatpacker JBS acquired surveyed executives ranked the top risks Legal and regulatory risk – Fairness of judicial process – Unfair competitive practices – Enforceability of contracts – Protection of intellectual the US f irm Swift & Company in 2007, across 12 countries. The countries are –  peediness of judicial S property rights it almost immediately faced thorny (and ordered from most to least risky as evidenced process – Protection of private property unanticipated) labor and compliance by the number of respondents who cited –  iscrimination against D – ntegrity of accounting I foreign firms practices issues. Asked about investing in EFGMs, risks for each country. The risks are ranked – Confiscation/expropriation – Price controls survey participants cited the following in descending order of importance, starting operating risks, in order from most to with the most frequently mentioned risk Macroeconomic risk – Exchange rate volatility – Crowding out least prevalent: on the left (corruption). As the chart shows, – Recession risk – Interest rate volatility Indonesia, Russia, and Mexico are widely – Price instability  ailure to honor contracts, bribery, F cited for corruption; Indonesia and India for corruption, weak corporate governance poor infrastructure; and China and Russia Foreign trade and – Trade embargo risk – Capital account  ow-standard or costly infrastructure L for contract disputes. payments risk – Financial crisis – Current account convertibility (telephones, transport networks, – Discriminatory tariffs – Capital controls risk An array of concerns related to government – Excessive protection utilities) and bureaucracy are also highlighted by  iff iculties in f inding and promoting D the survey data. Most companies cited the Financial risk – Devaluation risk – Marketable debt senior local management following: political instability; unclear, – Depth of financing – Banking sector health changing, or highly localized tax rules; slow, – Access to local markets – Stock market liquidity C  redit risk corrupt, and ineff icient customs services; Diff iculties with business partners weak intellectual and property rights; Tax policy risk – Regime’s stability – Level of corporate taxation arbitrary, weak, or ineff icient courts; and – Discriminatory taxes – Retroactive taxation Rising wages / low productivity punitive taxes. But many businesses are  ack of key skills in areas such L f inding ways to deal with these concerns. Labor market risk – Trade unions – Specialized labor as engineering, software, marketing, – Labor strikes – Meritocratic remuneration – Labor laws – Freedom of association f inance, languages – Skilled labor Poor quality control Infrastructure risk – Port facilities – Road network – Air transport facilities – Power network –  etail and distribution R – Rail network network – IT infrastructure – Telephone network18 Private Company Services Private Company Services 19
  • 12. Despite the concern about bureaucracy,“Hong Kong Chinese and home-country personnel executives like Husco’s Mr Ramirez have found ways to work through the impedi- are no longer the primary ones running foreign ments — for instance, by employing local businesses on the mainland. The local people are staff who are familiar with local regula- taking on greater responsibility, too. This is what tions and can help build strong relationships with key civil servants. Indeed, 84% of we call the succession plan.” respondents say that they use locals to staff— Humphrey Choi PwC China foreign operations, and not just for junior posts: Where locals are employed, they occu- Macroeconomic instability Some companies are now looking again py senior positions in 75% of f irms surveyed. Aside from regulatory burdens, macro- at markets they previously considered too economic instability over the long term volatile. “Historically we steered away “The different kinds of taxes and all the But retaining staff can be a challenge. Fifty- remains a leading worry, cited by 81% of from setting up manufacturing [in Brazil] places where the taxes are levied” has been six percent of respondents say that pressure the companies we surveyed. The economic because the cycles there have been very challenging for the Brazilian operations on wages is a signif icant problem and that volatility of the past f ive years makes steep,” says Mr Ramirez of Husco. “Even of Koch Enterprises, acknowledges the job-switching is frequent. Speaking of his this an issue for all companies, public and though you make a lot of money in good company’s CEO Robert Koch. But he says f irm’s India operations, Mr Ramirez of Husco private, domestic and international, times, you tend to lose a lot of money in the company hired Brazilian accountants to says: “People tend to leave for smaller [wage] regardless of where they’re investing. While bad times. [But] I think that’s changing, help overcome the challenge and used the premiums than would be the case in the it’s true that companies investing in and my expectation is that over the next accounting system of a Brazilian f irm it had United States. But if you keep on top of it and EFGMs may be facing a legacy of the days f ive years we will likely have some form acquired while Koch’s management gained ensure that your key people are appropri- of emerging-market boom and bust, of manufacturing in Brazil as well.” familiarity with the different taxes. ately paid, compensated, and promoted, you including the crises in the 1990s (Mexico, can deal with that challenge.” Minimizing these and other risks entails Russia, Brazil, Argentina, and Asian learning to work with governments in countries), EFGMs have increased their EFGMs — and not just at a national level. economic resilience considerably in However, lack of access to government recent years. For many of them, growth “Brazil is stronger than it was before the global crisis off icials is among the risks cited by a large either held up well during the recent minority of companies surveyed, and global economic crisis or rebounded quickly began. Within six to eight months, our economy overcoming it may take a concerted effort. thereafter. Meanwhile, macroeconomic rebounded. Fortunately, Brazilian companies were According to Mr Koch, when a f irm invests volatility in mature markets has grown. already running lean before the crisis started, and so in China, “you invite all the local govern- ment off icials, and there are f ireworks and they were in good shape to weather the downturn.” a big party.” — Carlos Mendonça PwC Brazil Corruption Economic instability Poor corporate governance Poor infrastructure Political instability Contract disputes Figure 10 60% Top risks by country cited by surveyed executives 40% Only countries and risks with at least 15 responses were included 20% Indonesia Russia South Africa India Mexico China Brazil Turkey Poland Czech Republic South Korea Taiwan20 Private Company Services Private Company Services 21
  • 13. What to do now Cultivate local talent. Local exec- As they take these actions, companies will“Companies should come here with a long-term utives — and local partners — will become have to continually assess the shifting risk the rule. Aware of the risks in each market landscape — and against the backdrop of an strategy. Those that do tend to be more and drawing on their experience there, local increasingly volatile world economy. That successful than businesses that come looking executives and partners will be able to f ind landscape is broader than the EFGMs. Says for short-term gains.” ways to mitigate those risks. Mr Kozyra of TI Arup’s Mr Whittleton of the company’s Automotive partly credits his company’s decision to look outside the UK: “You could— Rama Krishna PwC India ability to deal with local obstacles to the deci- say that the UK is pretty risky at the moment sion to employ only local staff at all locations on the grounds that expenditures are being and levels around the world. cut and growth is very doubtful.” One could say that about other mature markets as well. In the new competitive landscape, where Build a strong due diligence businesses from across the world are process. Companies should learn as much And so investment in EFGMs — where competing everywhere in the world, private as they can about how the local business growth is near certain — looks ready companies are increasingly looking to environment might affect operations. Says to surge. Companies that regard such invest- EFGMs for the best growth opportunities. Mr Koch of his company’s entrance into ment as vital to their business strategy They’re eyeing not only the BRICs, but China and Brazil: “Probably the longest part will f ind no shortage of opportunities along- also smaller economies that are equally was our preliminary investigations, learning side the challenges — and may even f ind dynamic and ascending rapidly. Successfully more about the country, the culture, the that the rewards outweigh the risks, as pursuing growth opportunities in EFGMs geography, where our customers would be, many of the companies in our survey have entails putting the following actions at the where competition might be, the quality already discovered. heart of a company’s corporate strategy: of competition.” Here is where tapping net- work relationships can be especially helpful, Build networks. Executives should particularly for private companies that don’t develop strong networks of advisors, part- have the investigative resources of a large, ners, and government contacts to ensure public multinational. that they go into markets well-informed of the operating realities. One example is Focus on planning, leavened Koch Enterprises’ solicitation of advice from with f lexibility. Companies that operate its Brazilian customers before its move in — or plan to enter — EFGMs need to plan there. Another is Goss’s joint venture with well. In economies as dynamic and evolving Shanghai Electric. as EFGMs, good planning entails constantly ref ining strategies to meet local needs and keep pace with competition. Says Arup’s Mr Whittleton about the need for f lexibility: “There is no single development model for us that suits all of these markets. There’s no template that you take to Russia that you [then] take to China and Vietnam. You have to tailor it to the local needs.”22 Private Company Services Private Company Services 23
  • 14. Country snapshotsBrazil, China, India,Indonesia, Mexico
  • 15. China India Brazil Annual data 2010 Historical averages 2006 –10 2010–14 Indonesia Population (m) 193.3 Population growth 1.05% Growth /risk forecastBrazil Japan Mexico GDP growth GDP (US$ bn) 2,013 Real GDP growth 4.44% Size of bubbles shows Russia GDP per head (US$/market rate) 10,420 Real domestic demand growth 5.94% relative size of US Exchange rate (av) R:US$ 1.76 Inflation 4.68% 2010 GDP in US$: Operating risk All country information © 2011 Economist Intelligence Unit. Used with permission.Brazil’s business environment has steadily improved overthe past decade. The next f ive years should be charac-terized by stability, a growing domestic market, modestimprovements in physical infrastructure, and furtherstrengthening of democracy. Continuity of macroeconomicpolicy will drive continued investment and employmentgrowth, underpinning domestic demand. Brazil’s weaknessesremain its burdensome tax system, skill shortages, anda formidable bureaucracy. In addition, small and medium-sized companies are likely to continue to face restrictedaccess to credit.Analysis developed by the Economist Intelligence Unit (EIU). Private Company Services 27
  • 16. Brazil Opportunities Challenges Developed by EIU Developed by EIU Relative market size / 2010 GDP Business risk ratings Risk category Rating Score* Comments Overall assessment C 45 Improving environment despite bureaucratic hurdles and onerous taxes in billion Security risk B 39 Organized and violent crime high, but foreigners rarely targeted US$ Political stability risk B 25 Democracy is solid, but party indiscipline obstructs policy Government effectiveness D 68 Political system often ineffective; corruption affects all levels of government US China Germany Brazil India Russia Mexico Indonesia Legal/regulatory risk C 45 The legal system is generally fair but slow 14,723 5,697 3,317 2,013 1,600 1,465 998 707 Macroeconomic risk B 40 The economy is growing very strongly, but there are overheating risks Foreign trade/payments B 29 Still closed relative to peers; liberalizing moves have stimulated trade growth Financial risk B 33 Financial markets are deepening, but lending rates are high Tax policy risk D 62 Taxation is onerous and the system is complex per capita in US$ Labor market risk C 50 Restrictive formal labor market, but low risk of industrial unrest Infrastructure risk C 59 Infrastructure has not kept up with growth; increased investment underway *0–100 / 0 = least risky US China Germany Brazil India Russia Mexico Indonesia 47,560 4,340 39,990 10,420 1,350 10,340 8,930 2,909 Operating risk rating comparison Scale of 0–100 / 100 = lowest risk BRICs average Brazil OECD average Key forecasts 100 80 2010 2011 2012 2013 2014 2015 60Real GDP growth (%) 7.7 4.3 4.7 4.8 4.7 4.4 40Consumer price inflation (av; %) 5.0 6.1 4.7 4.6 4.5 4.5 20Budget balance (% of GDP) -2.3 -2.4 -2.5 -2.0 -1.9 -1.6 0 l y ke r re en ll y ili al es nt to l / ic en de /Current-account balance/GDP -2.4 -2.8 -3.4 -3.9 -4.1 -4.1 ia ar bo m ra lic rit la ga om ab ic en e tu t t ty s ry ts nc ss ve cu iv m po m La ym ra st olit gu Le uc na on ct rn se O pa n t Se trMoney market interest rate (%) 9.8 12.0 11.7 11.0 10.8 10.8 x P Fi fe ve ec Ta as ig ef Go ro re fr re In as Fo acExchange rate R:US$ (av) 1.76 1.68 1.76 1.86 1.94 1.99 M Key to risk rating Relative GDP growth Categories and types of risk Cumulative real GDP growth: Brazil vs rest of the world (%) Overall assessment Unweighted average of the 10 risk scores Growth rates shown as index with 2005 = 100. 2005–2010 are actual; 2011–2015 are EIU forecasts. Security Armed conf lict, violent unrest, organized crime, kidnapping or extortion Data not available for non-OECD countries from 2013–2015. Political stability Disorderly transfer of power, excessive executive authority 180 Government effectiveness Excessive bureaucracy, cronyism, corruption, human rights abuses Developing economies Brazil (Non-OECD) Legal/regulatory Protection of investments, enforcement of contracts, speedy and fair judicial process 160 Macroeconomic Recession, inf lation, currency and interest rate volatility 140 Foreign trade/payments Capital controls, trade restrictions, discriminatory tariffs World Developed economies Financial Availability of local f inancing, liquidity of local markets, bank risk 120 (OECD) Tax policy Tax rates, tax predictability, tax transparency, risk of retroactive taxation Labor market Power of trade unions, frequency of labor unrest, right of free association 100 2005 2007 2009 2011 2013 2015 Infrastructure Quality and reliability of port facilities, air transport, distribution, utilities, Internet 28 Private Company Services Private Company Services 29
  • 17. PwC Partner Carlos Mendonça PwC partner Carlos Mendonça has witnessed f irst hand Brazil’s rapid recovery following the economic crisis. In a conversation with us, he noted that while the strength of the Brazilian marketplace has kept it a top destination for foreign investment, there are also key challenges private companies should keep in mind. What are the key advantages  / The rapid growth of Brazil’s consumer There is also considerable new invest- What top challenges/barriers have opportunities for foreign investors class is just one development that is ment opportunity in the production of you noticed foreign companies in Brazil today? presenting new opportunities for foreign petroleum — specif ically in the “pre-salt” encountering in Brazil? investors. There is also Brazil’s success region off the coast of Brazil, where in winning the bid to host the World Cup several years ago sizable oil f ields were Nowadays, foreign companies are less For oil exploration and other business in 2014 and the Olympic games in 2016. discovered beneath a layer of salt under interested in setting up business here for ventures in Brazil to reach their prof it- Those two global events should accelerate the ocean f loor. Unlike in the past, how- export purposes and more interested ability potential, the country needs much-needed investment in Brazil’s ever, foreign companies that don’t already in selling directly to Brazilians. Among to make the type of large infrastructure infrastructure, including its highways, have pre-existing licenses for oil explora- recently surveyed1 private companies, improvements I’ve mentioned. Today, ports, and railroads. tion and production in Brazil will have two-thirds that do — or are considering ships in the port can wait as long as 15 to to partner with the state-controlled oil doing — business in Brazil say that The state-owned Brazilian National 20 days to unload. This is costly to Brazil’s producer Petrobras. Under new legisla- selling goods and services presents the Development Bank (BNDES), which has economy. The roads, too, are congested tion passed by Congress, Petrobras will best opportunity for them here — above played a critical role in subsidizing and poorly maintained, making the be granted a minimum 30% stake in joint manufacturing and sourcing. long-term f inancing for infrastructure, transport of goods slow and diff icult. ventures with other oil companies that estimates that the required investment We need to put more speed on address- The strong internal demand for goods bid for exploration licenses. Building and could total more than $145 billion over ing these problems. and services has come with the rapid maintaining good relationships with the next three years. BNDES f inancing growth of Brazil’s middle class. From government off icials should help foreign Addressing them requires long-term alone, however, will not be enough. Addi- 2003 to 2008, the number of Brazilians companies navigate the new system. f inancing. At present, sources of capital tional investment must come from the living in extreme poverty was halved, in Brazil are very limited and expensive. private sector. Incentives for such invest- driven in large part by government initia- The state-owned bank BNDES is an excep- ment include tax credits given by Brazil’s tives, including a 100% increase in the tion, offering medium- and long-term Growth and Acceleration Program (PAC) minimum wage. As more Brazilians f ind f inancing at reasonable rates. But gener- to companies that invest in national adequate pay in the formal economy, ally, to leverage an investment, you need infrastructure, with a focus on energy, they are beginning to open bank accounts to seek f inancing abroad. As the Brazilian transportation, and construction. and obtain consumer credit. From 2007 economy continues to grow, it is important to 2009, consumer credit in Brazil grew that local capital markets start to provide 1 Conducted by the Economist Intelligence Unit 28% annually in nominal terms. on behalf of PwC more-diversif ied sources of long-term f inancing for private-sector investments.30 Private Company Services Private Company Services 31
  • 18. Taxes in Brazil are another top challenge. Other challenges that inbound compa- Since the economic crisis, have you To that end, we’re seeing continual They are both high and complex. Out of nies face generally result from cultural noticed a change in the dynamics foreign direct investment in Brazil, 183 economies examined in a joint study differences, which are encountered of doing business in Brazil? including the acquisition of local com- by PwC and the World Bank Group, Brazil anytime you enter a new foreign market. panies by private equity f irms. During ranked highest in the number of hours Often, foreign investors in Brazil nego- the f irst half of 2010, private equity Brazil is stronger than it was before the it takes companies to comply with tax tiate such differences by forming an investors took part in 41% of the deals global crisis began. Within six to eight regulations.2 This is not just a technical alliance with a local company. In many here, particularly transactions involving months, our economy rebounded. For- issue but also a political one. Brazilian cases it is a family-owned business. industry consolidation and small and tunately, Brazilian companies were regulators have been postponing tax Family businesses — which contribute medium-size companies in sectors such already running lean before the crisis reform for more than 10 years. The fed- to half of Brazil’s GDP — tend to have as IT and mining. So, yes, there are started, and so they were in good shape eral government is reluctant to reduce greater f lexibility and quicker decision- challenges, but I’d say that generally the to weather the downturn. Throughout, taxes because those are what fund making procedures than public com- dynamics of doing business in Brazil internal consumer demand remained Brazil’s large social benef its. panies. On the other hand, they may also are good for foreign investors. high, which kept unemployment low. have less-stringent governance controls. The government has, however, recently With 60% of Brazil’s GDP driven by domes- Recently surveyed private companies 3 Carlos Mendonça introduced a system that should decrease tic demand, companies here couldn’t nonetheless say their concern about inad- Leader of Private Company Services at PwC Brazil the lengthiness and complexity of afford to dismiss workers. They needed Tel +55 (11) 3674 3343 equate corporate governance is lower complying with tax regulations. Called them to build cars, TVs, refrigerators. carlos.mendonca@br.pwc.com vis-à-vis Brazil than with respect to other the Public System of Digital Bookkeeping BRIC countries. With a tighter f iscal and monetary policy, (SPED), the new approach eliminates however, Brazil should expect to see paperwork and unif ies the information Foreign partners in Brazilian joint ven- a slowdown over the next year, with GDP required by the federal, state, and munic- tures do, however, need to be aware that growth declining from 9% — which is ipal tax authorities. Although SPED if they have a disagreement with their what it was in the f irst quarter of 2010 —  should make tax compliance easier over Brazilian counterpart, and the dispute to an anticipated 5% in 2011. Other the long term, and therefore less costly, goes to court, the matter can take a very contributing factors include declining its initial adoption is entailing some long time to resolve — upwards of f ive prices for certain Brazilian commodities effort by companies. or seven years, due to the complexity of and an unfavorable exchange rate for Brazil’s judicial system. Most foreign exports. Sustainable growth will result companies are aware of this before com- only with increased productivity and ing here and draft their business contracts higher investment levels. accordingly. Often, though, businesses later discover that they didn’t anticipate the full range of potential scenarios and so end up in court, after all. To reduce the likelihood of such surprises, foreign companies may want to enlist local expertise when drafting contracts. 2 Paying Taxes 2011: The Global Picture, PwC and the World Bank Group 3 Conducted by the Economist Intelligence Unit on behalf of PwC32 Private Company Services Private Company Services 33
  • 19. China India Brazil Annual data 2010 Historical averages 2006 –10 2010–14 Indonesia Population (m) 1,312 Population growth 0.56% Growth /risk forecastChina Japan Mexico GDP growth GDP (US$ bn) 5,697 Real GDP growth 11.18% Size of bubbles shows Russia GDP per head (US$/market rate) 4,340 Real domestic demand growth 11.56% relative size of US Exchange rate (av) Rmb:US$ 6.76 Inflation 2.99% 2010 GDP in US$: Operating risk All country information © 2011 Economist Intelligence Unit. Used with permission.China’s business environment will continue to improveover the next f ive years. The economy will grow at a slower,albeit still robust, pace of 8% per year, powered by invest-ment. Rising prosperity will lead to consumption growth asthe economy becomes increasingly market-oriented. YetChina’s f inancial markets remain immature and its banks areweighed down by bad debt. The political environment isalso an ongoing concern. A bloated and opaque bureaucracyand inconsistent implementation of policies, especially atthe local level, undermine government effectiveness.Analysis developed by the Economist Intelligence Unit (EIU). Private Company Services 35
  • 20. China Opportunities Challenges Developed by EIU Developed by EIU Relative market size / 2010 GDP Business risk ratings Risk category Rating Score* Comments Overall assessment C 46 Improving climate; big social changes and dense bureaucracy pose risks in billion Security risk B 32 Regime exercises tight control over crime and dissent US$ Political stability risk C 55 Momentous socio-economic changes pose a threat to stability Government effectiveness D 79 Bloated and opaque bureaucracy; inconsistent implementation of policies US China Germany Brazil India Russia Mexico Indonesia Legal/regulatory risk C 60 Business law developing fast, but enforcement is poor and courts politicized 14,723 5,697 3,317 2,013 1,600 1,465 998 707 Macroeconomic risk B 25 Extraordinarily rapid economic and consumption growth Foreign trade/payments B 36 Imports are growing, but access to some sectors remains difficult Financial risk B 33 Immature capital markets; massive bank lending poses risks to stability per capita Tax policy risk B 38 Tax rates remain high by international standards in US$ Labor market risk D 61 Shortage of skilled labor and of experienced managers; passive trade unions Infrastructure risk C 47 Speedy improvement, reaching developed world standards in some areas *0–100 / 0 = least risky US China Germany Brazil India Russia Mexico Indonesia 47,560 4,340 39,990 10,420 1,350 10,340 8,930 2,909 Operating risk rating comparison Scale of 0–100 / 100 = lowest risk BRICs average China OECD average Key forecasts 100 80 2010 2011 2012 2013 2014 2015 60Real GDP growth (%) 10.25 9.0 8.7 8.6 8.1 8.0 40Consumer price inflation (av; %) 3.2 5.0 3.6 4.1 4.0 3.8 20Budget balance (% of GDP) -2.2 -1.7 -1.6 -1.4 -0.8 -0.8 0 l y ke r re en ll y ili al es nt to l / ic en de /Current-account balance/GDP 5.5 4.3 3.9 3.1 2.5 2.1 ia ar bo m ra lic rit la ga om ab ic en e tu t t ty s ry ts nc ss ve cu iv m po m La ym ra st olit gu Le uc na on ct rn se O pa n t Se trMoney market interest rate (%) 3.4 4.0 4.2 4.0 4.3 4.1 x P Fi fe ve ec Ta as ig ef Go ro re fr re In as Fo acExchange rate Rmb:US$ (av) 6.76 6.47 6.30 6.08 5.86 5.70 M Key to risk rating Relative GDP growth Categories and types of risk Cumulative real GDP growth: China vs rest of the world (%) Overall assessment Unweighted average of the 10 risk scores Growth rates shown as index with 2005 = 100. 2005–2010 are actual; 2011–2015 are EIU forecasts. Security Armed conf lict, violent unrest, organized crime, kidnapping or extortion Data not available for non-OECD countries from 2013–2015. Political stability Disorderly transfer of power, excessive executive authority 160 Developing economies Government effectiveness Excessive bureaucracy, cronyism, corruption, human rights abuses (Non-OECD) China Legal/regulatory Protection of investments, enforcement of contracts, speedy and fair judicial process 140 Macroeconomic Recession, inf lation, currency and interest rate volatility World Foreign trade/payments Capital controls, trade restrictions, discriminatory tariffs Developed economies 120 (OECD) Financial Availability of local f inancing, liquidity of local markets, bank risk Tax policy Tax rates, tax predictability, tax transparency, risk of retroactive taxation Labor market Power of trade unions, frequency of labor unrest, right of free association 100 2005 2007 2009 2011 2013 2015 Infrastructure Quality and reliability of port facilities, air transport, distribution, utilities, Internet 36 Private Company Services Private Company Services 37
  • 21. PwC partner Humphrey Choi PwC partner Humphrey Choi has watched China’s business environment undergo rapid changes in recent years. In a conversation with us, he described what some of those changes mean for private companies looking to invest in China today. What are the key advantages / Inevitably, the higher wages that are Indeed, more and more, we’re seeing Another trend in recent years is that opportunities for foreign investors turning Chinese workers into consumers foreign private companies go straight Hong Kong Chinese and home-country in China today? are also making it more expensive for to China’s inner provinces and elsewhere personnel are no longer the primary multinationals to manufacture here. Which on the mainland, establishing fully ones running foreign businesses on the is not to say that manufacturers are turn- owned subsidiaries there. This is a depar- mainland. Over the past few decades, Increasingly, China’s market growth is ing away from China. On the contrary, ture from the common practice of f irst Chinese expats who’ve been educated becoming the country’s biggest draw over one-quarter of the surveyed private setting up headquarters in Hong Kong at places like Harvard and Yale have now that Chinese workers are beginning companies with current or contemplated or doing a joint venture. come back to take up the management to afford the goods they once made operations in China regard manufactur- positions in foreign-owned companies. purely for export. Certainly this is what That said, joint ventures are still a fa- ing as their best opportunity here. And the local people are taking on we’re hearing from many private com- vored means of entering the Chinese greater responsibility, too. This is what panies. Of those recently surveyed,1 over China’s extensive manufacturing base market. We continue to see a lot of we call the succession plan. Although half that are doing — or considering has been steadily building since the inbound private companies pursuing certain experience is still lacking, China’s doing — business here cite selling goods economy here began opening up several such arrangements with Chinese private labor pool is quickly catching up. and services as their top opportunity decades ago, spreading from the coastal enterprises. Chinese businesses that in China. regions to China’s second- and third-tier want to expand outside the country and cities further inland. There you can still acquire other companies are especially f ind low-cost labor and inexpensive prop- likely to enter such alliances, particularly erty. Inland China also has vast supplies with businesses from the United States of natural resources, such as iron ore, and Europe. This is a def inite trend. It is which have been drawing the attention of mostly large private companies, however, heavy industries like steel manufacturing. that we’ve seen coming to China, rather than smaller ones. 1 Conducted by the Economist Intelligence Unit on behalf of PwC38 Private Company Services Private Company Services 39
  • 22. What top challenges / barriers have Another top challenge for many foreign Since the economic crisis, have you you noticed foreign companies companies when they f irst arrive here noticed a change in the dynamics encountering in China? is dealing with regulatory issues. We have of doing business in China? one country but maintain two systems. Hong Kong still runs under British rules, Don’t underestimate cultural differences. The global economic situation has had while mainland China is under local They can have a signif icant impact on a big impact on China, making it neces- Chinese law. And within the mainland how you run your business in China. It’s sary to sustain growth through domestic itself, interpretation and implementation not just differences between China and demand. The Chinese consumer has there- of laws can vary among the many minis- other parts of the world that you have fore become very important to China. tries and cities. As China’s business to consider. Foreign companies also need So has the Chinese entrepreneur. environment continues to undergo rapid to be aware of cultural differences transformation, newly issued interpreta- You can see this in new governmental throughout China itself. tions of regulations may become frequent. policies. For instance, banks used to be Each city and local government here has Such changes could have a considerable restricted by certain lending rates but its own way of doing things, with busi- effect on how you do business. Staying are now encouraged to lend in a more ness practices sometimes varying greatly abreast of them and understanding the aggressive manner. One result of this from one place to the next. For instance, vagaries of China’s rules, tax policies, is that Chinese people are able to borrow foreign investors who understand how and legal frameworks are essential to money to start their own businesses. business is done in Shanghai should not being successful here. Tax incentives and lower land costs are assume that they therefore know how among other measures the government Other barriers include government business is done in Beijing. Mingle with is taking to maintain China’s GDP growth. restrictions around certain sectors, such the people, consider the local business as the high-tech industry. There are Another shift is that Chinese businesses practice in each city where you do busi- also restrictions around petroleum and are no longer in the shadow of their ness, but realize that it takes time. certain mineral resources that are foreign counterparts. Several of the Bridging cultural differences requires very important to keeping China’s manu- world’s top dozen companies by market establishing and keeping up relation- facturing base going. It is diff icult for capitalization are from China, including ships with local off icials. We call this foreign companies to set up direct subsid- PetroChina, China Mobile, and the “guanxi.” Cultivate as many of these iaries in these industries, and the gov- Industrial and Commercial Bank of China, relationships as possible, since different ernment might want an ownership stake. which is the world’s largest bank by off icials have different areas of respon- market value. In fact, in PwC’s 2010 sur- Despite these challenges and the risks sibility. The importance of maintaining vey of foreign banks in China, respon- they pose for foreign companies, over a diversif ied portfolio of relationships, dents identif ied Chinese banks as their two-thirds of the private businesses that if you will, is one of the reasons it’s biggest competitors — this for the f irst were surveyed have operations in China advantageous to have local Chinese on time in the f ive years we’ve conducted or are considering establishing them the management team. the study.2 The business landscape is in the next three years. For the majority def initely changing. of those companies, the risk level that China’s business environment poses is 2 Foreign Banks in China, PwC, May 2010 commensurate with the level of return. Humphrey Choi Leader of Middle Market and Private Company Services at PwC China Tel +(852) 2289 1066 humphrey.choi@hk.pwc.com40 Private Company Services Private Company Services 41
  • 23. China India Brazil Annual data 2010 Historical averages 2006 –10 2010–14 Indonesia Population (m) 1,184 Population growth 1.6% Growth /risk forecastIndia Japan Mexico GDP growth GDP (US$ bn) 1,600 Real GDP growth 8.2% Size of bubbles shows Russia GDP per head (US$/market rate) 1,350 Real domestic demand growth 8.5% relative size of US Exchange rate (av) Rs:US$ 45.72 Inflation 8.7% 2010 GDP in US$: Operating risk All country information © 2011 Economist Intelligence Unit. Used with permission.India’s economy, powered mostly by domestic demand, hasgrown rapidly in the last decade and will continue to doso through 2015. The country’s political system is stable andits legal system is relatively impartial, though slow. Never-theless, businesses face problems with corruption, red tape,and poor transport infrastructure. Government authorizationis required to lay off workers in many cases, and no reformsperceived as weakening worker rights are likely to gaintraction. Property disputes are common, as are unclear rulesand obstructive bureaucrats.Analysis developed by the Economist Intelligence Unit (EIU). Private Company Services 43
  • 24. India Opportunities Challenges Developed by EIU Developed by EIU Relative market size / 2010 GDP Business risk ratings Risk category Rating Score* Comments Overall assessment C 53 Pro-market democracy shackled by red tape and tight labor rules in billion Security risk C 46 Threats include Kashmir militants, disputes with Pakistan, and terrorism US$ Political stability risk B 25 Established, stable democracy with popular government Government effectiveness D 68 Red tape is significant and corruption a major problem US China Germany Brazil India Russia Mexico Indonesia Legal/regulatory risk C 60 Legal system is relatively impartial, but suffers from lengthy delays 14,723 5,697 3,317 2,013 1,600 1,465 998 707 Macroeconomic risk B 35 Rapid growth; the large fiscal deficit and high rate of inflation pose risks Foreign trade/payments C 54 Tariff system being rationalized; high import duties remain in some sectors Financial risk C 46 High inflation threatens the rupee Tax policy risk E 81 Complex tax system; reform efforts are underway per capita in US$ Labor market risk C 57 Labor market is highly regulated Infrastructure risk C 56 Poor transport infrastructure causes delays and deters investment *0–100 / 0 = least risky US China Germany Brazil India Russia Mexico Indonesia 47,560 4,340 39,990 10,420 1,350 10,340 8,930 2,909 Operating risk rating comparison Scale of 0–100 / 100 = lowest risk BRICs average India OECD average Key forecasts 100 80 2010 2011 2012 2013 2014 2015 60Real GDP growth (%) 9.1 9.0 8.7 8.6 8.7 8.7 40Consumer price inflation (av; %) 11.9 7.0 5.0 5.2 5.9 5.6 20Budget balance (% of GDP) -5.1 -5.0 -4.7 -4.0 -3.9 -3.4 0 l y ke r re en ll y ili al es nt to l / ic en de /Current-account balance/GDP -2.7 -2.7 -2.3 -2.0 -1.4 -1.2 ia ar bo m ra lic rit la ga om ab ic en e tu t t ty s ry ts nc ss ve cu iv m po m La ym ra st olit gu Le uc na on ct rn se O pa n t Se trMoney market interest rate (%) 6.2 6.7 6.7 6.8 7.2 7.2 x P Fi fe ve ec Ta as ig ef Go ro re fr re In as Fo acExchange rate Rs:US$ (av) 45.72 45.13 44.45 43.45 42.70 42.0 M Key to risk rating Relative GDP growth Categories and types of risk Cumulative real GDP growth: India vs rest of the world (%) Overall assessment Unweighted average of the 10 risk scores Growth rates shown as index with 2005 = 100. 2005–2010 are actual; 2011–2015 are EIU forecasts. Security Armed conf lict, violent unrest, organized crime, kidnapping or extortion Data not available for non-OECD countries from 2013–2015. Political stability Disorderly transfer of power, excessive executive authority 180 Developing economies India Government effectiveness Excessive bureaucracy, cronyism, corruption, human rights abuses (Non-OECD) Legal/regulatory Protection of investments, enforcement of contracts, speedy and fair judicial process 160 Macroeconomic Recession, inf lation, currency and interest rate volatility 140 Foreign trade/payments Capital controls, trade restrictions, discriminatory tariffs World Developed economies Financial Availability of local f inancing, liquidity of local markets, bank risk 120 (OECD) Tax policy Tax rates, tax predictability, tax transparency, risk of retroactive taxation Labor market Power of trade unions, frequency of labor unrest, right of free association 100 2005 2007 2009 2011 2013 2015 Infrastructure Quality and reliability of port facilities, air transport, distribution, utilities, Internet 44 Private Company Services Private Company Services 45
  • 25. PwC Partner Rama Krishna PwC partner Rama Krishna shared with us his insights about India’s large and highly varied marketplace, explaining how those two qualities  — size and diversity — present opportunities and challenges in equal measure for private companies seeking to invest there. What are the key advantages / One-quarter of private companies say The market potential of rural India is For the most part, foreign companies can opportunities for foreign investors that selling high-margin goods and likely to keep growing now that people set up business in India quite easily. in India today? services, in particular, is where the best in those regions are f inding better-paying Restrictions apply to only specif ic areas, opportunities lie for them in India. work in small and medium-scale indus- such as banking, real estate, wireless This ref lects the rise in personal income tries, such as tourism, matchbox-making, communications, nuclear power, f ire- The greatest attraction for foreign here and people’s increasing ability and handicrafts, whereas a decade or so arms, and the mining of certain minerals. investors who come here these days to spend earnings on things beyond the ago rural citizens depended primarily on To operate in those sectors, a foreign is India’s market potential. Among basics. Cars are one such item. Mainly small-scale agriculture for their income. company must obtain formal approval private companies recently surveyed,1 it is in the urban centers where you see Women are becoming actively involved in from the federal government. In most 52% of those that do — or are con- a growing middle class capable of these industries as well, contributing to other cases, companies needn’t obtain sidering doing — business in India say making this type of purchase. But India’s the rise in household incomes. such approval. that selling goods and services is the rural population is seeing a rise in best opportunity for them here, as com- Because of the Indian market’s size and The preferred way of getting started income as well. This is signif icant. Nearly pared with 20% of respondents who location, the country is also becoming here is for a foreign company to open three-quarters of the country’s popula- cited manufacturing and 17% who a key entry point in the region. In our a liaison off ice, study the market, tion resides in rural areas. There you cited sourcing. experience, companies will often come understand the local practices, and then have what remains a largely untapped here f irst, penetrate and consolidate start to generate some business for the consumer base. the Indian market, and then move into parent company. Once it f inds a business other Asian markets. We have seen model that it’s comfortable with, the 1 Conducted by the Economist Intelligence Unit on behalf of PwC this, for example, with the automobile- entity will generally go ahead and incor- components industry. porate as a private company — that is to say, as a subsidiary of the parent company.46 Private Company Services Private Company Services 47
  • 26. For some companies, the next step may What top challenges / barriers have Another obstacle is that a signif icant Foreign companies are being engaged in be to enlist local partners. Doing so you noticed foreign companies portion of the rural population does not deliberations about these matters — as can make it easier for foreign businesses encountering in India? have access to banking facilities, though well as being looked to as a potential part to pursue certain investment opportuni- banks have slowly begun making inroads. of the solution. We advise our clients ties, such as projects for improving This hasn’t, however, held back the tele- to be proactive in this respect. One such The Indian market is highly diverse. India’s infrastructure, much of which is communications sector, which has rapid- client is a ceramic-tile company, which Inbound companies sometimes under- government-regulated and therefore ly achieved high penetration of the rural has committed roughly 1.5% of its prof its estimate this. For instance, if you hard to invest in without a local partner. market. In India, talking time on a mobile to community projects near its factory, test-market in one region, you cannot phone can cost less than one cent per including the development of drinking- With a local partner, there are ample automatically extrapolate your f indings minute, and so usage does not depend as water and road facilities — a gesture opportunities in this area — roads, to other regions. Habits, tastes, cultural much on easy bank access as many other that has engendered good relations with railroads, ports, and power facilities preferences, languages, and other regional forms of consumption do. both the local governmental agencies all need large amounts of investment, traits vary widely across India. You need and the broader community. although there may be restrictions to be f lexible in introducing a bit of differ- Other industries are trying to determine around ports, due to national security. entiation to your products and services, how they, too, can reach India’s rural Water supply is another big infrastruc- and to your marketing strategy, depending population. For instance, quite a few Since the economic crisis, have you ture concern. India will face a signif icant on a region’s characteristics. agricultural-input companies are devel- noticed a change in the dynamics scarcity of water unless large, continual oping retail outlets in rural areas and, of doing business in India? You also need to be patient. Not only investments are made. Partnerships in doing so, are teaming up with banks. are there wide-ranging cultural varia- between foreign investors and local orga- This arrangement allows farmers to tions, but there are also many different The level of foreign direct investment nizations could be a key way to address purchase seeds, fertilizer, and other agri- regulations across India’s regions and in India dipped in late 2008, but a buffer this problem. cultural inputs on the spot by having administrative districts. Although India’s to that was the large investment made their accounts debited directly. Such com- We are also seeing a fair number of joint regulatory system and tax policies have here by the telecommunications sector panies are also developing call centers ventures between foreign companies improved a good deal in the past two in 2007 and early 2008. In 2009, FDI to f ield all farm-related queries. Slowly and Indian businesses in the telecommu- decades, complexities remain. These take in India was over $34 billion. Since then, these outlets are starting to serve as chan- nications sector, with a lot of big players time to understand. however, the level has dropped to $24 bil- nels for other consumer goods as well. coming here to tap the Indian market. lion. This is nonetheless much higher Maintaining good contacts with govern- Recent revelations about corrupt licens- Initiatives like these — which benef it not than FDI was as recently as 2004, when ment off icials in the region where you do ing practices in this sector may put some only the companies behind them, but also the level was just $6 billion. Meanwhile, business can help you work through these foreign investors off until the necessary the surrounding rural communities — the Indian economy has shown it is capa- challenges. Such relationships are not reforms are made. In the meantime, are increasingly becoming an imperative ble of growing on its own. This is not established overnight. Companies should market demand here for telecommunica- for multinational companies that operate to say it has decoupled from the global therefore come here with a long-term tions is unlikely to ebb. in India. Indeed, nowadays, the moment market, but increasingly India’s home strategy. Those that do tend to be more you say you are part of a global orga- market is able to support domestic growth. successful than businesses that come to nization, India’s societal expectations India looking for short-term gains. increase. This is a departure from the Rama Krishna For companies looking to tap India’s past. Ten years ago, there wasn’t much Executive Director of Advisory rural market, a key barrier is poor focus on community issues. Since then, Private Company Services at PwC India infrastructure, with many villages being NGOs, environmental groups, and other Tel +(91) (40) 6624 6666 rama.krishna.p@in.pwc.com unreachable by motor vehicle. The Indian social activists have established a pres- government says that $500 billion will ence in India, and so now the develop- need to be invested in roads and other ment concerns of local communities are infrastructure over the next few years. openly discussed.48 Private Company Services Private Company Services 49
  • 27. China India Brazil Annual data 2010 Historical averages 2006 –10 2010–14 Indonesia Population (m) 242.9 Population growth 1.2% Growth /risk forecastIndonesia Japan Mexico GDP growth GDP (US$ bn) 706.7 Real GDP growth 5.7% Size of bubbles shows Russia GDP per head (US$/market rate) 2,908.7 Real domestic demand growth 5.2% relative size of US Exchange rate (av) Rp:US$ 9,088.3 Inflation 7.8% 2010 GDP in US$: Operating risk All country information © 2011 Economist Intelligence Unit. Used with permission.Indonesia has experienced 11 consecutive years of positiveeconomic growth and should continue to grow quickly overthe next f ive years. Strong domestic demand has encouragedcompanies to revive projects shelved during the globaleconomic crisis. Yet several categories of operating risksare high. The danger of terrorist attacks remains alive.Corruption is widespread at all levels of government. Andalthough the government has prioritized infrastructuredevelopment, port and power facilities remain inadequatedue to insuff icient funding.Analysis developed by the Economist Intelligence Unit (EIU). Private Company Services 51
  • 28. Indonesia Opportunities Challenges Developed by EIU Developed by EIU Relative market size / 2010 GDP Business risk ratings Risk category Rating Score* Comments Overall assessment C 55 Persistent and rapid growth; issues with contract enforcement and corruption in billion Security risk C 57 Risk of ethnic and religious conflicts persists, as do terrorist threats US$ Political stability risk B 35 Young but stable and vibrant democracy Government effectiveness D 75 Widespread corruption and lack of accountability for public officials US China Germany Brazil India Russia Mexico Indonesia Legal/regulatory risk D 72 Erratic contract enforcement; some discrimination against foreign investors 14,723 5,697 3,317 2,013 1,600 1,465 998 707 Macroeconomic risk B 35 Sustained strong growth and volatile inflation Foreign trade/payments C 43 Open to foreign trade and investment, but nationalist sentiment is strong Financial risk C 58 Banking sector increasingly robust; illiquid equity market per capita Tax policy risk C 44 Moderate tax burden; many local taxes and levies are being rescinded in US$ Labor market risk D 61 Inflexible; skill shortages a problem Infrastructure risk D 72 Infrastructure is inadequate; budget constraints limit investment *0–100 / 0 = least risky US China Germany Brazil India Russia Mexico Indonesia 47,560 4,340 39,990 10,420 1,350 10,340 8,930 2,909 Operating risk rating comparison Scale of 0–100 / 100 = lowest risk BRICs average Indonesia OECD average Key forecasts 100 80 2010 2011 2012 2013 2014 2015 60Real GDP growth (%) 6.1 6.2 6.4 6.3 6.3 6.4 40Consumer price inflation (av; %) 5.1 7.3 6.1 6.2 6.3 6.4 20Budget balance (% of GDP) -0.8 -1.3 -1.1 -1.0 -0.8 -0.3 0 l y ke r re en ll y ili al es nt to l / ic en de /Current-account balance/GDP 1.0 1.3 1.1 0.8 0.7 0.7 ia ar bo m ra lic rit la ga om ab ic en e tu t t ty s ry ts nc ss ve cu iv m po m La ym ra st olit gu Le uc na on ct rn se O pa n t Se trMoney market interest rate (%) 6.1 7.3 8.3 8.5 8.5 8.5 x P Fi fe ve ec Ta as ig ef Go ro re fr re In as Fo acExchange rate Rp:US$ (av) 9,088.3 8,927.3 8,965.4 9,058.6 9,133.0 9,213.3 M Key to risk rating Relative GDP growth Categories and types of risk Cumulative real GDP growth: Indonesia vs rest of the world (%) Overall assessment Unweighted average of the 10 risk scores Growth rates shown as index with 2005 = 100. 2005–2010 are actual; 2011–2015 are EIU forecasts. Security Armed conf lict, violent unrest, organized crime, kidnapping or extortion Data not available for non-OECD countries from 2013–2015. Political stability Disorderly transfer of power, excessive executive authority 260 Indonesia Government effectiveness Excessive bureaucracy, cronyism, corruption, human rights abuses Legal/regulatory Protection of investments, enforcement of contracts, speedy and fair judicial process 220 Macroeconomic Recession, inf lation, currency and interest rate volatility 180 Developing economies Foreign trade/payments Capital controls, trade restrictions, discriminatory tariffs (Non-OECD) Financial Availability of local f inancing, liquidity of local markets, bank risk World 140 Tax policy Tax rates, tax predictability, tax transparency, risk of retroactive taxation Developed economies (OECD) Labor market Power of trade unions, frequency of labor unrest, right of free association 100 2005 2007 2009 2011 2013 2015 Infrastructure Quality and reliability of port facilities, air transport, distribution, utilities, Internet 52 Private Company Services Private Company Services 53
  • 29. PwC partner Ray Headifen PwC partner Ray Headifen has spent nearly a decade in Indonesia, during which he’s seen that country become an increasingly attractive investment destination. He recently took time out to discuss with us the opportunities that are drawing private companies to Indonesia and the challenges they may face once they arrive. What are the key advantages / Such consumption looks likely to con- Sourcing may begin to see an uptick In general, investment from neighboring opportunities for foreign investors tinue. The government aims to cut the among foreign investors, particularly Asian countries is what we’re seeing in Indonesia today? country’s poverty rate by one-third over where Indonesia’s natural resources at the moment — more so than invest- the next several years, as well as create are concerned. With growing interest in ment from the United States or Europe. 10.7 million jobs in that period. If those biodiesel as a fuel alternative, Indone- Possibly that’s because Asian investors As the fourth most populous country in goals are met, a growing number of sia’s palm oil plantations are becoming tend to have a greater risk appetite than the world, Indonesia is becoming an Indonesians will have money to spend. big business. We’ve also witnessed Western multinationals. They are used increasingly attractive market for multi- It’s no surprise, then, that among private considerable interest in coal mining. to operating in the region, and so they national companies. The consumer base companies recently surveyed,1 56% of Until recently, mining by foreigners expect the unexpected. Expecting the here is growing rapidly. I’ve witnessed those that do — or are considering was restricted here. A change in the law, unexpected — or, to put it another way, this f irst hand during my nine years doing — business in Indonesia say that however, now allows foreign direct knowing what you don’t know — is in Jakarta. The large increase in motor selling goods and services is their best investment in this area, and so there’s a helpful psychology to have when you vehicles on the road during that time investment opportunity here. Manufac- been increased attention, particularly enter the Indonesian market. is one example of the surge in consumer turing came in second, at 28%, and from Indian and Chinese investors. spending. So is the ever-expanding Japanese companies are among the sourcing was cited by 12% of respondents. mobile phone market. Asian investors pursuing opportunities in Indonesia. They’ve shown a particular 1 Conducted by the Economist Intelligence Unit on behalf of PwC interest in teaming with the Indonesian government to build new power plants, which the country greatly needs. Indone- sia’s electricity demand is growing at roughly 8% a year.54 Private Company Services Private Company Services 55
  • 30. Other infrastructure projects must The need to work through grey areas like Foreign companies should also bear in Since the economic crisis, have you receive substantial investment as well this is common in Indonesia. It’s often mind Indonesia’s labor laws, which tend noticed a change in the dynamics if Indonesia is going to continue to a result of the natural tension between to favor workers. For instance, if after of doing business in Indonesia? grow and become a major global player. centrally issued regulations and local 10 years of service a worker is deemed The government has announced that regulations, with various ministries or redundant and laid off, the employer Indonesia didn’t suffer too badly in the $20 billion needs to be invested in Indo- governmental branches issuing con- could end up paying the person two years global crisis — probably because of the nesia’s ports alone. Indonesia’s roads, f licting guidelines. Determining which of compensation. Therefore, labor can shakeout in 1997 and 1998. The country airports, railways, and water supply also of the conf licting regulations applies be a sting in the tail for some foreign in- did a lot of bank restructurings back require signif icant improvement, pre- to a company’s particular case can take vestors. Meanwhile, the country’s mini- then, which spared it the need to take senting key investment opportunities for up to a few years. mum wage continues to rise. That said, such measures in this latest crisis. foreign companies. Indonesia’s workforce is still quite com- Successfully sorting through these com- Despite a drop-off in foreign investment petitive cost-wise. plexities requires maintaining good during the initial downturn, the under- relationships with government off icials It should also be acknowledged that lying economy here remained relatively What top challenges / barriers in the regions where you operate. foreign investors are generally cautious strong. The government has been quite have you noticed foreign companies However, government posts can change about Indonesia because of certain prudent in its economic policies, running encountering in Indonesia? quite frequently, so it’s important that misconceptions out there. For example, a low budget def icit, around 1% — the you don’t rely on just one or two key I don’t think the security risk is as dire legal mandate is 3%. It’s important to be f lexible if you are relationships. Companies that recognize as it’s been made out. I’ve been here quite The country’s economy grew roughly investing in Indonesia. Regulations, for this reality going into Indonesia are some time, and I don’t feel intimidated 6% in 2010. Indeed, by the f irst quarter, instance, often change, are unclear, or less likely to grow frustrated when they working here from a security perspective. foreign direct investment had already conf lict with one another, so companies hit regulatory bumps in the road or Overall it’s pretty stable, and not just risen 41% from a year earlier, coming in need to keep on their toes. encounter other snags. with respect to security — Indonesia is at a total of $12.8 billion for 2010 overall. politically stable as well, despite being Take, for example, the new mining law Another challenge for foreign compa- Indonesia’s Chamber of Commerce and a still-young democracy. That political that Indonesia introduced in 2009. Under nies can be Indonesia’s tax-audit environ- Industry forecasts that the economy will stability may be a factor in Indonesia’s the new law, foreign investors in mining ment, which is considered relatively do even better in 2011 if key infrastructure improved ranking on Transparency Inter- operations must divest 20% of their shares tough. Tax-audit disputes often end up improvements are made — a prediction national’s index of perceived public- to Indonesian investors within f ive years in Indonesia’s tax court. Once there, echoed by the US Ambassador to Indone- sector corruption around the globe. The after operations commence. But this companies can f ind themselves on a bit sia. The country’s central bank estimates country’s ranking has moved favorably requirement hasn’t been understood very of a rollercoaster ride, with disputes total FDI for 2011 at $14.4 billion. So you by 33 points over the past few years.2 well. If a foreign company owns, say, potentially taking up to three years to could say that, all in all, the dynamics 80% of a mining operation, and the other resolve. If all your affairs are in order, So yes, there are challenges, but what for investing in Indonesia have remained 20% is owned by Indonesians, does that though, you should have nothing to fear. I’ve seen time and again is that compa- good despite the economic crisis and mean the foreign company has to divest Taxpayers typically get a fair hearing nies who come here with the “knowing are continually improving. 20% of its 80% ownership interest? Or in the tax court. what you don’t know” principle in mind would the requirement apply only in the tend to fare better than investors who 2 Transparency International Corruption Perceptions Index, 2007 through 2010 case of full ownership? At present, the think they can just set up business and answer is unclear. Investors are nonethe- move rapidly forward. If you enter In- less looking to set up structures to accom- donesia with your eyes open, show Ray Headifen modate the potential divestment while f lexibility in dealing with issues, and Tax Partner at PwC Indonesia continuing to seek guidance in this matter. are patient about achieving results, you Tel +(62) 21 521 2901 should do reasonably well. ray.headifen@id.pwc.com56 Private Company Services Private Company Services 57
  • 31. China India Brazil Annual data 2010 Historical averages 2006 –10 2010–14 Indonesia Population (m) 112.5 Population growth 1.1% Growth /risk forecastMexico Japan Mexico GDP growth GDP (US$ bn) 998.3 Real GDP growth 1.7% Size of bubbles shows Russia GDP per head (US$/market rate) 8,880 Real domestic demand growth 1.8% relative size of US Exchange rate (av) Ps:US$ 12.6 Inflation 4.4% 2010 GDP in US$: Operating risk All country information © 2011 Economist Intelligence Unit. Used with permission.Mexico is a stable, pro-market democracy that presentsa moderate level of operating risk for foreign businesses. Itsinternal market offers major opportunities, and its role asa low-cost manufacturer for the US market will grow. At thesame time, Mexico’s overdependence on the US economyhas held back its growth relative to its peers. Uncertainty hasbeen compounded by a steady deterioration of the securitysituation, which undermines business conf idence. Skilledlabor shortages, red tape, and a burdensome tax system alsoweigh on the business environment.Analysis developed by the Economist Intelligence Unit (EIU). Private Company Services 59
  • 32. Mexico Opportunities Challenges Developed by EIU Developed by EIU Relative market size / 2010 GDP Business risk ratings Risk category Rating Score* Comments Overall assessment C 44 Stable, pro-market democracy; problems with government effectiveness in billion Security risk D 64 Violent crime is widespread, though perception may be worse than reality US$ Political stability risk B 40 Political system is stable, but government’s position is weak Government effectiveness C 54 Shift to more parliamentary system has exposed institutional weakness US China Germany Brazil India Russia Mexico Indonesia Legal/regulatory risk B 40 Vested interests thwart enforcement of competition policy 14,723 5,697 3,317 2,013 1,600 1,465 998 707 Macroeconomic risk C 45 Return to growth in 2010; dependence on US market a concern Foreign trade/payments B 25 Tariff and non-tariff barriers will continue to fall Financial risk C 42 Shallow financial markets, volatile exchange rate Tax policy risk B 25 Widespread tax evasion; large companies disproportionately burdened per capita in US$ Labor market risk D 61 Widespread skills shortages and regulatory rigidities Infrastructure risk C 41 Infrastructure is in need of fresh investment *0–100 / 0 = least risky US China Germany Brazil India Russia Mexico Indonesia 47,560 4,340 39,990 10,420 1,350 10,340 8,930 2,909 Operating risk rating comparison Scale of 0–100 / 100 = lowest risk BRICs average Mexico OECD average Key forecasts 100 80 2010 2011 2012 2013 2014 2015 60Real GDP growth (%) 5.0 3.5 3.3 3.7 3.7 3.5 40Consumer price inflation (av; %) 4.1 4.0 3.6 3.6 3.4 3.5 20Budget balance (% of GDP) -2.6 -2.2 -1.1 0.0 0.0 0.0 0 l y ke r re en ll y ili al es nt to l / ic en de /Current-account balance/GDP -0.9 -1.5 -1.9 -2.2 -2.9 -3.3 ia ar bo m ra lic rit la ga om ab ic en e tu t t ty s ry ts nc ss ve cu iv m po m La ym ra st olit gu Le uc na on ct rn se O pa n t Se trMoney market interest rate (%) 4.5 4.5 5.8 6.0 6.8 7.0 x P Fi fe ve ec Ta as ig ef Go ro re fr re In as Fo acExchange rate Ps:US$ (av) 12.6 12.3 12.4 12.6 13.3 14.1 M Key to risk rating Relative GDP growth Categories and types of risk Cumulative real GDP growth: Mexico vs rest of the world (%) Overall assessment Unweighted average of the 10 risk scores Growth rates shown as index with 2005 = 100. 2005–2010 are actual; 2011–2015 are EIU forecasts. Security Armed conf lict, violent unrest, organized crime, kidnapping or extortion Data not available for non-OECD countries from 2013–2015. Political stability Disorderly transfer of power, excessive executive authority 160 Developing economies Government effectiveness Excessive bureaucracy, cronyism, corruption, human rights abuses (Non-OECD) Legal/regulatory Protection of investments, enforcement of contracts, speedy and fair judicial process Mexico 140 Macroeconomic Recession, inf lation, currency and interest rate volatility World Developed economies Foreign trade/payments Capital controls, trade restrictions, discriminatory tariffs 120 (OECD) Financial Availability of local f inancing, liquidity of local markets, bank risk Tax policy Tax rates, tax predictability, tax transparency, risk of retroactive taxation Labor market Power of trade unions, frequency of labor unrest, right of free association 100 2005 2007 2009 2011 2013 2015 Infrastructure Quality and reliability of port facilities, air transport, distribution, utilities, Internet 60 Private Company Services Private Company Services 61
  • 33. PwC Partner Abelardo Macotela PwC partner Abelardo Macotela talked to us about the risks and opportunities that private companies face when doing business in his country. Here’s what he had to say regarding the top considerations that foreign businesses should keep in mind when coming to Mexico. What are the key advantages / These are among the reasons that many Our proximity also helps them control An even greater draw than Mexico’s opportunities for foreign investors companies consider Mexico a good place their shipping costs. This keeps Mexico manufacturing capacity is its market in Mexico today? to set up manufacturing activities. Indeed, competitive with manufacturing hubs potential, according to the private 31% of recently surveyed1 private compa- like China, where labor expenses may companies surveyed. Two-thirds of them nies that do — or are considering doing — still be lower than ours in some cases that do business in this country or are Mexico’s economy is one that foreign business in Mexico say that manufacturing but the cost of transporting goods to considering it say that selling goods and businesses can enter relatively easily. offers the best business opportunities countries in the Western hemisphere is services presents the best opportunity Ease of entry is due, in part, to Mexico’s for them in Mexico, which is slightly considerably higher. Once here, multi- for them in Mexico. Which isn’t surprising numerous free trade treaties, which more than the percentage of companies national companies can benef it not only when you consider that Mexico is Latin grant preferential access to key trading making the same claim about China.2 from the narrowing gap between Mexi- America’s second biggest economy. We partners, including North America This assessment of Mexico tends to be can wages and those of China and other gained over 730,000 jobs in 2010, with and the European Union. Mexico has especially prevalent among companies low-cost manufacturing bases, but also the average salary rising from what it was also been streamlining its approval operating in the United States and Latin from Mexico’s pool of qualif ied execu- a year earlier. As Mexico’s middle class procedures. An entrepreneur can com- America, as our proximity allows those tives, a number of whom are Ivy League- grows, so does its consumption. plete the necessary procedures within businesses to receive just-in-time deliver- educated — a fact that foreign investors just 13 days. It takes longer to obtain ies from their Mexican suppliers. That, are often unaware of before coming here. a construction permit — 138 days —  in turn, helps them better manage their but that is faster than in many other inventory levels and expenses. emerging markets. 1 Conducted by the Economist Intelligence Unit on behalf of PwC 2 Among those companies doing or considering doing business in China62 Private Company Services Private Company Services 63
  • 34. What top challenges / barriers have The government — which has signif i- Since the economic crisis, have you For 2010 overall, FDI was $19 billion, you noticed foreign companies cantly reduced the number of required noticed a change in the dynamics with FDI for 2011 estimated at between encountering in Mexico? tax payments in recent years — says of doing business in Mexico? $18 billion and $20 billion.4 Meanwhile, that in 2011 it will start to apply just one Mexico’s ranking on the Foreign Direct of the two corporate taxes, eliminating Investment Conf idence Index rose to 8 in A key challenge for companies doing In 2009 there was a signif icant slowdown the other. It is also trying to decide, 2010 (up from 19 in 2009), putting it business in this country is the f luidity of business in Mexico. That year we saw in conjunction with Mexico’s congress, above countries such as the UK, Canada, of Mexican tax laws. A company that only $14.4 billion in foreign direct invest- whether the value-added tax should be and Russia5 — this despite Mexico’s thoroughly studies Mexico’s tax code ment, down 51% from the previous extended to all sales transactions — or, heavy reliance on the fortunes of the US before setting up business here may year. Much of the decline was due to the alternatively, whether the government economy, which is recovering at a slow discover that rules have changed by the economic downturn in the United States, should simply raise the tax rate. rate. Our many free trade agreements time it arrives. which is Mexico’s largest source of for- with fast-growing economies such as Chi- These potential measures could reduce eign direct investment. Other contributing One such change in recent years has been na, Turkey, South Korea, and Indonesia the time it takes to comply with tax regu- factors may have been foreign investors’ the restructuring of the so-called f lat tax, may help reduce that reliance. lations and, in turn, help to prevent late concern about security in certain Mexican in 2008. This means that two corporate payment. This is important for companies, provinces, which receives a great deal of taxes — an income tax and a f lat tax — 3 To learn about Mexico’s tax-reform efforts, since the Mexican tax authority’s f irst attention in the press, and the challenges see Paying Taxes 2010: The Global Picture, coexist in Mexico, with companies paying question of a business tends to be, “Did posed by frequent changes in tax laws. PwC and the World Bank Group. the higher of the two. The tax calculations you f ile your return on time?” If the 4 American Chamber of Commerce of Mexico. are quite complex and time-consuming, There is nonetheless good reason to business answers no, the tax authority 5 The A.T. Kearney 2010 FDI Confidence Index ranks particularly as both tax amounts must believe that Mexico’s economy will the top 25 destinations for foreign direct investment. may say that none of the company’s be determined. The f lat tax, which has improve as global conditions get better disbursements can be deducted — a con- to be determined on a cash basis, can be and the Mexican government works sequence that’s in addition to paying Abelardo Macotela especially challenging to calculate. on advancing key projects, including the a late f ine. Leader of Middle Market and Companies new to Mexico should take reduction of tax-related red tape.3 Private Company Services at PwC Mexico note of this and plan accordingly, making Newly arrived companies also need to Indeed, moderate recovery was already Tel +52 (0) 55 5263 6090 sure they have suff icient expertise on have a basic understanding of Mexico’s evident within the f irst half of 2010, abelardo.macotela@mx.pwc.com hand to make the calculations in a timely legal system. Take, for instance, the with foreign direct investment in Mexico manner. Using local tax advisors is courts’ handling of labor disputes. Judges increasing 28% over what it had been generally advisable. generally favor employees in those a year earlier. disputes. While in some countries it might be permissible to dismiss an employee for being unproductive or aggressive, those are insuff icient grounds for laying off a worker in Mexico. Doing so can result in heavy penalties for employers. One way an inbound company may avoid labor disputes is to partner with a local business, which can help the company f ind workers who are well-matched to its operational needs and long-term plans.64 Private Company Services Private Company Services 65
  • 35. AcknowledgementsA core team at PwC worked diligently with the EIU to produce this publication. We’d like to acknowledgethe contributions of Cristina Ampil, Cecily Dixon, Amy O’Brien, Eric Parnes, Dean Pontius,Deepali Sussman, Tenaya Taylor, and Reena Vadehra.Moving beyond tomorrow’s uncertainty and growing your business matters to you, and to us. Experience whatit is like to work with professionals dedicated to serving private companies and their owners. Working withyou on both day-to-day and more-complex issues such as compliance, controls, cash f low, expansion, succession,and personal f inancial matters — this is PwC’s Private Company Services.You talk, we listen and share insight. We are proud to serve as advisors to more than 60% of America’s LargestPrivate Companies,1 collaborating to help you achieve long-term success.Experience the difference. Visit us online at pwc.com/us/pcs, email us at pcs@us.pwc.com, or call us at800-844-4PCS to start the conversation.1 2010 Forbes America’s Largest Private Companies List
  • 36. www.pwc.com/us/pcsTo have a deeper conversation abouthow opportunities and challengesin the BRICs and beyond may affectyour business, please contact:Rich StovskyUS Private Company Services leaderTel (216) 875 3111richard.p.stovsky@us.pwc.comDean PontiusInternational Tax Services partnerTel (216) 875 3514dean.c.pontius@us.pwc.comAmy O’BrienUS Private Company Services marketing directorTel (312) 298 2878amy.w.obrien@us.pwc.com© 2011 PwC. All rights reserved. “PwC” and “PwC US” refer to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member firmof PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. This document is for general information purposes only,and should not be used as a substitute for consultation with professional advisors.