Emerging Markets Insights

Saudi Arabia is identified by most of Frontier Strategy Group‘s clients as their number one market in the Middle East and North Africa (MENA). Foreign investment opportunities abound as the government aggressively diversifies its oil economy by executing on plans to spend more than US$300 billion on education, healthcare, IT infrastructure, and other non-oil sectors.

At the same time, doing business in Saudi Arabia can be difficult due to operational challenges. The introduction of new and stringent labor regulations, which could begin to affect MNCs as early as December 2011, is the latest example. The new law, known as Nitaqat, seeks to bolster Saudi employment in the private sector by imposing limits on the number of foreign workers that companies can maintain. In response, some companies are considering relocating operations or shifting strategic focus in MENA. FSG advises clients that such a shift would not be wise, as it would significantly weaken any regional investment strategy.

The kingdom’s economy makes up nearly 40% of regional GDP and high public spending on the local population and government projects ensures opportunities across sectors. Any company eschewing this opportunity will not be able to make up for the losses incurred.

The Saudis are unlikely to back down

The latest iteration of the Saudization program introduces the most comprehensive measures to achieve higher employment yet. The numbers explain why: more than 60% of Saudi Arabia’s population is under the age of 24, and youth unemployment rates are upwards of 25%. In order to keep up with demographics, the economy must create 400,000 new jobs every year. Increasing private sector employment would ease pressure on the public sector, which cannot carry the full burden of job creation in the long-term. Currently, 90% of the private sector’s workforce is composed of expatriates. The government is likely willing to take a hit to FDI to accomplish its goal, which it believes could play a large role in staving off domestic unrest and supporting its young population in a sustainable way.

Christopher Johnson, who is managing attorney at Sharif law office in Riyadh, comments that, “Saudi Arabia sees the labor issue as an existential one, and crucial to flowing with rather than against the ‘Arab Spring‘. There are also strong pressures from the Majlis al-Shura, the king’s advisory body, to limit foreign investment, on the theory that many of the services currently provided by foreign companies should be reserved for Saudis.”

What MNCs need to know about Nitaqat

Nitaqat updates quotas for the percentage of a company’s workforce that must be composed of locals. It designates non-compliant companies as red or yellow, and compliant and exceptional companies as green or blue. Companies finding themselves in the yellow or red categories could face a host of restrictions, such as limitations on issuing or renewing visas for expatriate workers. On the other hand, compliant companies will benefit from an expedited hiring process. For example, there will be fewer restrictions on hiring away stand-out workers from other major players. Nitaqat replaces the blanket 30% quota across industries that failed to shift the composition of the workforce significantly.

The new labor plan varies in application by company size and industry. For example, while a manufacturing company only needs to employ 15% Saudis to avoid penalties, oil and gas sector players must employ at least 45% to meet the same threshold. Zahid Hussain, head of OD for an Al-Rajhi Group Company based in Jeddah, says that some industries will be impacted less than others. “Medicine and pharmaceutical, aviation, education, fashion, media, advertising, marketing, will be less affected compared to automobile, telecom, IT, and HR as the former already have a large chunk of locals on the job.”

MNCs must adapt to the new labor regulations

While Nitaqat will pose new challenges, an informed executive can take the right steps to successfully navigate the shifting labor landscape and capitalize on new opportunities as a result. Even though private sector salaries will rise to compete with public sector wages, Zahid Hussain points out that the new regulations will save companies money in other areas such as visas, travel, and relocation.

Matthew Lewis, Director of the Middle East at executive search firm Boyden advises foreign companies to, “hire locals and concentrate on training. It is easier than in other Gulf countries when you consider the size of the population and deeper talent pool as a result.” Christopher Johnson is finding success in hiring Saudi expatriates, who are returning in increasing numbers to the kingdom. “There are 100,000 Saudi students abroad that are beginning to return. They are more flexible and adaptable than their brothers who stayed home,” says Mr. Johnson. This ‘re-pat’ strategy is one that other companies have found success in implementing in Sub-Saharan Africa.

Small to medium size businesses may be the most affected by the new regulations. As a result, companies should make sure that local partners are not impacted and offer help if so. The Saudi government admits that up to 20% of companies could find themselves in the red zone with punitive action beginning in December 2011. Leveraging resources to assist a local partner now is a much more palatable option than the disruptions to business operations over an extended period of time.

No escape from the new Middle East

MNCs must adapt to the new environment due to Saudi Arabia’s market opportunity, but also because more stringent labor regulations are becoming a wider regional trend. In October, Gulf Cooperation Council labor ministers agreed to provide greater employment opportunities to their citizens through new policies. This year’s regional unrest has acted as a catalyst to accelerate the implementation of rigorous nationalization standards. The new regulations are not anti-globalization, but they are nationalistic in character and protectionist in some instances. While this is the new reality of the Middle East, the fundamentals of investment remain as strong as ever: high government spending, oil revenue, economic diversification programs, and attractive demographics.

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“If Greek voters vote no, Greece will default and drop the Euro as its currency, switching to a “New Drachma.” Frontier Strategy Group sees a greater than 50% chance that Greece will leave the Euro.”

Markets reacted strongly this morning to Prime Minister George A. Papandreou’s announcement that Greece would hold a referendum on the EU plan for aid. The surprise announcement put the future of the Euro firmly in the hands of Greek voters who are likely to say no to aid for additional austerity. Share prices for European banks, who hold large amounts of Greek debt, plunged 8% and broad European markets were down 4% in early trading.

The Greek government used the referendum as a policy maneuver to buy time to negotiate more favorable terms with EU creditors. The play may backfire as Greek voters are tired of austerity, unemployment and ineffective government. If Greek voters vote no, Greece will default and drop the Euro as its currency, switching to a “New Drachma.” Frontier Strategy Group sees a greater than 50% chance that Greece will leave the Euro.

The referendum will most likely take place in January. As a result, companies have two months to put contingency plans in place for Greece. Companies choosing to remain in Greece will need to develop strategies to finance suppliers and distributors as credit from Greek banks will dry up. Opportunistic companies are considering using Greece as an export hub, as leaving the EU would likely devalue the local currency by 50%, making Greece an attractive long-term play from a cost point of view.

Impact on emerging markets

Greece leaving the Euro increases the likelihood of a double dip recession across Europe. European banks will take major losses in the their bond portfolios. Markets will also view a Greek exit from the Euro as a precedent for similar action in Portugal, Spain and potentially Italy. Exposure to derivates on bad debt is still unknown, compounding the uncertainty that will cause lending to dry up in both Western and Eastern Europe. Last time Europe went into recession, CEE markets, Russia and Turkey suffered disproportionately. This time, many emerging markets are more linked than before.

While many emerging markets will be impacted by the crisis, leading companies have already identified winners and are prioritizing resource allocations for those markets. India, Indonesia and Africa are set to be the biggest winners as domestic demand is driving robust growth in those markets. The Middle East and Brazil will also carry on through the crisis although they have higher linkages to developed markets because of commodities exports. China, on the surface, is positioned to outperform, but bad domestic debt and a slowing manufacturing sector are causes for concern.

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Most Asian countries have maintained strong economic growth in recent months despite the turmoil in global markets; however, significant downside risks threaten the region’s continued performance. In Thailand, floods threaten to undermine the country’s growth and disrupt regional supply chains. In China, a spate of defaults in the informal banking market is casting a shadow over the country’s prospects

• Bangladesh: Bangladesh’s deal with India will likely lead to long-term growth of bilateral trade and improvement of domestic infrastructure
• Cambodia: As Cambodia becomes increasingly integrated into the regional and global economies, it will start drawing significant attention from investors
• China: Multinationals should watch for news of further SME defaults as they could put a drag on Chinese growth
• India: India’s Right to Information Act is beginning to create serious problems for corrupt politicians and businessmen
• Indonesia: Indonesia’s policymakers have shifted their attention from inflation to growth, confident that they have price pressures under control
• Japan: The economy’s slow path to recovery will further decelerate due to the global economic slowdown, rising Yen, and continuing energy issues
• Malaysia: Malaysia has drawn significant FDI so far this year, suggesting that the country remains an attractive destination for manufacturing
• Pakistan: Recent interest rate cuts, which were aimed at promoting growth, are likely to spur already high inflation
• Philippines: A recently announced fiscal stimulus package may create opportunities for multinationals operating in the Philippines
• South Korea: New anti-graft reform measures should help to improve South Korea’s corruption landscape over the medium term
• Taiwan: Taiwan’s business environment will continue to improve as the island’s leaders work proactively to attract investment
• Thailand: The recent floods will impact global supply chains for agricultural goods, automobiles, and consumer electronics until at least Q1 2012
• Vietnam: Pledged foreign direct investment is dropping as growing domestic risks give companies reason to pause

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Bristol-Myers Squibb (NYSE: BMY) recently announced changes to its top management team, including key changes to its emerging markets leadership. The company was able to promote from within because, as CEO Lamberto Andreotti remarked, “a focus on developing talent at all levels is a key element of our Bristol-Myers Squibb culture.”

Many executives, when pressed to explain what differentiates their corporate culture from that of their competitors will say something along the lines of, “our company is like a family” or, “employees are attracted to our values.” At established offices in developed markets, where hundreds of long-time employees live and breathe the corporate culture, this ambiguous but definition may be sufficient.

In emerging markets, however, companies do not have this luxury. Very few employees in a local office will ever make the trip to headquarters to absorb and live that culture first-hand. Furthermore, as companies rapidly expand their local headcount, the ratio of “indoctrinated” employees to “un-indoctrinated” employees will become even more skewed. Some locations may get lucky, organically developing their own unique corporate culture in the local office that successfully engages talent and differentiates the work environment, but relying on luck is never a best practice.

The companies that have been most successful in attracting and retaining top talent have put in place formal processes for defining, differentiating, and instilling their corporate culture in their furthest-flung emerging market locations. One case study that Frontier Strategy Group recently developed highlights the three-part strategy implemented by a prominent beverages company. To briefly summarize, the company:

1. Conducted an internal assessment using an employee survey, focus groups, and one-on-one interviews to understand more specifically the key levers of employee engagement: Individual (how employees find personal meaning in their work), Team (understanding the optimal degree of non-work related interactions necessary to ensure open and honest communication), and Community (how to engage employees in issues that truly matter to them, their families, and their communities)
2. Evaluated and re-defined their incentive structure through three unique lenses: monetary, professional growth, and personal engagement
3. Provided front-line managers with tools, training, and incentives to align the day-to-day work environment to the defined vision

The process used to instill the corporate culture should reflect the company’s ethos and mission. The example above heavily reflects the profiled company’s roots as a marketing and consumer-oriented company; the strategy is designed to make current and former employees brand ambassadors. Another company FSG recently featured in a case study, a technology services provider, took a much more quantitative approach to defining and measuring a differentiated corporate culture. This approach was designed to reflect its very scientific and technical corporate mission, but the goal of defining and reinforcing a more concrete corporate culture to attract and retain talent remains the same.

The next post in this series will focus on the role of senior management in reducing attrition of top talent in emerging markets.

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The death of former Libyan ruler Muammar Gaddafi marks the symbolic beginning of a new era in North Africa and transitioning states are keen to attract foreign investment. Companies should avoid being paralyzed by uncertainty, and must begin planning to re-engage and expand in the region to capture medium to long-term opportunities.

Investment opportunities exist across sectors though key considerations differ by country

• Consumer Goods: Egypt’s market size and strong sector growth, especially in cities, make it an attractive investment, while relative stability in Morocco and Tunisia will support a healthier outlook (see MarketView screenshot above)
• Industrials: Ongoing public and private investment in oil and gas will support Algeria’s desirability as an investment destination in related sectors. Rebuilding opportunities and an effort to bring oil production back online will mean strong growth in Libya
• Technology/Telecommunications: Size and growth underpin the outlook in Egypt, where plans could be revisited to become an outsourcing hub, while ICT services make Algeria’s B2B market an attractive investment target
• Healthcare: Tunisia’s market does not offer robust size or growth, but it is a safe bet due to previous investment in the healthcare sector. Conversely, Libya’s healthcare infrastructure suffers from years of neglect, but the country is a wildcard for future growth due to high GDP per capita among a small population

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Venezuela presents a major challenge for MNCs who recognize the country’s market potential and high profit margins, but are troubled by the risks associated with any significant presence in the country. The upcoming elections in 2012 and recent concerns over Chavez’s health has renewed speculation over medium-term political and economic scenarios for Venezuela.

Advantages of Venezuela

Attractive demographics offer long-term prospects

• 90% of Venezuelans live in cities and half of Venezuela’s 30 million people are under 25
• GDP per capita is fifth highest in the region

Oil profits allow government to encourage domestic demand

• Government maintains lending rate below inflation to encourage consumption

Business tax system is competitive with the region

• Corporate and ordinary income tax rats are 34%
• Attractive incentives such as non-taxable dividends for distribution of earnings and profit

Major Challenges

The operating environment is opaque and unpredictable

• Little separation between executive, legislative, and judicial branches
• Currency devaluation and expropriation are constant risks

Consumers behave differently than those in free market economies

• Consumer spending is volatile as it is dictated by government spending policies
• Price controls, inflation, and shortages alter consumer purchasing habits

Major structural challenges hinder growth prospects

• Drought has led to shortages and rationing of electricity
• Crime remains rampant, and a source of disillusionment with the Chavez regime
• Oil production is rapidly declining

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Frontier Strategy Group built a proprietary model in 2008 to test the assumption that “emerging markets are decoupled from western economies (G7)”. We found that certain markets such as Nigeria and Peru were not only decoupled but provided multinationals with consistently high growth opportunities. Conversely, growth in markets such as Turkey, were highly dependent on a recovery in western economies.

Surprisingly, in 2011, our model shifted to indicate that emerging markets are no longer thought to be as decoupled as before. Very few markets such as Morocco and Indonesia provide above average growth opportunities with less dependence on the status of western markets.

In 2008 we built a model to understand the global impact of a recession:

2011 data shows markets are more coupled than before

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While the impact of Western volatility on Asian markets is cause for concern, this is just one force buffeting the Indian economy. Other risks to watch in Q4 and first half of 2012 are currency volatility, inflation, policy paralysis and farm output:

1) Western Recession

• While India’s exports have withstood the global gloom so far, prolonged insecurity in Western markets could have a large impact on exports

2) Currency Volatility

• The weak rupee may provide a short-term boost to exporters, but uncertainty around currency volatility will negate the benefits

3) Inflation

• Inflation remains a consistent threat to business input costs, wage levels, and household consumption, as FSG observed in Q3

4) Policy Paralysis

• This summer’s scandals halted business as usual in Parliament, and may continue to stall crucial policymaking on social and business issues

5) Poor Farm Output

• Agriculture accounts for 17% of GDP and employs over 50% of the populace. A weak monsoon will hurt rural markets and heighten inflation

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With 155 million people and projections of 7.4% GDP growth in 2011, Nigeria is already a “can’t miss” consumer market opportunity. That said, in the next several years there will be multiple bumps on the road as Nigeria transitions from a corrupt, ethnically divided, oil driven economy, to a modern, diversified powerhouse.

In 2012 in particular FSG believes there is a 50% likelihood of a double dip recession. The following outlines what the potential impact of a recession could have based on your current Nigeria footprint:

Remote Exports to Nigeria

• Volumes could decline as currency weakens
• Distributors may be crunched for credit
• Lower logistics, fuel costs as oil prices moderate
• Greater flexibiliy to increase/reduce export volumes
• Indicators to watch: Exchange rates, Oil prices, Credit growth

South Africa Exports to Nigeria

• Volumes could decline as currency weakens agains rand
• Distributors may be crunched or credit as oil prices moderate
• Greater flexibility to increase/reduce export volumes
• Indicators to watch: Exchange rates, Oil prices, Credit growth

Nigeria as a Regional Hub

• Distributors may be crunched for credit
• Lower logistics, fule costs as oil prices moderate
• More protection from volatile exchange rates when assessing domestic market
• Greater responsiveness to market dmeand
• Indicators to watch: Domestic food prices, Oil prices, Exchange rates

Pan-Africa Business Units

• Distributors may be crunched for credit
• Lower logistics, fuel costs as oil prices moderate
• More protection from volatile exchange rates when manufacturing in domestic market
• Greater responsiveness to market demand
• Indicators to watch: Pan-Africa GDP, Exchange rates, Oil prices

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Starbucks announced last Monday that it will bring its low-fat soy lattes to one of the world’s most dynamic, fast-growing markets: India. While its focus might be on the rapid growth of the middle class, or the competitive threat from local players Barista and Café Coffee Day, Starbucks should be worried most about their partnership with Tata Coffee. They don’t want to join the long line of failed joint ventures that came before them:

Virgin and Tata Teleservices. Danone and the Wadia Group. Walt Disney and the Modi Group. General Electric and Godrej. Renault and Mahindra & Mahindra.

To succeed in India, Western executives must build their own capabilities to prioritize opportunities and localize their strategy – instead of relying solely on joint venture partners. But prioritizing and localizing is particularly difficult in India, where much of the business potential lies in diverse, hard-to-penetrate markets beyond the metros. Few executives have the information or experience to meet these challenges.

Frontier Strategy Group is pleased to introduce our India Growth Package - two new tools designed to support executives in prioritizing opportunities and localizing their strategy:

• India MarketView: An online, executive tool that provides an in-depth view of India’s 35 states and union territories, and an independent, 3^rd party assessment of growth opportunities
• India Growth Forums: Ongoing expert teleconference series to support execution in the marketplace

Click here to inquire about FSG’s India Growth Package

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