What lies beneath? The hidden costs of entering rapid-growth markets

15 Septembrie 2011

ERNST & YOUNG S.R.L.

 

The CFO’s role

We believe these six segments represent the breadth of the CFO’s remit. The leading CFOs we work with typically have some involvement in each of these six — either directly or through their team. While the weighting of that involvement will depend on the maturity and ambition of the individual, the sector and scale of the finance function, and economic stability, they are all critical to effective leadership.

This report is the latest in Ernst & Young’s The Master CFO Series and relates to the CFO’s role in relation to rapid-growth market entry, and the true costs of doing so. It is based on a survey of 921 CFOs from around the world, conducted with the Economist Intelligence Unit, as well as a program of in-depth interviews with leading CFOs and senior executives.

 

Executive summary: What lies beneath?

The opportunities in rapid-growth markets are undeniable. So are the potential risks and the likelihood that budget overruns can temper growth prospects. Over one-third of CFOs underestimate the costs, and 4 out of 10 the time, involved in entering markets where even the smallest miscalculation can erode profitability. Where others see primarily opportunity, the CFO must be able to spot complexity — the costs both manifest and hidden. This requires ongoing scrutiny, and not just an initial investment evaluation.

The choice of investment destination is becoming more diverse

The increasing importance of rapid-growth markets to their future prospects is encouraging multinationals to look beyond the first-tier rapid-growth markets, such as the BRIC countries, into less familiar economies. Although countries such as China and India will remain vital destinations for investment, finance leaders surveyed for this report say that their companies are also looking further afield, to countries including Indonesia, Thailand, Mexico and Ukraine.

The CFO must retain oversight at every stage of the investment

The CFOs surveyed tend to play a more active role at the preentry stage of investment than at the post-entry stage. In order to safeguard the promise of investment and sustain growth in markets where the pace of change is rapid, the leading CFOs interviewed stress the need for involvement at all stages of the process. Given that it may not be practical for the CFO to stay close to every investment in a global portfolio, the ability to delegate and secure the right balance of local and group finance expertise is critical.

More than one-third of companies underestimate the costs of investing in rapid-growth markets

Companies should not assume that rapid-growth markets are also low-cost ones. Among our survey respondents, more than one-third say that the overall costs of investing in rapid-growth markets were higher than they expected. Time overruns are an even bigger problem, with 43% saying that the investment took more time than they had anticipated. Unexpected costs in rapid-growth markets can be a serious issue. With low per capita incomes requiring investors to adopt a high-volume but low-margin business model, even small increases in costs can erode profitability.

Of the many and varied costs of market entry, there are six we have identified as areas of particular concern for CFOs. In order of the reported likelihood to overspend, they are:

1. Financing costs – rising inflation and currency fluctuations
2. Mode of entry costs – choosing the right partner and accuracy of valuations
3. Operational costs – R&D costs and finance function integration
4. Regulatory costs – evolving regulatory systems and high levels of bureaucracy
5. Human capital costs – shortage of the right talent and high levels of attrition
6. Political costs – Government instability and dealing with bribery and corruption

1. FINANCING COSTS: RISING INFLATION AND CURRENCY FLUCTUATIONS ARE BECOMING KEY CONCERNS FOR FOREIGN INVESTORS

Surging capital flows into rapid-growth markets are stoking inflation and pushing up currency values. Although policy-makers in these markets are trying to cool their economies by tightening monetary policy, the potential for currency risk remains a key source of unexpected cost for foreign investors. International policy is creating another source of currency risk. Growing pressure on the Chinese Government to further revalue the renminbi and allow it to appreciate more quickly could raise costs substantially for exporters and alter the rationale for investment in China.

2. MODE OF ENTRY COSTS: CHOOSING THE RIGHT MODE OF INVESTMENT IS CONSIDERED THE MOST CRITICAL DECISION, WITH VALUATION A KEY CHALLENGE

When asked to advise their peers on where to pay most attention in relation to investing in rapid-growth markets, respondents point to the mode of entry as the most critical decision that must be made. Even more so than the investment destination. It also pays to take a long-term view. Over time, given increased liberalization in many markets, the mode of investment may need to change. Companies planning an investment should consider whether this will be possible and what the implications will be.

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