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Cross the Rubicon

Helping Your Company Sell Into, Raise Capital From, and Find Partners in Emerging Economies

Cross the Rubicon - Helping Your Company Sell Into, Raise Capital From, and Find Partners in Emerging Economies

The Healthcare Investment Opportunity In Myanmar

In March, I will be heading into Myanmar as part of a syndicated research project with the objective of profiling the country’s healthcare infrastructure.  We will be evaluating distribution channels for pharmaceuticals, medical devices and diagnostics.  Included in our analysis will be profiles of the existing distribution companies who currently have the footprint in country to effectively and efficiently access Myanmar’s healthcare system.  We will also be profiling regulatory issues in general, as well as those specific to healthcare.

Once among the most reclusive nations in the world, Myanmar (also known to many as Burma) has begun a series of political reforms that are designed to attract foreign investment into the country.    With a population the US government estimates at approximately 55 million, Myanmar is the 24th most populous country in the world and the second largest country in Southeast Asia in terms of landmass.  Despite its plentiful natural resources such as natural gas and timber, Myanmar is the poorest country in Southeast Asia.  The country’s poverty stands in stark contrast to its relative wealth from only 50 years ago when, at the beginning of the military junta’s rule, Myanmar was the wealthiest country in Asia.

Much of the hopes foreign investors have today for Myanmar are based on a recollection of what Myanmar once was, and hopes the foundations for a prosperous country can still be found. In addition, for many multinational companies (MNCs), Myanmar further adds to the commercial opportunities in the region.  Many MNCs believe they will be able to pivot from their operations in Thailand (65.9 million people) to serve Cambodia (14.5 million), Laos (6.4 million) and Vietnam (87.8 million) and now, the possibility of Myanmar as well.  Viewing the combination of these five countries together and crafting distribution strategies tailored to the almost 230 million consumers in the region constitute an important and compelling business opportunity.

For Myanmar to become a viable emerging economy where MNCs and private investors can confidently deploy resources, the recent attempts at democratization of the country’s political system and liberalization of its economy must continue.  Neither is certain.  The country’s recent political reforms took place against a backdrop of long-standing grievances by its people regarding political and economic issues.  At a very basic level, the new government’s pledge to triple the country’s GDP in five years is a reflection of the political reality that further turmoil is likely unless the economy can find its footing.  This admittedly audacious goal may be within reach providing Myanmar is able to pivot government economic development away from central planning and military spending towards free markets and investments in education and healthcare specifically.

Political reforms have certainly created latitude for the new government to act even in the face of a similar crisis; however, the final note potential investors should keep front of mind is that Myanmar’s reforms are still reversible.  While the release of 700 political prisoners, the accommodation of certain limited but substantial democratic reforms, and the relaxation of basic freedoms are encouraging, Myanmar has a long way to go.  Nobel Peace Prize winner Aung San Suu Kyi pointed this out earlier in 2012 when she noted, “”Ultimate power still rests with the army so until we have the army solidly behind the process of democratisation we cannot say that we have got to a point where there will be no danger of a U-turn. Many people are beginning to say that the democratisation process here is irreversible. It’s not so. We must wait until after the elections to find out whether or not there have been real changes. And depending on these changes, there should be suitable changes in policy.”

The Myanmar government of today led by Thein Sein has retained many of the same military officers who previously constituted the junta.  While it is not surprising these former military officers now have positions in the new government, their resistance to key democratic reforms and their willingness to allow foreign companies to compete with previously protected domestic companies will be key to monitor.  In the same way, most of the established businesses that had found a way to survive and prosper under Myanmar’s repressive political and economic system for the last several decades are likely losers in the midst of a broad opening of the country’s economy to outside investment.  President Thein Sein’s proposed changes to the State-Owned Economic Enterprises Law (SEE Law) resulted in significant pushback from the established businesses, largely a reflection of these fears.

Regardless of these cautionary notes, Myanmar has already been successful drawing FDI. Some of the early in-bound investment has come from Chinese and Thai investors in low-wage, high labor-content industries eager to take advantage of these factors.  Other more promising areas that have driven FDI thus far have been oil and gas exploration (in particular natural gas, of which Myanmar is estimated to have the world’s 10th largest reserves of), mining and forestry.  Cumulatively, China has close to US$14 billion of investments in Myanmar, followed by Thailand (US$9.6 billion) and then third Hong Kong (US$6.3 billion). Most of these investments have gone to secure oil and gas resources as well as mining and some agricultural land.  Myanmar’s potential as a regional agricultural exporter is significant; China already is looking to source feed crops from Myanmar. Thus far, Myanmar’s FDI patterns are noticeably different than those of what are commonly referred to as the Asian Tigers.

As other resource-rich countries globally have illustrated, simply having access to bountiful natural resources does not guarantee a wise use of tax revenue and national wealth accrued as resources are extracted and exported.  Those hopeful about Myanmar’s future believe the country has the capability to develop political leaders capable of rooting out corruption and ensuring FDI and tax revenues flow towards the nation’s economic development.  One of the primary beneficiaries of such a positive approach would be the further development of Myanmar’s healthcare system.  However, the danger does exist that Myanmar’s FDI may be misdirected.  Some analysts believe the comparison between Myanmar and other regional economies is, at least thus far, an un-earned comparison.  Jared Bissinger, an academic researcher on Myanmar’s FDI policies recently wrote, “While there’s also some interest in telecoms and banking, it’s the extractive industries that are Burma’s main draw for potential investors.  The Asian Tigers, by contrast, were mostly resource-poor and relied on export-oriented manufacturing to develop.  Their foreign direct investment (FDI) was mostly in manufacturing, not resources.  They also developed in a much different international environment, one with far fewer competitive exporting countries.  They sold their wares mostly to the high-consuming countries of the West, the same countries that are now grappling with the lingering effects of the global financial crisis.”

Over the course of the next month, our blog will be introducing more details about the challenges specific to healthcare FDI into Myanmar with an eye on how to best capture the opportunity represented in the country’s recent opening to foreign investment and expertise.  We will be discussing structural issues related to basic infrastructure (power, water, road, rail, etc.) as well as very specific questions such as how to get the necessary government approvals for new drugs to be brought into the country.  Ultimately, the research completed as part of this project will be summarized in a market research report that will be available for purchase.

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A Voice of Experience from Nigeria

When American and Europeans think about emerging economies, most naturally gravitate to China, ASEAN countries like Vietnam and Cambodia, India and a handful of countries outside the region like Brazil and Russia.  But evidence is increasingly mounting that we need to broaden our horizons even more; specifically, that we need to incorporate Africa into our thinking about emerging economies.  What to make of Africa has been something I have written about here, here, here and here.  The challenges of successfully navigating Africa are many, and it was my good fortune to recently spend some time chatting with Marc Schreuder, the Principal at M2D Consulting, a company specialized in Pan-African QSR and Retail with offices based in both Lagos and South Africa.

Marc is an old hand at business in Africa in general, but Nigeria specifically.  He was instrumental in helping introduce the KFC brand to Nigeria, and has worked in Lagos with Eat “N” Go Limited, the company responsible for bringing Dominos Pizza into Lagos.  Prior to his work in Nigeria, Marc worked in Kenya running the operations for Nandos, Pizza Inn, Chicken Inn as well as 2 other QSR brands and On the Run, the convenience retail brand at the back court for Exxon Mobil.  Beyond his work in Nigeria and Kenya, he has worked in Saudi Arabia, Uganda and South Africa, always with an eye towards operations, quality, and P&L management.

I was curious to get Marc’s read on how as both an expat living in Nigeria, but also someone with a long history in Nigeria and a life lived largely in Africa writ large, what he makes of the growth story the west is hearing about Nigeria specifically.  Marc was emphatic:  “what is going on here is very exciting.  The country has changed tremendously since I first came here.  When I am gone for just a month you see major changes when you come back:  constant improvement through new roads, more visible policing with less corruption, and (some what) better power. There are lots of new buildings, a lot of high rises under construction.”

Anecdotally these are powerful observations, but many still have deep reservations about going into Nigeria, which led me to ask Marc whether it was still pre-mature for western companies to be thinking about a strategy for the country.  Marc responded, “Absolutely not.  If you look at the population in Nigeria, Lagos alone has around 14 million people, with an influx of 60,000 people a month coming into the city.  There is hay to be made by anyone who can execute.”  If that is the case I asked him, what are some of the reasons companies aren’t successful?  Marc added, “The fault a lot of people make is they come in with their own preconceived notions about what will work … some almost seem to want to re-colonize Nigeria … you have to go into the country with an open mind, know what you’ve done in the past, but adapt to local expectations.”

This begs the obvious question of which he has seen do this poorly, and who has done this localization well.  In Marc’s mind, the best example of this was a South Africa telecom company who went into Nigeria only to exit with a multi-million dollar loss.  They brought in what Marc described as “the same way of running their business as they would have done in South Africa, the same marketing campaigns, but the marketing in Nigeria is very different.”  I found the example Marc shared fascinating.  South African radio marketing for telecom is pretty traditional when compared to western radio advertising; the difference in Nigeria is that because of the atrocious traffic, radio advertisements are much longer.  Marc said that “in Nigeria, radio ads are between 3-4 minutes long, and the product is mentioned maybe twice in total.”  What do they fill up the balance of this time with?  They tell a story, one that the decision maker can relate to:  a harried mother who has “screaming kids in the car, is being shouted at by her boss, doesn’t have any cash in her purse, but thank goodness ‘Bank X’ has an ATM around the corner so she can buy food for her family.”

If marketing is different, are the motives that ultimately drive a Nigerian consumer to spend more on a western brand that much different than what we see in other emerging economies?  Based on what Marc shared, I would have to say no:  “Nigerians are highly, highly aspirational.  Up until 10-12 years ago there was no middle class.  Even now, that is a small part of the country.  They have satellite TV, so they see everything the west has to offer.  When I first opened up KFC, I would see them take pictures outside the restaurant.”  However, Marc was quick to add that this aspirational nature was not de-coupled from a sense of value.  In his mind, “For Nigerians, the value of premium versus price is critical.  If they perceive a premium, they will pay for it, but if he doesn’t he’ll buy a copy at the corner market.”

Because this aspirational feature is critical, Marc learned to pay particular attention to how his stores looked and the level of service he offered customers.  In his restaurants, “your stores have to look sexy – clean, well lit and friendly.  In Nigeria especially, customers are not used to friendliness; culturally, they tend to come across aggressive.”  For Marc, he always wanted his store employees and the store itself to reinforce the aspirational dimension of his customers.  As he put it, “They want to be seen with a big meal:  ‘I am walking into a KFC or Dominos or a Mango clothing store because I can afford it.’  That is how they want to be seen and it is who they want to be.”

Marc admitted the many challenges of developing a strategy for getting into Nigeria are real, but as he sees it the evolution of the Nigerian middle class is about 10-15 years behind what he saw happen in Kenya.  What he was very clear on, and a point I am emphatic about as well, is that thinking about an “African Strategy” is a mistake.  This was one of the issues I had with the otherwise illuminating book Africa Rising.  Specifically, trying to think about Africa as one large market is a terrible mistake.  Marc commented, “what works in South Africa won’t work in East Africa, and what works in East Africa probably won’t work in West Africa.”

In addition, businesses like Yum! Brands will need to find competent local partners.  As Marc pointed out, “Local shareholding is not a requirement by law but it is highly suggested that a local partner is involved.”  Marc was founding chairman of the Anti Counterfeiting Coalition of Nigeria and was impressed by the number of law firms that focus on IP law and protection for foreign brands. British law principles are the basis of the Nigerian legal system unlike South Africa that uses Roman Dutch law principles.

When reflecting on the government, Marc shared, “Investment strategies by Government are not clear cut and goal posts can change. However the banking sector is particularly solid with the banks that have foreign shareholding as well such as Standard Chartered and Stanbic along with some others.  The CBN policies make good sense and are rigorously enforced having a stable influence on the sector that is improving its reputation month on month.”

Towards the end of our conversation, I asked Marc to build on what he saw as the biggest challenges for a company seeking out a strategy in Nigeria.  Marc pointed to the high cost of retail space as one problem, largely because you have to pay three years ahead in order to secure a spot.  In addition, the supply of power remains a real bottleneck.  At KFC he shared that “I had two stand-by generators … that obviously has a huge impact on costs and overhead.”  In addition, water supply is problematic and transportation problems related to infrastructure (road, rail and port) are all in need of improvement.

Having said this all, these are problems that savvy companies who have been successful in other emerging economies will also recognize, and in most cases, have been able to rise above.  Many of the factors that Marc and I discussed are out business’ control:  the stability of the national government, the efficacy of the fuel subsidy reforms, violence in the country’s north are all good examples of what can’t be controlled.  But what can be controlled are the operational and strategic factors like service levels, infrastructure and brand positioning.  Ultimately staying focused on what you can control versus what you can’t is the key to success in a market like Nigeria.

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Due Diligence for Senior Housing Operators in China

Note:  This is cross-posted from my blog today over at AsiaHealthcareBlog:

As North American senior care operators expand into China, one of the first decisions they will make – who to select as their real estate partner – is also likely to be one of the most critical.  This would always be a pivotal decision entering any foreign market, but in the midst of very specific concerns related to the financial viability of well-known Chinese real estate developers during what appears to be a massive slowdown in China’s real estate market, understanding the condition of potential developer partners is more important than ever.

A word on what is going on in China’s real estate sector is, unfortunately, a necessary detour.  Readers may be familiar with the story of Chinese property developer China Evergrande, one of the ten largest property developers in the country.  For those not familiar with the backstory, reading the following from China Economic Review will help capture the sort of downside risk many fear is endemic with China’s property developers:

“Property developer China Evergrande (0333.HKG) said it was considering legal action against Citron Research after the short-seller group accused Evergrande of financial irregularity and bribery, Reuters reported. Evergrande’s shares fell more than 4% and its bonds dropped 1.3 basis points on Friday, following a 11.4% fall in the company’s stock on Thursday that wiped out about US$1 billion of the firm’s market capitalization. Evergrande Chairman Hui Ka Yan, who owns 63% of the company, denied allegations that it was insolvent in a conference call on Thursday, saying the company has RMB13 billion (US$2 billion) of cash on hand, sufficient to cover its operations. In a note on Friday, Barclays Capital said there was “still no clarity on whether the accusations are true or false.”

 

In my mind the absolute best real estate analyst, and also one of the best at explaining the banking system and overall economy in China, is for my money Patrick Chovanec.  Writing about the Evergrande situation, he had this to say about the concerns it brings up for him:

“… They do resonate with me, because they resemble or are connected to many of the systemic risks I see building up across China’s property, trust, and banking sectors.  The big question I have been asking myself all Spring — with so much developer debt coming due, and with their cash flow so visibly impaired by the property downturn — is why we’ve hardly seen any Chinese developers (and the trusts that have fueled their building binge) go bust.  The hidden losses alleged by Citron may help answer that question, and the explanation is unlikely to be limited to one ‘bad actor.’  Like the losses that have been brushed under the rug in the Zhongdan Guarantee fiasco, they are just one piece in a much bigger and interconnected mosaic. “

 

I’ll leave it to the readers to pursue stories about China’s ghost cities for further background on how deep the problem may go, as well as two other what I consider “essential” reads on the condition of China’s real estate, both by Chovanec.  The first was published in December 2011 by Foreign Affairs and the second is from May 2012 on his blog.  I really encourage senior care operators who are serious about understanding the pressures the overall real estate sector is under to take the time to read these both.  The point is to understand the downside risk at this particular moment in time within China specific to real estate developers is unique.

If this all has your attention, good, it should.  Where due diligence about the financial condition of a potential real estate partner in China was always going to be important, it just became exponentially more so.  The problem is, simply put, completing due diligence in China is not a science – it’s an art.  Unlike in developed economies, rating agencies like D&B and S&P have very, very, very little light to shed on the financial health of a potential partner.  So doing this well is an essential part of your market entry work.

Having said this all, acknowledging the art still means we have to distill the practice of competent due diligence down to a set of principles that can be followed.  The following seven are a combination of my own research as well as an extended conversation I had with a good friend, Kent Kedl, who runs Control Risks in China.  Control Risks is one of the pre-eminent due diligence firms around the world, and their China practice is focused on strategic due diligence.  Kent is one of the original China hands; he is into his fourth decade living in China and to my mind one of the best in the business.  Prior to running Control Risks in China he was a Principal with Technomic Asia, a China consulting firm that played essential roles in helping many Fortune 500 MNCs first enter China, a body of work that firm continues to build on today.  What you will recognize in each of these is the highly intangible aspect of what each of the lessons stress.  If this makes you uncomfortable that’s one thing, but none of this should stop you from developing a China strategy.  Perhaps the right way to think about all these “intangibles” is to make you careful, diligent and patient.

Due Diligence Lesson #1:  What they have already done is interesting; what they’re doing now is criticalLet me expand on this a bit.  Keep in mind that many potential real estate partners in China have been amazingly successful over the last thirty years by pursuing a strategy of “build it and they will come.”  So yes, and most obviously, you need to understand what they have built and the models they have used to finance and operate their developments; however, because this particular moment in time is potentially fraught with downside risk specific to China’s real estate sector, it is absolutely essential to understand what they are building today, and the offers they are making potential customers at these developments.

Here is the sort of due diligence you will want to do.  Get a list of the developments they are currently marketing and selling.  Get them to tell you about their pricing scheme, when they will be ready, etc., etc.  Then, as the firm Muddy Waters so eloquently puts it, “approach them the way a potential customer would.”  With the information about the current developments they are selling firmly in hand, send out your Chinese associates to approach these developments as potential customers, and then have them ask the same questions.

One thing I can almost promise you will come of this is eye-watering discounts at many developments.  I can personally vouch for multiple developments I have been at over the last quarter of 2012 around China where very nice condo and other residential housing was going for up to 50% discount from list.  A great anecdote about this can be read over at ChinaLawBlog.  Massive discounts are not the sign of a healthy developer.  That’s someone focused on cash flow over profitability and sustainability, and it’s happening all across the country.  If you get a Chinese associate posing as a potential buyer to visit the majority of your potential partners’ current developments and you see massive discounts, be careful.

None of this is to suggest that looking at what they have already built isn’t important.  You do want to understand what sort of operating models they have found to be best suited for their owners and management team.  Do they stay involved with a property, or do they look for an early exit?  Do they have experience building for, or staying engaged with, an operating model that has a hospitality or healthcare element to it?  If so, they are more likely to understand the longer-term commitment many senior care operators from North America will need.  In addition, it is important to understand whether the financial structures of their deals have materially changed over the last several years (i.e. are they using more debt than equity, and if so, where is the debt coming from, and what is the form of debt they are taking on?).  Trends, themes and narratives from each of these questions are deep veins to explore, and in many cases will illuminate a lot about the financial condition of a potential partner.

Due Diligence Lesson #2:  What did they earn, versus whom they know.  Let’s get the obvious out of the way:  China is a land where transactions close as much because of guanxi (relationships) as they do underlying commercial sensibility.  Consequently, you need a real estate partner with good guanxi.  But what you need to understand is how they came about getting this.  Are they just well connected, or do they have a high ability to execute a business plan?  On this point, Kent added, “You want to be able to tell the story of this guy:  How did he get to where he got?  In his background is a person – or persons – who this person knows who got him to where he is today.  You need to know what he has done in the past – not just the ones he puts on the website or presentation – but what he actually did in each one of his projects.  What were they given because of guanxi, versus what they earned because they understood the business?”

Think about this as a combination of relationship mapping and really understanding the narrative of their path to success.  None of this is mutually exclusive.  A potential partner that has been successful likely has great guanxi, and may be (and probably is) well connected with the local government.  What you’re looking for is more – more than just guanxi.  Because the concept of guanxi is one of the first ones most early entrants to China grab ahold of mentally, it is one of the ideas that people tend to look for and see – whether the conclusions they come to because of this are appropriate or not.  Since guanxi is this highly informal concept with very formal implications, it is important to understand not just the guanxi they have, but how they built the relationship network they have today.  Look for competence tied to connections, and if the option exists to get great connections over competence, that might not be the right trade at this particular moment.

Due Diligence Lesson #3:  Reputational Due Diligence.  So what does “more” than just guanxi actually look like?  Here we need to introduce the idea of reputational due diligence.  Kent first introduced me to this phrase when I was researching a deal in Moberly, Missouri with a Chinese company called Mamtek.  To make a long story short, the city of Moberly stepped up to finance a deal for a new artificial sweetener plant to be built in their city.  It should have been a great example of Chinese investment into the US, but it fell apart, leaving the city holding the bag.  The city made a series of mistakes, not least of which was capitalizing much of the deal themselves; however, there was also a problem with a fundamental lack of due diligence.  I was researching the story and reached out to Kent who raised the idea of “reputational due diligence.”  Had it been done with Mamtek, the deal would likely never have moved forward.

Related to the real estate sector in China, Kent suggested that you want to understand, “what is their reputation around what they have done.  In the US we do things like credit checks and litigation review, but in China so much is not in the public record or any government files and so much is just in the local community, where these people grew up and have become successful.   You need to go talk to their partners and suppliers to find out who they are.”  You are extremely unlikely to find a financial report showing your potential partner is deeply in arrears with his vendors, but his vendors will tell you that.  How?  You can obviously hire a company like Control Risks who can deftly handle these questions.  You can also use your Chinese associates to interview key vendors in the real estate developers’ supply chain under the auspices of your desire to understand the whole picture.  I can’t tell you the number of times in supply chain projects this sort of information has easily presented itself over the ubiquitous long business lunch or dinner.  It’s out there for the getting, but you have to be thinking creatively and put yourself in a position to ask the question indirectly.

Due Diligence Lesson #4:  Take any publicly available information with a grain of salt.  I have already made this point, but it bears repeating:  put very, very, very little credibility into the information you can access through rating agencies.  If you pull back the layers to the Evergrande story, one of the obvious lessons is that even documents prepared for a publicly listed company cannot be trusted.  If you have been watching the numerous stories coming out related to the crisis North American accounting firms are facing in China, one of the most obvious points is that even the absolute best accounting firms in the world – those that should know where to look to find half-truths and under-stated liabilities – are not able to do so effectively in China.

Due Diligence Lesson #5:  A network of competitors.  Obviously information that comes from a competitor has to be taken with a grain of salt.  But, what you will get as you sit down and talk to competitors, obviously with the objective of understanding whether they might be good fits in their own right, is a sense of the market.  Talk to 5-10 potential real estate developers in a particular city and a narrative will begin to evolve, one that will have a couple of key points about the challenges they are all facing, and more than likely themes about particular companies.  Again, look for themes, common threads, general unifying anecdotes that seem to shed light on your potential partner.  If none of them cause you to worry and seem pretty standard for how competitors view and talk about one another, then check that box and move on.

Due Diligence Lesson #6:  Get the government involved in your deal.  This may seem counter-intuitive, but it is again a lesson that comes out of the Mamtek deal.  As important as the Chinese concept of guanxi is, the role of “face” is as much so.  Consequently, this is something you can use to your advantage.  As you are evaluating potential partners, get feedback from the municipal government officials and get them engaged in how the deal is coming together.  Some of this will happen organically for you as you get the necessary commercial licenses from the Bureau of Civil Affairs and healthcare approvals at the Ministry of Health; however, do not allow this to be the only way you get the government involved.  Early on, make a point of building your own guanxi with local government officials.  Get them to become a stakeholder in your investment, admittedly in an indirect fashion (a hat-tip here to Malcolm Ridell over at China Debate who keyed me onto this concept as it could have been used by Moberly).  What this will do is create another person who stands to lose face if the right deal doesn’t come together.  Consequently, you have another individual who is going to be invested in making sure you get paired off with the right partner and that the underlying problems (regulatory approvals, land rights, etc.) are addressed.

Due Diligence Lesson #7:  Never take land rights for given.  Many much larger MNCs have been fooled by bad due diligence over land rights. Companies who thought they had properly secured the necessary land rights have found, some well into a build-out, that the land had not been properly purchased.  This is likely to become more of an issue given the central role property rights hold as one the top grievances by rural Chinese.  Among the many causes of social discontent within the country are China’s land right policies, or what may be more accurately termed China’s land taking policies.  Knowing for sure that your development partner actually has the necessary land rights is something you cannot take for granted.  You need to make sure a local lawyer has properly evaluated this.  The process for doing this is fairly involved and laborious, and is the sort of work only a local lawyer will be able to do for you.

On this point Kent shared, “while you own the building on the land, there are two commercial relationships you can have with the land.  You can lease the land use rights or you can own the land use rights.  You need to find out the commercial relationship the developer has with the land.  Specifically, if he doesn’t, who does – does he just lease them?  If he owns them it is greater protection against eminent domain should the government decide to build a highway through your development.  Does the person you are dealing with own the land use rights or represent someone who does?”  Again, this is information the developer is more than likely not going to tell you himself.  You should ask, and file his answer away as a test of his integrity once your own due diligence confirms or denies this, but take his answer with that in mind.  The only way to confirm land use rights is to hire a local lawyer to review the local files, chops and registrations.

On this point, I think it is worthwhile to elucidate in a bit more detail exactly what goes into this sort of local examination.  My friend Dan Harris over at ChinaLawBlog has written extensively on the question of evaluating company seals and chops.  Here is what he has to say on the matter:

“When asked how they go about confirming the validity of a seal, the lawyers told me that ‘you have to go the town where the company is located.’ Once there, you then have to determine if the seal is registered. Often the seal is not registered as registration of seals is not mandatory in China. Then you inspect various documents filed with the local authorities to determine if the same seal was used on those documents. If the seal is registered, or if the same seal was used on all company documents filed with the local authorities, you know that the seal is valid.”

It may seem un-necessary, but it is the sort of basic due diligence that you will never regret engaging, especially if you understand how tenuous property rights are in China, and how common it is for land issues to reverse developments that previously had the green light.

These seven due diligence practices constitute basic principles that should go into how you evaluate potential real estate partners.  They are, admittedly, very intangible.  Many are inexorably inter-related and may seem counter-intuitive, none more so than how guanxi is both necessary and yet not sufficient.  As such, if this all makes you a little uncomfortable, that is perfectly normal.  The challenge of due diligence in China is being able to use reputational factors in place of the more empirical means we have of evaluating potential partners in developed economies.  Getting good at this sort of due diligence is part of knowing the right questions to ask in the first place, and it is essential you have someone working with you who at least knows the right questions.

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You Can Never Complain About the Traffic Again …

After you read Joshua Hammer of The Atlantic‘s new article “World’s Worst Traffic Jam.”  He details a particularly bad traffic jam in Lagos.  The article talks about how it took 12 hours to go 40 miles and how, during the trip, the headlights of the car he was in were stolen by thieves who took advantage of the locked in vehicles, drivers and passengers to make off with whatever they could grab.  Hammer writes:

Lagos gridlock hasn’t always been this bad. But the city’s population has nearly doubled since the late 1990s, and a fuel subsidy has made gasoline cheap. The government repealed part of the subsidy this year, but Nigerians still pay only $2.75 a gallon, which has made owning a car—typically a broken-down, secondhand American gas guzzler—feasible for millions of people. And rapid growth in truck and oil-tanker traffic has overwhelmed Lagos’s ports, which handle 75 percent of the country’s imports. As a result, truck drivers use the expressway as a parking lot, waiting for days to return empty shipping containers or to pick up fuel and cargo, bribing police and port officials to look the other way.

 

His article makes for fascinating reading about what is going on in Lagos, but it also points out one of the major challenges for those who operate in emerging economies:  transportation.  I recall sitting for hours in a similar traffic jam in Shenzhen, apparently because of an accident so bad that even the Chinese police could not make their way to the scene.  That, or all the rubber necking and jockeying by Chinese truck drivers in an attempt to work around the scene had itself brought traffic to a complete stop. The clock was ticking on a flight out of China, and I was not too happy to think about the prospects for missing a flight.

The less personal aspect to this all is the need to understanding exactly how your product will get from ship to shore, from shore to rail, from rail to distribution center, and from distribution center to point of use.  Cumulatively, this is one of the first and most important issues you need to understand when exploring an emerging economy.  Defining this is not only an operational necessity, but it will give you a very good gauge on other peripheral matters:  how and when are containers staged as they leave the port?  Who speaks for what part of the many mark-ups that occur between you and your final customer?  Where are the most obvious inefficiencies exist?  Where can product potentially get sidelined?

As Hammer’s point makes clear, this is a huge problem in Nigeria.  Many companies who have had good success establishing distribution channels in countries like China are going to quickly find that expanding into other emerging economies shows how advanced China actually is in this regard.  A good friend with experience in Vietnam commented on how much of an issue this was for his company when they attempted to move a site from China to Vietnam.  All together, the role of mapping how your product gets from ship to customer is more important than many understand or appreciate.

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Warning Signs – India’s GDP Slowdown

Earlier this week, news outlets announced India’s GDP growth had dramatically slowed down to 6.5%, the slowest growth in a decade for one of the key countries in the now-ubiquitous BRIC group.  Thus far in 2012, the Indian rupee has lost 1/5th of its value against the American dollar, reflecting ongoing concerns about the Indian economy as well as the country’s ability to push through the next set of economic reforms outside investors are waiting to see.  The VOA wrote this week, that Prime Minister Manmohan Singh announced that “India will formulate an economic revival plan to tackle a loss of investor confidence as the country’s economic growth dips to its slowest pace in nearly a decade … Singh has called on officials to take measures to revive the ‘animal spirit’ in the country’s economy and reverse a climate of pessimism.  His remarks came after taking charge of the finance portfolio from Pranab Mukherjee, who stepped down earlier this week as finance minister to run for president.”

These concerns aside, both IKEA ($1.9bn to open 25 stores) and Coca-Cola ($5bn by 2020) have made recent announcements about making significant investments into the country, a sign that each believes the country remains a good opportunity for them to expand their businesses.  Both of these investments are important, not only because they are symbolically significant as a sign than MNCs continue to desire a presence in India even given the uncertain political climate and the slowing economy, but also because they illustrate that certain types of foreign businesses (specifically single-brand retailers) can be wholly owned by foreign investors in India versus regulatory limits on how much foreigners can own of multi-brand retailers in the country.  For those not familiar with this challenge, I have written extensively on these issues here, here, and here.

The Economist notes,

“The promise of a push on reforms has been made—and broken—consistently by the government for years. With a busy electoral timetable up to general elections in 2014, it may be harder to fulfill than ever. Still, others, stepping back from the hurly-burly, can see a silver lining in India’s great wobble, particularly the fall in the currency. T.C.A. Ranganathan, the chairman of Exim Bank of India, which finances trade, says: “The exchange rate has moved in our favor. I’m fairly happy.” He reckons a weaker rupee will help spur a long-awaited boom in manufacturing. Kaushik Basu, the government’s chief economic adviser, no slouch on the need for reform, agrees. A cheaper currency means India is “getting an advantage for our export sector”. Perhaps, in time, that may prove more important than today’s firefighting.”

 

Over the last two weeks, the world has seen a spate of articles on China’s slowing economy, ongoing concerns about China’s banking and real estate sectors, as well as earnings announcements from bell-weather companies like P&G, Nike and Ford, each of whom has pointed to slowdowns in their emerging economy portfolios that have led to inventory build-up and decreased profits.  India adds another dimension to these concerns, not only because its economy remains one of the key elements to the BRIC formulation, but also because India must make similar economic reforms as China needs to, many of which some outsiders are doubtful India has the ability to make.  Because many pundits have similar concerns about China, and in some cases have given up their hopes that China will make these necessary reforms, India’s ability to step up and see these reforms through would send an important message to investors around the world that the BRIC conception is still viable.

Conversely, if – as the Economist points out relative to India’s history – the country does not have this ability, it could well be that India’s relative open-ness and transparency (at least when compared to China’s opaque banking system) might be the first signal of something fundamentally wrong within the BRICs.  Keep in mind that as Carl Walter and Fraser Howie has written in their book Red Capitalism, a banking crisis in China can be masked over much more easily and for a longer-period than in any other country simply because of the role of the state in managing banks.  Consequently, by the time we are aware of a problem in China’s banking system or economy, it will be too late.  This is why many continue to watch India’s economy for signs of problems that other emerging economies and BRIC nations might be experiencing that India will be the first to manifest.  India’s debt-to-GDP percentage is 68.05%, a number that many analysts are beginning to grow uncomfortable with (keep in mind that beleaguered Spain has a debt-to-GDP of 63%).  The world is at a point in time where one of the last hopes we all have about how to sustain the global economy now rides on emerging economies:  if countries like China and India do not have the ability to make the necessary reforms they need to in order to continue attracting foreign investment and growing their middle classes, we could well be only mid-way into a global contraction and de-leveraging process that the 2008 financial crisis set in motion.

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Porsche in Nigeria

Late last week, Porsche announced that it was expanding into Nigeria with a new dealership to open in the capital city of Lagos.  What caught my eye reading this was not necessarily Porsche’s plans (although if you wonder how successful Porsche is going to be given Lagos’ reputation for gridlock, you’re not alone).  Rather, what I found interesting was the comment by Michael Wagner, Porsche’s Manager for Africa:  “The Nigerian market is in a league of its own. We see Nigerians’ spending power outstripping that of their South African counterparts.”

In case that surprises you, Jim O’Neill’s comments to the Guardian about his views of the South African economy may come as a shock.  O’Neill was made famous by his coining the BRIC term.  According to the Guardian, “He is also bearish about South Africa’s growth prospects over the next five years. Gross domestic product (GDP) growth has been revised down from 3.2% to about 2.7% for this year, 3.6% in 2013 and 4.2% in 2014. Comparatively, the rest of Africa is expected to grow on average by about 7% over the short to medium term, according to the International Monetary Fund (IMF). China and India, on the other hand, are expected to power ahead with between 7% and 10% growth.”  He went on to share “South Africa is already losing out on investment to other rising economic stars on the continent. Countries such as Nigeria carry more power now … Just look at what is happening in the African Union. South Africa can’t claim any more, apart from its sound fiscal and financial systems, to be the superpower on the continent.”

Whether or not Nigeria can rise to meet the challenge of becoming a legitimate emerging economy will have much to do with whether it can quell the violence in its northern regions, and the next set of economic reforms the country badly needs to finalize.  Regardless, moves like that Porsche recently announced suggest that multinationals believe Nigeria holds the potential to make this transition to a sustainable emerging economy, and they are positioning their businesses with the goal of accessing the Nigerian consumer in mind.

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P&G’s Nausea

This week FMCG giant P&G announced that it anticipated sluggish earnings and sales growth due to what it sees as an overall uncertain economic picture in both developed and emerging markets.  The company has been under pressure to grow its top-line and to cut costs, two objectives that might run at cross-purposes with one another in the short-term.

Bloomberg quoted P&G’s CEO Bob McDonald, ” there has been ‘slow-to-no’ growth in gross domestic product in developed markets like North America and western Europe, and significant unemployment. In the U.S., about 25 percent of households have at least one person looking for a job.”  Emerging markets, once the panacea to P&G’s domestic difficulties, are not looking very good either.  Bloomberg noted, “Emerging markets pose their own challenges. McDonald said foreign exchange, or the exchange of one currency into another, had been expected to add 2 or 3 percentage points to revenue growth. In fact it has hurt revenue by $3 billion. P&G is also dealing with government-mandated price reductions in Venezuela and import restrictions in Argentina.”

Here’s what put a cherry on the top:  McDonald noted that, “We’ve seen sequential deterioration in the rates of market growth in both the U.S. and Europe, and there has been a slowdown in the rate of market growth in China.”  What to take away from this?  If P&G is experiencing nausea the economies in both developed and emerging countries are slowing that is very disconcerting to us all.  Navigating uncertain waters like those that likely are ahead of us is going to require a willingness to let market research and core innovation advance.  The future will belong to those companies who continue to invest in better understanding their export markets, and who believe that the greatest upside potential exists in selling new products to consumers in emerging economies.

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In Case You Needed a Reminder …

Of why so many otherwise rational and grounded economists and businesspeople are so excited about the opportunities within emerging economies, viewing this graph should be helpful.  From Michael Cembalest, the Global Head of Investment Strategy at JP Morgan, the below graph illustrates the share of global GDP each country has represented since Year 1.  A couple of points to draw out of this.

First, as Derek Thompson of The Atlantic points out, the relationship between population and GDP needs to be understood:  the Industrial Revolution changed how these two were related to one another.  Prior to this, economic output was directly tied to population; after, economic output could outpace population growth.  One question this brings to mind is what happens when the most populous countries in the world catch up to the level of industrial modernization more developed countries possess.  The downside risks are those environmentalists and analysts focused on raw-material constraints are most concerned with; geopolitical issues related to similar levels of industrialization but widely divergent populations could easily set in motion the sort of “fear of inevitable superiority” that led Germany to attack France and Russia in World War I, except this time predicated on extreme economic insecurities felt by Western Europe and the United States towards a country like China.

The upside potential to this graph is the one every businessperson needs to understand:  developed economies are not going to be in the global economy’s driving seat much longer.  The share of world GDP that countries like China and India will likely ultimately come to account for are likely to, absent global war or encountering a new economic paradigm like a Chinese or Indian version of the Mexican middle income trap, return to historical norms.  This means that it is more important than ever to have a strategy in play for accessing these markets.  The historical narrative is clear and compelling, the question is how best to access these markets as they make their transition from emerging to semi-developed economies.

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To Kaidangku or to Not Kaidangku, That is the Question

While in Singapore recently, Sameer Desai’s presentation at the NextLevel Pharma event on “Innovative Strategies to Boost Market Access” briefly touched on a case study that I think is worth returning to:  P&G’s efforts to take Pampers’ diapers into China.  As an object lesson, P&G’s efforts are instructive for a couple of reasons, one of which stands out most to me:  when you go into an emerging market, don’t make the mistake of thinking all you need to do is make a cheaper version of a product you already make.  Rather, take the time to learn what your customer base values, and find a way to localize your features and benefits to meet their needs.  Some of this localization will build on what you already do, but much is likely to require subtle but meaningful adjustments to your product line.

In 1998, P&G launched its Pampers product line in China.  The version, by P&G’s own admission, was a cheap version of what they had successfully been selling in the United States.  The CBS article I linked to earlier quotes Bruce Brown, then head of P&G’s “$2 billion R&D budget” as saying that their efforts “just didn’t work.”  Why?  First, and most obviously, Chinese families don’t have a history of using disposable diapers.  Chinese families use either cloth diapers that can be washed and re-used, or they have what are called kaidangku, essentially open bottoms in a toddler’s clothing where the child can go to the bathroom “unimpeded” shall we say.  Odd to the western eyes, but one has to admit, quite affordable!  One other consequence of this practice is that Chinese children tend to begin potty training around 6 months of age versus between 22-30 months for children in the West.

P&G’s initial efforts to take Pampers into China were a total disaster.  The cheap plastic diaper addressed issues with hygiene, which was something the new Chinese middle class cared about.  It also provided for a solution to something (public defecating) that this same group was a bit ashamed to see happening around them.  Both of these are powerful social drivers that should have opened the market for P&G, yet they did not.  P&G’s experiences have a lot of light to shed on what can be learned by companies eager to sell into emerging economies.

First, P&G stepped back and acknowledged that they did not understand what would motivate a Chinese consumer to buy a disposable diaper in the first place.  Consequently, they commissioned a study with the Beijing Children’s Hospital and their Sleep Research Center specifically.  Their research showed that children who had a disposable diaper would “fall asleep 30% faster” and that the child would “sleep with 50% less disruptions.”  They also found that this improved sleep pattern could potentially help their child’s “cognitive development”.  With this information in tow, P&G launched their “Golden Sleep” campaign, which leveraged P&G’s marketing resources in a way that allowed it to project these findings across the country.

Second, in conjunction with P&G’s research at Beijing Children’s Hospital, they were also studying what parent’s wanted from the product itself.  The surprising take-away was that in P&G’s efforts to sell a low-cost version of the product, they ad inadvertently positioned the Pampers product line as not only low-cost, but much more importantly, low quality.  New Chinese parents, who wanted something much softer next to their new baby’s skin, rejected the plastic “feel”.  P&G initially thought they were rejected for cultural and cost reasons, but they were actually rejected because they did not make enough of an effort to build the narrative around how their product would benefit the child and parents (who both benefit if the baby sleeps more soundly), and because they assumed cost was the primary driver when softness actually was.

P&G remedied this error and now has what is estimated at 30% market share in China, with over $500m in sales.  Not too shabby considering where they were in the early 2000’s.  What should we take from P&G’s experience?  Three things:  first, you will never regret investing up-front in the market research necessary to explore what your target market actually values.  This research will shape your marketing strategy and product design efforts in ways that are invaluable.  Whatever up-front cost you pay now will easily be recovered based on your ability to move more nimbly and sell more aggressively once this research has been internalized.  Second, remember that your product needs a narrative to fit into.  Sometimes this is the “aspirational” marketing strategy we have discussed before.  Sometimes it is the quality marketing strategy that FMCG and healthcare companies in particular have been successful with in emerging economies.  The point is to make sure you have a narrative and that it fits into your target market in a compelling way.  The third lesson is that with your market research and narrative in hand, you do have to localize your offering.  What exactly this will mean is something you have to be open to, be flexible about, and acknowledge might be a bit uncomfortable.  Uncomfortable in the sense that some of what your market might value might seem inconsistent with what you know has built your success in your domestic market.  The point is not to abandon these historical insights, but to view them as longer-term value points that your emerging market consumers are likely to converge onto, but not yet.  Cumulatively, P&G’s experience taking Pampers into China is an impressive observation into the sorts of oversights that even the most successful and strategically minded FMCG companies can make.

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Getting Dirty

Yesterday here in Singapore, I had an interesting conversation with a Fortune 500 executive in a FMCG company who is responsible for developing strategies for selling into emerging markets.  A number of comments he made stand out to me, several of which I’ll be blogging about down the road, but one question we discussed was why companies – even the largest ones – struggle to really embrace bottom of the pyramid strategies.

His response was simple, elegant and right to the point:  “it takes a willingness on the part of somebody to get dirty.”  What does he mean by this?  Specifically, the sort of research that drives good bottom of the pyramid product development, distribution strategies, and pricing plans comes from having immersed yourself (or someone in your company) in the target market in question and learning what the barriers are for these potential customers to use your products.

For Nokia, this was a process they set in motion with the work of Jan Chipchase, an anthropologist who was comfortable navigating the inner workings of cultures and sub-cultures in small villages and rural settings.  This is the sort of capability that companies need to find as they begin crafting a bottom of the pyramid strategy.

This is why missionary activities are so important for companies eager to get into emerging economies:  you have to find someone who is willing to do the “tip of the spear” market analysis, distribution mapping, and identification of what consumers really want.  If you try to short-circuit this process, what you’ll find is that it is impossible to meet the expectations of your market because you’ll carry over too many legacy design and quality standards from your existing products rather than designing specifically for the needs at the bottom of the pyramid.

As this industry veteran and established executive pointed out, it all starts with a willingness to get dirty.  If you can’t do it yourself, and don’t have the staff willing to do it either, then find someone who is willing to do this sort of early-stage missionary market analysis.  Trust that the feedback you get from this will allow your existing staff to efficiently design and deploy products that will meet the needs of your potential customers.

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