The global economy is in transition, not so much as the result of fluctuating superpower politics, but more so as the quiet byproduct of shifting investment in emerging economies. We are at the end of supersized returns previously found in Brazil, Russia, India, China, and South Africa (BRICS), foreign direct investment constants since 2001 that have in recent years become increasingly fragile economies. Their era as primary centers for investment has been replaced by a “Frontier Era,” a period marked by a concentration on economies scattered throughout Africa and Asia. This will be a dramatic shift as hundreds of millions of dollars in foreign direct investment will swing from the pockets of one group to new, emerging markets.Frontier nations, as defined by Aldo Musacchai and Eric Werker in the Harvard Business Review, are countries at an early stage of economic and political development, characterized by weak legal systems, heavy corruption, low human development and significant political turmoil. As such, these nations present numerous risks to multinational companies. Despite these negatives, as Musacchai and Werker found, 19 of the 25 economies forecast to grow the fastest over the next five years are frontier countries. Key frontier economies include Angola, Mozambique, Myanmar, Vietnam, Ethiopia, the Democratic Republic of the Congo, Cote d’Ivoire, Bangladesh and Kenya.
Identifying the known and uncovering the unknown risks is definitively different from assessing risks in modern markets, where rule of law can be relied upon in business affairs. In frontier economies, as in the early BRICS, risk management requires extensive and broad expertise to provide insights and resolve problems. Gathering data in these environments, for instance, can be thwarted by not only cultural and language differences, but by national, tribal, or personal loyalty. Safety is a fear at the personal level and security of business operations can be threatened by both organized terrorist groups or opportunistic criminals. Additionally, with corruption as a factor, interaction with government representatives presents constant uncertainty. Therefore, the data needed to establish and operate a successful business or make a capital investment is often initially unobtainable.
A New Level of Risk Management
While operating and investing in these frontier economies poses substantial risks, companies can increase their chances for success through robust preparation and contingency planning. Gathering key data not only about the nation-state but about how one’s specific company fits into the national ecosystem is the obvious start, to be done prior to an entry decision. Notably, this data gathering must exceed the typical due diligence completed for routine investments in developed economies. Elements discounted in other situations must be emphasized here: security, corruption, government stability, rule of law.
The means through which companies obtain this information must necessarily be expanded. The risk management, facility security, logistics and investment staff of U.S.-based corporations do not have the requisite skills to obtain information about key factors of frontier nations. Complementing the team with external firms experienced in such exploration and sophisticated enough to operate without jeopardizing the opportunity or client brand is a critical aspect of managing the risk.
Properly analyzing the relevant information is another step in which companies fall short, leaving them open to certain gaps:
- Groupthink, during which no one can safely serve as the “devil’s advocate” and ask probing questions, especially common when the venture is initiated or championed by the CEO.
- Run of the mill due diligence, formulaic in nature, which therefore lacks the creativity and scope to consider critical questions relevant to the specific situation, such as “who has the authority to revoke our license?”
- The lack of structured contingency or scenario planning exercises that would uncover risks through the simulation of business operations on the ground.
- Analytical processes that are based on gut instinct alone and eliminate or discount the insights identified through proven, systematized analytical methodologies.
- The lack of clearly articulated recommendations with supporting evidence and that include pros and cons as well as accountability for ongoing oversight.
- A risk management plan and process that fails to continually gather data, analyze information appropriately, and address concerns directly to senior management. Seeing a risk management plan that follows the same template as that used for previous investments is a signal that the venture is at serious risk of failure.
- Using only in-house risk management officials, who often only nominally carry the risk management title along with other job responsibilities, or are limited with financial risk management skills alone. Complementing this team with external nonfinancial risk experts must be considered given the nature of these endeavors.
- Not specifically addressing security concerns, which are the predominant anxiety of company staff. U.S.-based corporate security representatives have expertise in domestic facility, perhaps even cyber issues, but are not likely to have expertise in how best to secure facilities, personnel, transportation and operations in Africa and Southeast Asia.
Executives must also consider options and alternatives and be prepared to adjust their business model should various scenarios arise. Government changes, both revolutionary and planned, are not unheard of in these frontier economies, for example, and require executives to contemplate various future environments. Through simulated exercises executives can ensure that operating models are flexible and creative. Along these lines, prior to market entry, business leaders together with risk experts must prepare an exit strategy. Key to this strategy is the identification of indicators for when the market becomes too risky or unstable, and establishing a monitoring program to quickly identify those indicators. Focusing on the long-term success while being ready for volatility in the near-term is the balance needed.
Most critically, companies need to develop a lucid understanding of the complete set of unique risks posed within each country and analyze how these dynamics, including competition, infrastructure, government and regulation, challenge their operations.