Apr 4, 2011
Much has been made lately of the emergence of Africa as the next developing economy likely to experience the considerable growth recorded by the likes of China and India in recent years. With close to one billion people, Africa certainly mirrors the latter two countries’ vast populations of economically under-exploited consumers. To some degree, the regional/provincial variation in culture, language, business practices, regulations, politics and consumer habits within the boundaries of each of the two eastern giants are not too dissimilar to the differences between each of Africa’s 55 sovereign states. It is not farfetched then to expect that there will be some similarities in the challenges an investor could face when looking to invest in Africa compared to investing in Asia’s largest economies.
Of course, one should never forget that Africa is bound to present some unique opportunities and challenges. However, looking at what worked elsewhere is surely better preparation than pursuing a ‘land grab’ strategy of buying into a new market. Companies looking to take advantage of the bounty that Africa has to offer would therefore do well to learn from their own and others’ experience of investing in other developing economies.
A good number of multi-national corporations that invested in India and China in the past decade did so on the back of acquisitions of local companies with a suitable footprint and market presence. Strategies to develop from there, varied from further bolt-on acquisitions, organic growth driven by access to new sources of capital and/or the introduction of the corporations own products/services. Some have done better than others and particularly in China, large multi-nationals have found it difficult to make their investments work for them. Some common pitfalls and challenges to emerge from these developing countries include:
- These governments are known to be very bureaucratic and regulatory. Ownership structures are often onerous and not necessarily in line with the investor’s best wishes. Corporations and their advisors have devised cunning structures to circumvent this without contravening regulations. It is essential to consult and plan well to avoid the costs and negative business effects of an unwieldy corporate structure that is detrimental to growth and the bottom line.
- Corporate governance, financial controls, reporting frameworks and accounting systems are often less sophisticated than those in developed economies. This raises the risk profile of the investment as the decision to invest and the value of the investment could be based on questionable data. It also means an additional cost of upgrading these to standards expected by boards of directors and shareholders.
- Most multi-nationals prefer ex-pats familiar with their business to take up senior management positions in their new ventures in developing countries. Although this gives the parent company some peace of mind that its investment is being looked after, it can inhibit the company from achieving the kind of growth the investment was intended for. Perhaps braver than most, some corporations have retained local management teams and trusted their entrepreneurial spirit and knowledge of local conditions to grow the business. A mix of expat expertise and local knowledge is perhaps a recipe to deliver the best of both worlds.
- Labour action can have a substantial impact on business operations and profitability. In some developing countries labour rights are virtually non-existent (even child labour is still prevalent in some parts of India) while others have powerful union movements and sophisticated labour laws. Understanding the intricacies of the local labour market and areas of skills shortage is imperative.
- Choosing the right company to invest in is vital, more so in developing countries where the playing field is not always level. Family or government connections, monopolistic distribution channels and lack of competition can make certain companies more likely to succeed than others. It is worth doing homework to determine what really makes a target company successful and whether these traits will continue going forward.
- Exchange control regulations can be a considerable hindrance to expatriating cash from certain developing countries. Corporations need to bear this in mind in deciding on funding structures and particularly the source of cash flows to fund debt repayments and the costs and time associated with expatriating cash.
- With the exception of the likes of China and Venezuela who have pegged their currencies to the US Dollar, developing nations’ currencies are known for their consistent volatility. Movements in exchange rates can have a significant impact on earnings (either negative or positive) and hedging options may be limited. While nobody can predict what exchange rates will do in future, it is important to understand the underlying performance of the target business when forex impacts are stripped out and the sensitivity of profits to exchange rate fluctuations.
- Working capital management often takes a back seat in favour of chasing revenue and profits. This is compounded by developing markets being predominantly cash driven with limited flexibility in credit terms. It does provide opportunity for relatively low-effort extracting of value through improved working capital management though.
- Manufacturing quality and control may be at lower standards than those required by multi-nationals in their home countries, leading to once-off correction costs and potential environmental and consumer protection contingent liabilities. Don’t just turn a blind eye to identified mal-practice – it might be condoned locally, but damage to an organisation’s reputation should an incident occur, could be costly.
In summary, there are many challenges to investing in Africa but the reward for the patient and well-prepared investor is probably beyond what is on offer from any other region in the world.