Chapter 3: ANALYSIS OF THE MARKET

CHAPTER 3

Analysis of the Market

INTERNATIONAL BUSINESS RELATIONSHIPS , particularly JVs between parties from different countries, cultures, and legal systems, present unique challenges. Parties tend to focus on the business and economic terms and consequences of their relationship, but they must also respect the different values they will encounter when they approach a cross-border relationship. For the process to succeed, a careful analysis should always be made of the markets in the country or countries where the JV will be active.

Social and Political Factors

In an international JV, the cross-border nature of the transaction requires that the parties pay close attention to the social and political factors that might impact the success of the JV. The social and cultural beliefs and practices of another population are based on its history, education, and fundamental understanding about how society ought to be ordered and regulated. Political factors can extend beyond the structure of government and the rule of law to include informal methods of power and influence in the marketplace.

In many ways, the decision to enter into a new foreign market is an adventure in cultural anthropology. The foreign party needs to consider carefully all the traits and activities that make up the way of life in the subject country. This analysis requires identification and understanding of the controlling institutions and customs that regulate how people think and what goals they seek in their dayto-day lives. These cultural values will, in turn, influence the structure and operation of business enterprises. For example, consider the argument that management practices in a Japanese corporation, including the emphasis on group values and subordination of the desires of the individual, are a byproduct of the social organization in that country. Consider also how clan and extended family relationships in a small developing country can often overwhelm the nominal authority of the government, thereby reducing the degree to which foreign parties can rely on guarantees of the state with respect to the operation of a JV.

In addition, a foreign party must carefully evaluate the political environment of the subject country. Political evaluation has often been neglected, or contemptuously ignored, by managers in developed countries. The results can be disastrous, leading to misunderstandings between the parties and direct clashes between the foreign investor, regulators, and other institutions within the subject country. Relevant considerations include an estimate of the political stability and the likely direction of political development in the subject country, an appraisal of the quality of the public service, the possibilities for long-term economic growth, and the attitude of the government and people toward foreigners in general and toward the prospective venturer’s nation in particular. National pride and sensitivities must be taken into account. Finally, the foreign party should remember

that, particularly in smaller developing countries, an investment will often have farreaching and unexpected effects on policy developments in the host country and on overall political relations between the countries involved.

Country Analysis

Country analysis is a holistic approach to understanding a country’s past activities, particularly within its government, and its future trends during the term of the JV. Government activities are of special significance because they are chiefly responsible for establishing and maintaining the framework, including the institutions and behavioral rules, through which the country develops its economic, political, and social structure, and relates to the activities of other countries. The analysis focuses first on identifying and evaluating a country’s performance and national goals and objectives. Then the analysis turns to the construction of scenarios reflecting possible trends in evolution and development of the country over the JV term. Using these scenarios, a party can make an educated guess as to the effect of future events on its interests and can attempt to build protection into the JV documentation.

ECONOMIC PERFORMANCE One of the most important factors in selecting a new foreign market for investment is the historical and projected economic performance of the country or region. Most countries regularly publish data on economic performance.

Although some indicators are more important than others for a particular JV, attention should always be paid to such factors as the balance of payments situation; the exchange rate; aggregate output, prices, and employment; savings and investment rates; productivity measures; and distribution of income broken down by demographic characteristics (area, age, ethnic group, and so on).

NATIONAL GOALS Like businesses, countries generally have specific national goals or objectives that drive the various policies implemented by their governments. A country may have many goals, some more real than others, some more important than others.

Among the most common are autonomy, productivity, and equity. Autonomy is the freedom from foreign domination, and it is generally expressed through a country’s foreign investment regulations. Productivity refers to the skills and processes that can create wealth and increase the overall standard of living. The need to enhance productivity often drives incentives for foreign investment, which sometimes puts the government at odds with concerns over foreign domination of the economy. Finally, the notion of equity includes questions surrounding distribution of income and opportunity. Equity concerns can lead to substantial political uncertainty in a country, as well as to laws and regulations (e.g., required profit-sharing with employees) that impact the JV’s anticipated profits.

ECONOMIC AND SOCIAL POLICIES A country seeks to meet its goals and objectives through a series of policies. The process of policy selection involves a balancing of many public and private interests and the actual choices are subject to various constraints, including the resources available

within the country, the structure of the government and other institutions, and political realities. Among the areas that must always be considered are the following: ■ FOREIGN POLICY Countries tend toward one of three distinct foreign policy orientations: (1) territorial or political expansion, (2) maintenance of the “status quo;” or (3) adherence to a low profile and an inward-looking focus. The country’s foreign policy focus may be relatively unimportant for short-term JVs.

On the other hand, a country looking to expand is likely to devote substantial resources to defense-related activities, while a lower profile policy is more likely to free up resources for private investment and enhancement of local markets. ■ FISCAL AND MONETARY POLICIES Fiscal policies relate to government spending and tax policies, while monetary policies influence the money supply, the price of money (i.e., interest rates), and the convertibility of local currency into foreign currency. Issues of concern might well include decisions of the government with regard to procurement and funding of programs in a particular geographic or industrial area, the tax rates, and foreign exchange policies. Also, if a government has substantial deficits, the entire market might well be adversely impacted. ■ INCOME POLICIES A country’s income policies concern the regulation of the level and distribution of income within the country. For example, countries attempting to reduce the level of inflation may adopt wage and price controls.

Income maintenance programs, such as unemployment insurance and social security, are used to preserve certain minimum standards of livelihood to eligible citizens.

■ FOREIGN TRADE AND INVESTMENT POLICIES Foreign trade and investment policies regulate the flow of trade and capital in and out of a country.

Trade policy includes tariffs and non-tariff barriers to imports, as well as incentives for exporters who can distribute the country’s products in foreign markets in exchange for valuable foreign currencies. Investment policies are particularly important to JVs because they regulate the terms of foreign participation in the local economy. Analysis of foreign trade policies has become more complex with the growth in the number of bilateral and multilateral agreements between and among various economies. ■ INDUSTRIAL POLICY Industrial policy was a very popular topic during the 1980s, as developed and developing countries sought to identify strategies to promote and enhance the competitiveness of their domestic industries. At the macroeconomic level, industrial policy might have been in the form of changes to the tax system in order to promote savings and investment. But, in many cases, industrial policy consisted of a package of policies that effectively favored one industry over another. While these policies sometimes brought short-term success, they often tended to protect businesses that lacked an effective management structure, because they did not have to present themselves to the judgments of independent capital markets. ■ SOCIAL POLICIES Social policies encompass some of the economic-based policies already mentioned, including income maintenance schemes and labor policies. In addition, a foreign investor must seriously consider the impact of

educational and population policies, and the government’s attitude toward organized religion.

CONTEXT The goals and policies of the government are usually established based on an understanding of the relevant constraints on the country, and its available resources during the planning period. This is often referred to as the “context” for government planning and requires consideration of the following factors: (1) the local and international political situation; (2) the country’s governing ideology; (3) the institutions that support its political, economic, and social infrastructure; and (4) its geographic and demographic characteristics. ■ GOVERNMENT STRUCTURE Obviously, the government is always one of the most, if not the most, important institution in a country. Foreign parties need to analyze carefully the form and structure of the government, the mechanisms for power transitions between leaders, the key power blocs, and the extent of popular support for the current regime. The identification of other sources of political influence, such as lobbyists, special interest groups, and tribal, clan and family connections is just as important. ■ OTHER INSTITUTIONS Other institutions outside of the government can have a profound impact on a country’s business environment. First, foreign investors need to evaluate the core business-related sectors in the local economy, including banking and finance, transportation, real estate, and construction. For example, management practices within the financial sectors can be an important indicator of the expected volatility of the domestic market. The investor should look for any mechanisms that might impact competition, including cartels, informal understandings, or interlocking directorates managed through banks. Other groups or activities that might rise to the level of an institution include farmers, agricultural workers, and organized labor. Finally, religious institutions play a key role in many countries, particularly if there is a Catholic or Moslem majority. ■ IDEOLOGY The ideological context for a country is often quite difficult to define and analyze. In general, ideology speaks to the core values of the country and common understandings as to how a society should be organized, and the rights and duties of the members of the society. Decisions made regarding ideology impacts the powers that reside in the key institutions and the way in which those institutions are expected to exercise those powers. For example, if the controlling ideology emphasizes equality, then one can expect to see government policies that emphasize freedom of opportunity and access. While this may seem laudable, firms from developed countries may be chagrined to see some governments pursue equality by failing to recognize intellectual property rights out of fear that they may deprive society of access to ideas that they believe should be open to use by all, regardless of who made the original investment. Finally, the goals and strategies of a country may well be constrained and driven by physical characteristics that cannot be changed, or changed only at substantial expense. Among the obvious features that might be expected to drive a country’s economy are arable land, deepwater harbors, mineral resources, climatic conditions, and population density.

EVALUATION AND FORECASTING The two final steps in the country analysis process are (1) evaluation of the country’s performance in light of its goals and policies, and (2) development of a forecast of future performance for use in constructing an appropriate strategy for investors considering entry into the marketplace. Of course, the analyst should carefully review all the performance indicators to make a broad assessment as to how well the economy is doing. Trends should be noted, such as whether performance is getting better or worse, and comparisons might be made to comparable countries. Most importantly, performance should be evaluated relative to the stated goals announced by the government over the last few years. ■ PAST PERFORMANCE If a country’s performance has been satisfactory, an attempt should be made to identify the reasons for success, and to determine if these represent specific strategic advantages that can be exploited in the future.

If, on the other hand, the country’s performance has been disappointing, the analyst must search for a diagnosis of the causes. For example, a country may have mismanaged its fiscal policy by following spending and taxing policies that adversely affected incentives to work and invest. In other cases, excessive growth in the money supply may have led to inflation and a high-cost, uncompetitive economy. Also, costly income maintenance and social security programs can result in the government taking too large a role in the economy. Apart from evaluating performance, the analyst should also attempt to identify inconsistencies between the country’s strategies and policies, and the context within which they are formulated and executed. For example, a strategy based on a particular rate of growth may be doomed to failure if the country lacks the requisite resources, or local firms are unable to meet the levels of productivity necessary for success. Likewise, strategies may be impossible to execute if they are not supported by key institutional groups, such as farmers or labor unions. This is a difficult area for foreign investors to evaluate because it requires an uncritical understanding of the ideology that drives local actors. Another possible problem might be that a given strategy is unrealistic in the international context, as might be the case when a country is looking to achieve growth through exports of goods that are unlikely to be accepted in other countries. ■ FUTURE PERFORMANCE If inconsistencies exist between strategy and institutions, a new strategic direction will most likely be required. Institutions often have historical roots that make them difficult to change, and any changes that are made will come quite slowly. In contrast, policies can be changed quickly, provided that consensus can be achieved within the government. However, even if policy changes are rapid, caution should be exercised in gauging the speed and efficacy of the changes and the associated political and economic costs. Analysis of the past is designed to allow a party to make an educated assessment of the future for purposes of planning for the proposed JV. A considerable amount of time and effort has been devoted to developing methodologies for analyzing the future, and a wide variety of approaches have been used. Many businesses represent the future environment by a forecast, often by a consensus forecast reflecting a compromise between optimistic and pessimistic views. This approach works reasonably well during periods of political stability and relative smooth economic growth. On the other hand, businesses may join military planners in scenario-based planning, which calls for the evaluation of several different strategies against alternative scenarios about the future.