The global economy is a fascinating ecosystem to both study and participate in. The term ‘globalization,’ while important, has an academic connotation that tends to underplay the very real and tactical implications for what it means to operate a business today. There are entirely new challenges to be faced and business competencies required to compete and win in today’s economy, many of which have very little to do with the product or service that companies deliver to their customers.
Stratfor has enjoyed a unique vantage point for observing the internationalization of business interests over the past 20 years. While there have always been international companies — Ford has been selling cars around the world since opening operations in Canada in 1904 and Europe shortly thereafter; ExxonMobil’s predecessor Standard Oil began international operations in China in the 1890s; and investment firms have traded globally for centuries — virtually all companies are now impacted by international events to some extent. Even companies that only operate domestically in the United States, for example, are influenced by global dynamics to a far greater extent than they were 20 years ago. Spikes or depressions in non-related commodities prices can cascade into shipping and transportation costs. Political upheaval in far-away places can impact labor costs for essential subcomponents controlled by suppliers. Default on large debt instruments by countries in “emerging” markets can impact domestic interest rates and investments.
Even domestically-focused companies must maintain global situational awareness to understand and stay ahead of these indirect risks.
However, more and more companies are taking the further step to actually operate in these international markets. This can manifest as selling products in new markets, opening offices to develop international capacity in fields such as software development, or developing supplier, product or distribution relationships. In some cases, companies' international exposure is limited to individual travel; in other cases it requires management of buildings, physical infrastructure and supply chains around the world. The risks associated with each type of operations are different, but all international operations incur some degree of risk. Even Europe, often considered a relatively risk-free region for new investments, has significant political, economic, and security risks that must be understood.
Not all risks associated with international operations are equal. The degree of risk is determined both by location and activity. International expansion into Nigeria entails different risks than would a similar program in France. Neither is inherently better or worse, but the political, economic and security risks are different and must be understood and mitigated accordingly. Thoughtful risk management entails a balance between the economic potential of an opportunity and the costs required to mitigate the risks associated with that opportunity. Companies understand that they get paid for risk, to some extent, and that it is possible to conduct operations anywhere in the world. But there are places where the costs of risk management outweigh the economic potential of the opportunity.
Framework-Based Risk Assessment
Stratfor has helped investors and corporate executives evaluate and manage risks associated with international operations for decades. We have developed a market-assessment framework to help our clients evaluate international opportunities - whether they are in moderate-risk locations such as Europe or in higher-risk locations around the world. This framework includes four primary areas of evaluation: political, economic, infrastructure, and security. In some cases, we will also look at demographics or other factors that impact the attractiveness of an international market for sales or hiring opportunities, but these four areas are at the center of the majority of our risk assessment efforts.
Political. Political risks involve local political decisions that could affect the viability of an investment or business interest. These risks can range from broad election-based shifts in a country’s political direction, to more specific regulatory moves that could adversely affect an industry or type of company. We have seen organizations who woke up one morning to find that the effective tax rate for their operations in a country doubled, changing the country business unit from an extremely profitable operation to one that was losing money and potentially needed to be divested. The challenge with political risk is that it needs to be understood on a forward-looking basis, as these risks are better avoided than worked through. If a company plans to buy a business in Eastern Europe it is helpful to understand the current political environment, but that is only the beginning of a responsible country assessment. What that company really needs is to understand the most likely political trajectory for that country over the next 10 years. Though this is difficult, and never error-free, it is possible.
Economic. Companies tend to excel at evaluating specific opportunity risks, but in our experience, are less proficient at evaluating the environmental or macroeconomic conditions that can also impact performance. A company looking to buy a company in Southeast Asia, for example, may completely understand the risks associated with that company - equipment replacement needs, product shortcomings and balance sheet issues, for example. That same company may miss the fact that the regional food-based commodities economy is under extreme pressure from other actors in the South China Sea, which could lead to significant operational risk that will be outside of their ability to control. In our experience, although investors are better at evaluating these types of risks, they remain challenging nonetheless. Economic risks range from currency issues (which are often political), to workforce availability, to the overall economic trajectory of a country and the cascading impact that can have on all companies operating in that market.
Infrastructure. First-world companies sometimes take for granted the availability of functional infrastructure, especially when considering opportunities in developing economies. Ports, roads and airports constitute critical supply chain and transportation nodes required for the success of a multinational enterprise. Healthcare and education systems can be considered important parts of national infrastructure, especially for companies that plan to operate, hire, and sell products in a region for decades. Telecommunications infrastructure is one of the most commonly under-appreciated infrastructure sectors, as gaps in telephone and internet connectivity are often not as obvious as shortcomings in ports and roads.
Security. Security risks are one of the most obvious areas of concern that companies evaluate, especially when they put people in less-developed “emerging” or “frontier” markets. Companies tend to inherently understand that there are security risks involved in sending employees to the Middle East, for example. The complexity comes from the need to do something about it; aside from telling our people not to go, how do we manage risk when we need to send a team member to a high-risk country? Stratfor evaluates security threats in terms of crime, terrorism, espionage, and business continuity, with the aim of helping our clients implement the right levels of protective measures to allow successful operations anywhere in the world. Industrial espionage and information security risks are specific areas where we have found that most companies understand that there are risks, but few have appropriate mitigating strategies in place. Travel to China, for example, is extremely important for many different types of businesses, and there are relatively simple measures companies can put in place to mitigate common information security risks.
Even small companies that send employees overseas only for limited travel to seemingly low-risk places need to understand the environments in which they operate.
While some of the use cases mentioned above may seem tied to large investments, these factors are important for all organizations to understand. Even small companies that send employees overseas only for limited travel to seemingly low-risk places need to understand the environments in which they operate. Information and physical security considerations are important for small companies with individual international travelers, just as they are for large companies with significant international business interests. Financial reward is often correlated in part with risk, and company executives understand that there are times where they need to incur risk in order to realize success. Risk must be managed in a balanced fashion. Excessive risk aversion can lead to missed opportunities while ignoring risks can lead to disaster.
Companies that can understand and manage risk in a thoughtful, cost-efficient fashion tend to have an advantage over their competitors. The most successful companies are those that go beyond understanding the present risk environment, and instead assess what it will look like in the next three to five years. This type of thinking facilitates the first-mover advantage, developing business infrastructure and relationships in a country before it becomes obvious that the risk environment there has improved. Companies that lead in this fashion can be extremely successful, benefiting from the rush of competitors and capital that follow once the market understands that the risk environment has changed.