Mantras for emerging markets
Alan Rosling, executive director of Tata Sons, explains the reasoning behind his belief that China and India will emerge as major global economies in the coming 20 years
A mantra is a prayer, an incantation, a few sacred words repeated again and again in order to achieve deliverance from worldly concerns. Quite often while working in emerging markets, you need to repeat your mantras to preserve your sanity, to keep you focused on the goal, to deliver you from everyday frustrations.
A few years ago I was asked to step in as the managing director of a company that was in serious trouble. The company was bleeding cash losses, shareholders were deadlocked on the way forward, staffers were dispirited and good people were leaving the organisation. My straight-talking Scottish boss overseas was demanding immediate solutions. He was a turnaround expert and wanted a classic fix: sell or close now. Each option we examined to move us forward seemed to be blocked, by legal, regulatory, commercial or labour issues. We struggled for some months, to the growing exasperation of my hard-driving boss, who kept saying: I want this done now. We kept saying, You cant do that in India because
While it is tricky to restructure in India, it is not impossible. In my case, after some months of hard work and careful planning, at last we began to make some progress. We sold some assets and reduced debt. We closed five operations in three months. We reduced our workforce by more than 50 per cent. We turned cash positive. My hard-nosed Scottish boss flew from London to review progress, and grudgingly gave us some praise. You know, said the boss one night in the bar, I would never have the patience to work here. Its crazy. How do you manage it?
What that Scot needed was a mantra for emerging markets. To bring down his blood pressure. To bring it all into perspective. To keep his sanity. After all, its all maya.
I have two mantras for emerging markets to share with you. The first is very simple.
Change equals opportunity
What are emerging markets if not markets that demonstrate change? Dynamic change. Unpredictable change. Rapid change. Structural change. And with that change comes growth. And growth means enormous opportunity for business.
So while you are riding the roller-coaster ups and downs of an emerging market, keep the frustrations and excitement in perspective, because change does equal opportunity.
When I was the strategy director of United Distillers, the worlds largest spirits company, we had a growth problem. Our major mature markets in the US and Europe were flat, or even on the decline. So it was natural for us to seek growth in the emerging markets of the world, in Asia, Russia and Latin America. A similar quest for growth has led many other multinationals to the developing world in the past decade.
In 1985, foreign direct investment (FDI) in developing countries totalled just $13 billion. Thats just the equivalent of a handful of decent-sized power or petrochemical plants. By 2003, FDI flows to emerging markets had grown to $267 billion. Every reasonably sized company in the West must now have an emerging-market strategy. They are seeking a share of the opportunity represented by emerging markets, to participate in the change occurring so fast in these countries.
Unfortunately, few equations are as simple as they appear. And from simple equations you inevitably move on to more complicated formulae, including simultaneous equations. So let me introduce a second, less welcome equation, an equation that works in tandem with my first.
Higher returns equal higher risks
The second feature of emerging markets, beyond the opportunity they represent for business growth and high returns, is that they entail greater risk than do mature markets. Emerging markets are difficult places to do business. There are often complex regulations and difficult bureaucracies. Information is scarce and enforcing contracts takes time.
Emerging markets are unpredictable. They entail volatility and risk. And in emerging markets the unexpected often happens. Emerging markets do not always emerge in a linear fashion. Economic crises, changes in government policy, wars, famines, even plagues of locusts, have a nasty habit of spoiling the party. Businesses that succeed in emerging markets must have the patience to manage through the unexpected. Those who stay the course can make excellent returns, but it is sometimes a bumpy ride.
Take the example of Cadbury in India. Cadbury owns the chocolate market here and makes very nice returns. The Indian market represents a significant chunk of the profits of Cadbury Schweppes PLC. In 2003, the company was suddenly plunged into crisis: there were repeated claims of worms being found in Cadburys products. The media went to town, decrying the callous multinational. Sales plummeted in the run-up to the key Diwali season.
The management responded rapidly: it opened Cadburys factories to scrutiny to demonstrate their systems and standards in production; it introduced new packaging that assured the customer that infestation in distribution could no longer occur; it mounted a major advertising campaign, using Amitabh Bachchan to endorse the product. A year later, Cadburys sales and share have recovered.
Events such as these happen in a market like this. You can anticipate and plan against eventualities, but when they occur you must also react swiftly. To keep myself sane in the insanity of emergence, I keep repeating my two mantras for emerging markets, my simultaneous equations.
Why choose to grab the tiger by the tail and ride the emerging market seesaw? Why not settle for the comfortable predictability of the mature market? Why not follow my Scottish boss in saying life is too short for this? Its a question that my wife keeps asking me. Why do we live in Bombay rather than Boston?
My answer is because, in the medium and long term, emerging markets do in fact emerge. If the technology boom was the growth story of the 1980s and 1990s, emerging markets may well prove the growth story of the next decade or so. In the meantime the roller-coaster ride is a lot more fun that the merry-go-round of a mature market.
Differential compound growth rates have huge impacts over the medium and long term, and they change the structure of the world economy. In my lifetime, China has emerged as a major economic force. This despite the volatility inherent in fast growth, despite unpredictable reverses.
In the 1960s, the US was growing on average at 4.3 per cent real, Japan at 10.4 per cent real, and Germany at 4.4 per cent real. In the 1990s, the US had slowed marginally to 3.4 per cent, while Japan was at just 1.3 per cent and Germany at 1.5 per cent. In general, the growth rates of the mature markets have slowed sharply, with maybe the US being an exception to the rule, driven perhaps by the technology revolution and associated productivity gains.
Meanwhile, in the key emerging markets growth rates have remained high, or have even accelerated. In the 1960s, China grew at an average growth rate of 5.2 per cent, India at 3.4 per cent. By the 1990s, these growth rates had accelerated to 10.3 per cent for China and 6 per cent for India. You have to believe that economic growth will tend to follow an S-shaped curve, picking up momentum for some critical years, then slowing down as per capita incomes converge with those of developed markets.
Sectors within economies replicate the S-shaped pattern. So, as the economy develops, you can expect to see many sectors developing at a differentially rapid rate within the economy. The actual pattern of growth will, of course, not be as smooth as the S-shaped curve implies. There will be variations, ups and downs from year to year. And there will be occasional major hiatuses. Poor government policy or events of other kinds can hold back emergence, but not forever. Growth will eventually reassert itself.
India has been a perennial underperformer for 50 years; it has been held back by bad politics, bad policy choices and bad infrastructure. It is my belief that over the next 50 years India will at last begin to capitalise on its abundant advantages: of democracy and the rule of law; of cheaply available, skilled, English-speaking manpower; and, above all, of a thriving, well-managed and competitive private sector.
Economists tell us that whatever the endowments of a country in terms of production factors, income and growth are ultimately determined by productivity. The key reason behind Indias poor performance until recently has been its poor record of productivity growth. A recent study by the Tata Groups Department of Economics and Statistics found that, pre-reforms, the total factor productivity (TFP) was growing in India at just 0.7 per cent every year. Post-reforms (from 1991), TFP growth increased to 1 per cent. But the 50 largest manufacturing companies achieved a growth in TFP post-reforms of 3.5 per cent annually. And the six leading Tata Group companies logged a growth in TFP post-reforms of 4.4 per cent.
I recently visited the Nhava Sheva International Container Port in Bombay. This is a private-sector infrastructure investment run by P&O Ports. The facility is built to handle 0.5m TEU per annum. After five years of operation, it is handling some 1.1m TEU, more than twice its design capacity, with some of the highest efficiencies of operations of any container port anywhere. It really is a world benchmark.
The facility faces two hindrances. First, it is dependent on its main competitor, the Bombay Port Trust (BPT), in a whole range of areas. Not surprisingly, BPT, a public-sector entity, does not always cooperate with its private-sector rival. Second, the facility is dependent on the infrastructure around it. Just outside the gates is complete chaos, with truck queues up to 3-km long waiting to get in. The rail and road infrastructure supporting the port has just not been built to meet the requirements of growth. And I read a newspaper report which suggested that into this chaos has stepped the local mafia, offering truck drivers the chance to jump the queue and get into the port for a fee.
Indias dynamic private sector is performing well, but remains shackled to the different performance standards of the public sector, and the creaking state of the infrastructure.
I have suggested that over the medium to long term the world economy is hugely dynamic; change happens. This is equally true of the corporate world.
When I started my career in 1983, 35 of the top 50 corporations in the world by market capitalisation were from the US, 10 were Japanese, four from the UK and one from the Netherlands. Twenty years later, of the top 50 companies, 32 are from the US, nine from the UK, two each from Japan, Netherlands and Sweden, and one each from France, Finland and Italy. Other than the relative decline of Japan, not much change, you might conclude. The largest companies in the world are still based in the US. Well, yes and no.
First, within these top 50 companies there has been dramatic change. Yes, GE, Exxon and IBM are still there. But no less than 33 of the top 50 companies have changed. Companies such as Microsoft, Walmart, Berkshire Hathaway and Vodafone have muscled their way into the top group of corporations from nowhere.
Second, the top 50 companies are a bit more of an international mix than in 1983. Instead of four countries being represented, there are now eight. But all of them are from developed markets, not from emerging markets for now.
If you expand your view from the top 50 corporations to the top 500, as listed by Fortune, a slightly different picture emerges. Of the top 500 corporations in 2004, 226 are from the US, 53 from Japan and 38 from the UK. But 4 are from China (13 if you include Hong Kong), 5 are from Taiwan, 5 from Korea, 4 from Brazil, 3 from Russia and 2 from India (it would now be 3 from India following our recent listing of Tata Consultancy Services).
Now think forward 20-30 years. No doubt, the largest corporations in the world will still be predominantly from the US. But I think they will have been joined by a serious number of new competitors from emerging markets, from South Korea, from China and from India.
I said earlier that one of my reasons to be bullish about the prospects for the Indian economy is the strength and entrepreneurialism of the private sector in this country. I can think of no other emerging market that has such a depth of world-class companies, of management talent and of technical skills.
Among the top 50 private-sector companies in India, growth has averaged some 20 per cent over the past five years, while return on capital averages some 25 per cent. And there are some big companies here: ONGC, the most valuable, is worth some $20 billion in market cap.
In the last 20 years, Indian industry and commerce has gone through a dramatic reinvention. It has been forced to because of the international competition now permitted to enter the country. But entrepreneurs have also seized the opportunities of liberalisation to create new companies with world-class standards. In IT, pharmaceuticals, engineering and metals, Indian businesses have begun to take on the world and win.
I think some of these corporates are poised to grow rapidly, based on the essential Indian proposition of world-class designed and engineered products at third-world costs.
I suggest that in the next 20 years we will see a clutch of genuinely significant global corporates emerge from India. Some we have heard of already: Infosys, Tata Consultancy Services, Ranbaxy, Tata Steel. But others are likely to emerge from nowhere, just as Microsoft and Walmart did in the past 20 years.
It is our intent that among the emerging Indian corporates on a global scale will be a number of companies from the Tata Group.
As with the wider Indian economy, the Tata Group has transformed itself over the past decade to respond to economic liberalisation and increased competition. We have divested some businesses and acquired some others. We have entered new growth sectors such as telecom, retailing, auto components and insurance. We have shaken out costs and capital in our old-economy businesses like steel and motors (Tata Steel is today one of the lowest-cost producers of steel in the world).
And now we have embarked on a new phase of growth, the internationalisation of select businesses. We start this drive to internationalise with the advantage of a sizeable export business. About $3.1 billion, almost 22 per cent of our sales, came from overseas sales last year. The bulk of this is of course from IT, but in addition it comes from telecom, tea, hotels and vehicle exports.
The key feature of our new drive to internationalise is that we now seek to place our people and assets wherever in the world makes most economic sense, in contrast to Indias export model of the past. We may source, design, manufacture or sell in different geographies, according to cost and customer needs. For example, rather than just outsource to India, Tata Consultancy Services has established development centres in North and South America, Europe, China and Australia.
Where appropriate, we will use acquisitions to build these international businesses more rapidly. Our first cross-border deal was in 2000, when Tata Tea successfully bid for Tetley, a company then three times its own size. This acquisition catapulted Tata Tea to the No 2 slot in the tea industry worldwide (after Unilever). This year Tata Motors has completed the acquisition of Daewoo Commercial Vehicles and Tata Steel has taken over NatSteel in Singapore, which will bring the company access to five high-growth markets in Asia.
I think that the fast-growing, large emerging markets will be among the key transformational stories of the next 20 years. China, certainly, and India, I believe, will emerge as major global economies. With this growth will come the creation of new corporate powerhouses on a global scale, taking their place in the top 50. And along the way there will be great opportunities for individual managers.