Why Focused Strategies May be Wrong for Emerging Markets

By: Tarun Khanna & Krishna Palepu

Antithesis of Core Competency Theory or Focus Strategies:

How Conglomerates can still add value in Emerging Markets.

Limitations of Emerging Markets

Western companies take for granted a range of institutions that support their business activities, but many of these institutions are absent in other regions of the world. The institutional context vis--vis product market, capital market, labour market, regulatory system and its mechanism for enforcing contracts are weak.

Understanding the Role of Conglomerates

Product Market:

Severe dearth of information exist for 3 reasons:

1. Communication infrastructure in emerging markets is underdeveloped. Relatively poor telephone services in several parts of the country, power shortages impacting the regularity of this service, problems with postal / courier services, high levels of illiteracy.

2. No mechanisms exist to corroborate claims made by sellers. Consumer-information organizations are rare, govt. watch dog agencies are ineffective and analysts are not sophisticated. 3. Redress mechanisms do not exist for consumers if product does not deliver on its promise. Besides, law enforcement is slow and sometimes capricious (unpredictable).

As a result of these problems, companies in emerging markets face much higher costs in building credible brands than in other markets.
Thus a conglomerate with reputation for quality can leverage its group name to enter new and even unrelated businesses [faith factor]. Korean Chaeblos and Indian business houses have done this with lan: LG & Samsung in Korea and Tata & Reliance in India.

Capital Markets:
Efficient capital market mechanisms propel investors to invest in ventures. The capital market uses institutional mechanisms like reliable financial reporting, a dynamic community of analysts and an aggressive / independent financial press to build investor confidence.

Such mechanisms either dont exist or are weak and unreliable / inefficient in emerging markets.

With a track record of superior performance large conglomerates have greater access to capital markets. Besides acting as venture capitalists, conglomerates act as lending institutions to existing member enterprises, who may not be able to easily raise capital from the market.
Conglomerates are also attractive to foreign investors eager to invest in fast-growing emerging markets as these domestic entities have a reputation to keep.

Labour market:
Emerging markets suffer from a scarcity of welltrained manpower. [15% engineers employable] Business Groups can create value by developing promising managers, and they can spread the fixed costs of professional development over the businesses in the group. [TAS for TATA group]

Korean Chaebols, for example, have set up special programs in collaboration with US B-schools to impart state-of-the-art training to their people.

Govt. in emerging markets as well as the labour unions make it difficult to lay off workers as there is no govt. provided unemployment benefits available for retrenched workers. To counteract rigidities of the overall labour market, conglomerates can develop extensive internal labour markets to transfer people within group companies based on requirements. [AV Birla group]

Regulatory system:
Governments in emerging markets intervene, CONTROL much more extensively in business operations than their counterparts in the west. Besides, predicting actions of regulatory bodies too is difficult. In India though the license raj is out, yet Indian bureaucrats have a great deal of discretion in applying rules.

Conglomerates can add value by acting as intermediaries with Govt. when their individual companies or foreign partners need to deal with the regulatory bureaucracy.
Even educating bureaucracy is an important part of the job of conglomerates and MNCs. Of course bribes and corrupt practices may also be a part of the functioning of bureaucracy in emerging markets less heard of in the developed world.

Mechanisms for Contract Enforcement:

In advanced economies companies can work under contractual arrangements because of confidence in protection from courts. Courts in emerging markets often enforce contracts capriciously or inefficiently.

In such situations, local conglomerates can leverage reputation established by honest dealings in the past.

Conclusion:
Large and diversified groups generally add more value (because of scale and scope) in emerging markets. But some of the groups add no value or reduce it. Mahindra & Mahindra is focused on automobile and closely related business but has created a holding company to invest in a range of related projects without directly impacting the activities of its existing businesses.

Advised by a Management Consultant that unrelated diversification did not create value a Tata executive replied:

Dont enunciate a theory that will bring everything to a dead halt. If we do not start these businesses, no one else will either, and society will be worse off.