Political Risks and Market Entry Modes

Question 1.

Venturing into international markets can be a potentially powerful tool to improve the performance of a company’s investment portfolio. However,going into international markets is not that easy as it may seem on the first sight,for these operations involve high risks that can occasionally become even much higher, or at least more complex, than the risks companies usually face when doing business at home.Political riskis a fundamental example of such risks.

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Political risk refers to a specific type of risk, well known to multinational companies and banks, that a host country will enact a certain political decision, or more of them, that will then bring to adverse effects on multinational’s profits and/or goals. Unfavorable political decisions in the host country may vary from very harmful, such as some kind of destruction due to a revolution or even war, to those of a more financial character, such as the creation of new laws that prevent or hinder the free flow of capital (Phung n.d.).

The most simple definition of the political risk would be that it is a risk of losing money (internationally), due to sudden changes that occur in a host country’s government, or the regulatory environment. As an example, expropriation of assets by the host country’s government, or just the threat of seizure, can also have devastating consequences on affected companies. As Fidel Castro’s government took over control of Cuba, after a revolution in 1959, hundreds of millions of US Dollars’ worth US-owned property and companies, were seized. Unfortunately, and as in most of the time is the case, almost all of these US companies had no recourse (the right to acquire any of that money invested back).

There are two main types of political risks, in general, macroeconomic and microeconomic. Macro-risk refers to possible adverse actions of the host countries that will eventually strike all foreign companies doing business in these countries. The examples of macroeconomic risks are the already described risk of expropriation, or the risks of war and terrorism. On the other hand, micro-risk refers to adverse actions in the host country that will only strike a certain sector of industry, or type of business. Main examples of the microeconomic risks are corruption and adverse legal actions against companies from foreign countries. On the whole, regardless of the specific type of the political risk that amultinational or bankcould face up with, in a foreign country, they will usually end up losing a lot of money, if they were not well prepared up-front for these unfavorable situations.

The political risk in the insurance industry is more narrowly defined with the focus put solely on actions that take place within the host countries. According to this classification, political risks are divided into five different manifesting categories: (1) currency convertibility, (2) expropriation, (3) political violence, (4) breach of contract by a host government, and (5) non-honoring of sovereign financial obligations (Multilateral Investment Guarantee Agency 2009, 28) explained in more detail in Appendix 1. Against any of these types of political risk in a foreign country, any multinational can use an appropriate type of Political Risk Insurance.

Political risk insurance captures if not all, then most of the specific non-commercial risks investors face in foreign countries. This type of insurance seizes all political risks, arising from both direct and indirect actions of a host government and its bodies, which can possibly have a negative effect on foreign trade and investments.

Although some political risks cannot be completely avoided, they could be successfully managed, and altered, to some extent. These risks are taking modern shapes and different forms, and are nowadays arising from new and even unexpected sources. Crises, such as the Arab Spring protests, started in 2011 throughout the North Africa and the Middle East, took form rapidly and almost without any warning in advance, completely deteriorating the economic conditions in the affected countries. The problem is also that, unlike other types of economic risks, political risks are very difficult to accurately quantify and measure. While it is probable to calculate some sort of a political risk “score-card”, or other quantitative-looking benchmarks, it is important to understand that these will ultimately be judgments based on qualitative assessments only.

On the other hand, effective political risk management can enable companies to successfully join and smoothly navigate newly entered foreign markets and business environments, thus providing an enormous potential starting competitive advantage. Management of political risk can be effectively incorporated into the existing company’s enterprise risk management system, producing even possible longer-term benefits such as: lowering the overall risk management costs, producing new revenue streams from markets that would be too dangerous to enter without the risk management support, and providing better performance of existing businesses in the already emerged markets (Culp 2012).

Question 2.

Multinationals are constantly spreading their reach globally, carrying out their creation and production processes, final products and brands to new and diverse, emerging markets, as well as tailoring their global strategies to a more applicable local context, by creating products and brand portfolios that match their prerequisites with the local customers’ needs.

Globalization processes bring multinationals, their products and well-known brands into ever more remote corners of the globe. A huge number of prospective customers in the newly emerging economies brings up the expectations of an unparalleled demand for consumer goods of any kind. Yet, these multinational companies encounter new business conditions in these emerging markets that are not only totally dissimilar from those by which they are accustomed to do business at home or in established economies, but that are also considerably different among each other. It is because of these, rapidly changing global market conditions, a commonly held belief that there is no single market entry strategy which is appropriate in all situations and circumstances, came into the center of interest, of many academics, practitioners and businesses.

A key attraction of the emerging economies lies in their large, most recent, economic growth and matching expectation of highly increasing demand for consumer goods. However, these economies present unique challenges for multinationals due to their less sophisticated institutional and legal environment, and because of a probably even bigger problem, weak resource support from local companies. Businesses will for sure have to find a way to develop innovative strategies and new business models, in order to serve not only a few wealthy customers in these markets, but also, and more importantly, the mass market. Appropriate positioning of the multinationals’ brand portfolio is a crucial factor to success in the emerging markets (Meyer, and Tran 2006, 3).

More or less all markets are consisted of highly diverse groups of potential customers that have to be targeted with different brands, products, marketing strategies and business models. Therefore, potential new market entrants face serious trade-offs between at least two main market entry strategies. Either, they would develop a global brand for the premium segment in any market around the world, where truly significant margins can be earned, or they would develop products with large-scale and cost-efficiency for the mass markets, thus earning profits solely through the large sales volume.

Market penetration usually begins with a market entry strategy that has to secure access to local resources, of host country’s based firms, in example distributional systems, and a wide range of governmental and local authorities’ licenses. Investors in today’s emerging economies, have to think “outside the box” and beyond the traditional market entry methods, such as export, franchising, joint venture, or acquisition (explained in more detail in Appendix 2).

Different companies enter international markets for various business purposes. These varying objectives produce at the time of the market entry different strategies and forms of such entry. However, large companies still repeatedly follow some previously adopted and used standard market entry techniques and market development strategies, most commonly the “increasing commitment” market penetration pattern. This is a pattern by which a market entry is performed via an independent local distributor, or partner, with an afterward switch to a directly controlled subsidiary. The main objective of this approach is to build a business in the newly entered market as quickly as possible, although with an evident degree of patience, produced by the initial mean to minimize risk and the necessity to learn as much as possible about the country and especially the market, from a low beginning base of knowledge (Arnold 2003, 1).

Appendix 1. Political risk types and explanations of insurance against political risk, according to the Multilateral Investment Guarantee Agency (2009).

Appendix 2. Five main classes of market entry modes ordered by the increasing control of the entrant, according to Johnson (2007).

References

Arnold, David. 2003. “Strategies for Entering and Developing International Markets.” ftpress.com, Business Communication.

Culp, Steve. 2012. “Political Risk Can’t Be Avoided, But It Can Be Managed.” forbes.com, Leadership: 8/27/2012.

Meyer, and Tran. 2006. “Market Penetration and Acquisition Strategies for Emerging Economies.” Long Range Planning, 39, No. 2: 177-197.

Multilateral Investment Guarantee Agency. 2009. “World Investment and Political Risk.” World Bank Group.

Phung, Albert. N.d. “What is political risk and what can a multinational company do to minimize exposure?” Investopedia.com, Investing.

[1] Political Risk Insurance