Fast-growing economies often provide poor soil for profits. The cause? A lack of specialized intermediary firms and regulatory systems on which multinational companies depend. Successful businesses look for those institutional voids and work around them.
It’s no easy task to identify strategies for entering new international markets or to decide which countries to do business with. Many firms simply go with what they know—and fall far short of their goals.
Part of the problem is that emerging markets have “institutional voids”: They lack specialized intermediaries, regulatory systems, and contract-enforcing methods. These gaps have made it difficult for multinationals to succeed in developing nations; thus, many companies have resisted investing there. That may be a mistake. If Western companies don’t come up with good strategies for engaging with emerging markets, they are unlikely to remain competitive.
Many firms choose their markets and strategies for the wrong reasons, relying on everything from senior managers’ gut feelings to the behaviors of rivals. Corporations also depend on composite indexes for help making decisions. But these analyses can be misleading; they don’t account for vital information about the soft infrastructures in developing nations. A better approach is to understand institutional variations between countries. The best way to do this, the authors have found, is by using the five contexts framework.
The five contexts are a country’s political and social systems, its degree of openness, its product markets, its labor markets, and its capital markets. By asking a series of questions that pertain to each of the five areas, executives can map the institutional contexts of any nation.
When companies match their strategies to each country’s contexts, they can take advantage of a location’s unique strengths. But first firms should weigh the benefits against the costs. If they find that the risks of adaptation are too great, they should try to change the contexts in which they operate or simply stay away.
Buy CopiesWhat’s the fastest-growing market in the world for most products and services? Developing countries. Yet many companies shy away from doing business in these nations. CEOs are all too aware that such countries lack the market institutions needed to do business successfully—such as consumer-data experts, end-to-end logistics providers, and talent search firms.
But avoid investing in developing countries, and you won’t remain competitive for long. How to mitigate the risks? As authors Khanna, Palepu, and Sinha recommend, first analyze each country’s institutional context, including political and social systems; openness to foreign investment; and quality of product, labor, and capital markets.
Then decide: Should you work around your target country’s institutional weaknesses? Create new market infrastructures (for example, your own in-country supply chain)? Or stay away because adapting your business model would be impractical or uneconomical?
Dell Computer chose to adapt its business model to enter China. After discovering that Chinese consumers didn’t buy over the Internet (a cornerstone of Dell’s North American business model), Dell sold its products through Chinese distributors and systems integrators.
Correctly diagnose developing countries’ institutional contexts, and you make savvier foreign-investment decisions. You avoid markets you can’t profitably serve—while capturing the wealth of opportunities presented by other emerging markets.
The Idea in Practice
Based on your target’s institutional context, decide whether you’ll:
In the U.S., McDonald’s outsources supply chain operations. But when it tried to enter Russia, it couldn’t find local suppliers. So, with help from its joint venture partner, it identified farmers it could work with and advanced them money so they could invest in seeds and equipment. And it sent Russian managers to Canada for training. By establishing its own supply chain and management systems, it now controls 80% of the Russian fast-food market.
Home Depot’s value proposition (low prices, great service, good quality) hinges on many U.S.-specific institutions—including reliable transportation networks to minimize inventory and employee stock ownership to motivate workers to provide top-notch service. It avoids countries with weak logistics systems and poorly developed capital markets, where it would have difficulty using its inventory management system and may not be able to use employee stock ownership.
CEOs and top management teams of large corporations, particularly in North America, Europe, and Japan, acknowledge that globalization is the most critical challenge they face today. They are also keenly aware that it has become tougher during the past decade to identify internationalization strategies and to choose which countries to do business with. Still, most companies have stuck to the strategies they’ve traditionally deployed, which emphasize standardized approaches to new markets while sometimes experimenting with a few local twists. As a result, many multinational corporations are struggling to develop successful strategies in emerging markets.