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Keeping it real

Stefan Stern
Financial Times
24 March 2009

When Royal Bank of Scotland announced it was going to make a £1.2bn investment in Bank of China in August 2005, it solicited much comment.

David Cumming, head of UK equities at Standard Life Investments, said: “We are comfortable with the logic of the deal, which should enhance earnings. It doesn’t require too much capital and the growth opportunities are good.”

But another Shanghai-based financier told Scotland’s Sunday Herald newspaper: “If RBS really believes they are entering a long-term strategic partnership, with a view to a full merger further down the road, they are deluding themselves and being hopelessly optimistic. It would swallow up so much management time and effort to turn the Bank of China round it would make your hair curl ...

“I am a customer of the Bank of China in Shanghai and visit my branch regularly. The most extraordinary things go on there. For example, the chequebook I have is only usable in Shanghai. And yet it is supposed to be the Bank of China.”

In January this year, RBS sold its Bank of China stake, raising £1.7bn. A profit, in other words. So had the initial risk been worth taking, or was it all part of the previous RBS management’s over-ambitious international expansion, which ended up causing it so much trouble?

We may have to wait for the business school case study in a year or two’s time to know for sure. But the complexity and uncertainty of making big investments in fast-developing markets should be obvious enough to anyone. If the smartest people around are uncertain how to proceed, what chance does an ordinary business person have?

Nowhere does the risk/reward relationship play out more dramatically than in the area of foreign investment in emerging markets. But while such regions may appear to offer a lot of exciting opportunities – particularly welcome when other parts of the global economy are struggling – some of the apparent “gold mines” may not be quite as easy to exploit as optimists like to think.

“I’ve seen too many companies go in with grand hopes and they just do not materialise,” says Dean White, head of emerging markets at PA Consulting. “Either there is too much competition on the ground or what they plan to offer is too generic, or the numbers on which the investment was based turn out to be wrong.”

Ambition tempered with realism seems to be the right approach.

But what should corporate leadership teams do, when they are trying to get to know a new market with a view to doing business there? Mr White suggests a few sensible steps.

Your country’s embassy in the relevant emerging market may be a good place to start, he says, if only in a limited way. It will be able to offer some essential information. Still, it is also worth remembering that diplomatic staff might have a bunker mentality about the country in which they are based. They may even have an incentive, in the form of targets, to encourage investment in the local territory.

A proper survey of who else – particularly among competitors – is already doing business in a new territory is a vital early step. And then work hard to get under the skin of the business community to find out what life is really like there.

“This could mean finding out which hotels and coffee bars members of the business community like to hang out in,” Mr White says.

Due diligence in an emerging market also means serious research into the country’s legal system. Can you rely on contracts and the rule of law? How deeply involved are government officials in the workings of the economy?

Converting initially tentative relationships on the ground into something more valuable requires an investment of time and manpower, as well as money. “You have to have ‘skin in the game’,” as one consultant puts it. That means: being seen to be committing senior people to a new business.

Although there is a pitfall here, too: committing too many good people to a new market may take them away from your core markets for too long. But showing up in full strength is the best way to attract local applicants to join a new foreign-owned venture.

Getting the pricing of your new goods or services right is crucial. It is unwise to go in with “loss leader” prices. You are likely to be seen as “those cheap new guys from outside”, and will struggle to lift your prices to the right level subsequently.

Even bearing all these complications in mind, the appetite among business leaders to find new markets remains strong.

Research by KPMG’s advisory practice, published in a recent report called Exploring Global Frontiers, suggests that more new business locations are springing up, as traditional investment targets become saturated.

Some new centres for outsourcing have been identified. These include cities in Latin America (Campinas and Curitiba in Brazil, and Queretaro in Mexico) and Asia (Changsha in China, Davao City and Iloilo City in the Philippines) that only the most sophisticated of internationally minded business people may have heard of already.

According to Shamus Rae, advisory partner at KPMG: “These locations are still emerging and, as such, can carry a degree of risk; an element of venturing into the unknown.”

That is why corporate leadership teams need to make sure they have robust decision-making processes in place, and are not merely being carried away by the hype surrounding a hot new destination.

In their recently published book, Think Again, Sydney Finkelstein, Andrew Campbell and Jo Whitehead argue that leaders can easily delude themselves into believing that they recognise and understand a situation when in fact they are stumbling in the dark.

Leaders need to build in feedback loops and early warning systems to alert them to potential danger, the authors say.

To do this, they suggest four steps.

First, make sure you have as much information as possible before making a big investment decision to try to reduce the risk of failure at the outset. Second, allow group debate to challenge the prevailing view and conventional wisdom. Third, ensure good corporate governance – formal procedures and structures that ensure decisions are tested. And fourth, implement better monitoring of decisions.

Taken together, these measures may help prevent the worst kind of investment mistakes.

“You have to be realistic about emerging markets,” says Mr White of PA Consulting. “Sales cycles are going to be longer, and payment cycles are going to be longer, too. There are going to be lots of things you haven’t encountered before, and rarely is it all easier than you imagined it would be.”

But after 15 years of working in new markets, has Mr White had all his enthusiasm knocked out of him by various hardships and reverses?

“No. I’m still very bullish,” he says. 

Contact the international development team

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