Expanding Opportunities, Managing Risk

Globalization has been around for some time. When you think about Marco Polo going East to open trade routes with the Asian kingdoms in the 13th Century or the Europeans sailing West to the Americas since the 15th Century, they were “globalizing” their economies. Today, globalization’s trade winds are blowing strong once again, and the risks of staying ashore far exceed the ones of venturing into the open seas.

The opportunities available for Canadian companies to fully engage in global business more than compensate for an increased level of risk associated with those opportunities. Increased sales to Asia, Eastern Europe and Latin America are essential to balance trade and more equitably distribute our exports. With our trade more evenly distributed, localized catastrophic impacts in one country or region – for example, in the hurricane-prone area of the southern United States – are less likely to create havoc in the Canadian economy.

Canadian companies with increased sales outside North America will have to quickly develop the tools to analyze and deal with the risks of new clients. They could rely on the local-based foreign origin workforce to help with the task. Risk management is a key part of any consideration to expand into international markets.

On the foreign investment front, proximity to customers in Asia, Latin America and Europe will prove critical in reducing increased transportation costs due to higher oil prices as well as adapting products and services to local customer preferences. Where to locate distribution centers, marketing research teams and how to effectively manage the risks associated with operating in multiple regions across the globe will prove critical to determine successful companies in the next decades.

CANADA IN A GLOBALIZED WORLD

How do Canada and Canadian companies rank in a globalized world? Canada is well integrated in the world scene of trade and investment. Our country participates in many forefront initiatives fostering the progress and safe advancement of globalization – the Kyoto Protocol and the Child Labour Protection Act, for example. However, Canada’s trade is not well balanced; this may present a major challenge in the near future. In 2004, about 85% of our exports were to the United States. This high percentage has been increasing steadily since 1989. In comparison, Canada’s trade with Brazil, Russia and India has been below 0.5% and with China it is just growing past the 2% mark.

The issue with such an imbalanced trade is captured in the old saying: “You should not put all your eggs in one basket.” Although Canada’s commercial relationship with the United States has been a growing and positive one, that tide can shift rapidly – especially if the U.S. economy suffers slower growth or recession, or US politicians act on increased protectionist sentiments as they did in the case of the softwood lumber dispute. The United States is, and will likely continue to be, our major economic partner for some years to come. However, it is important to grow our trade and foreign investment; in doing so, it makes sense to look elsewhere for diversification.

WHERE TO GO AND HOW TO GROW?

Basically a company moves into international business in three phases. First, it produces locally and exports into one or several markets around the globe. Many small and medium-sized Canadian companies are within this phase. Second, when a company has secured an important slice of market share in key markets, it normally starts producing some parts – or delivering services – locally in that market or region in order to be closer to its customers. This proximity gives the company an advantage in time-to-market and allows it to manage its supply chain more effectively. This is the typical strategy of multinational corporations. Several Canadian companies, medium and large-sized business alike, fall into this category.

Lastly, when a company has mastered its global supply chain and secured key market share positions around the world, it can move its core operations – Finance, Research and Development, Operations – anywhere it makes more economic sense, truly becoming a global company. Surprisingly, Canada has some of its true global players in the middle market space, not only in the larger strata of business.

But if we are to grow abroad into markets other than the United States, where should Canadian companies look? I mentioned before Brazil, Russia, India and China. This group of economies, loosely referred to as BRIC, represents tremendous growth opportunities for Canadian companies. Among them:

* BRIC has a combined population of 2.7 billion people (44% of world’s population), estimated to reach 3.3 billion (52% of world’s) by 2050;

* BRIC has a median population age of 29, with an average per capita GDP of $1,600;

* BRIC has enough basic technological advancement and skilled labor to absorb parts of the production processes of Canadian companies, generating productivity gains due to lower labor costs;

* With the exception of Brazil, Canada has already entered into discussions to establish Investment Protection Agreements (FIPAs) with these countries and has already signed one with Russia.

* Canada, thanks to its open immigration policy, has a resident population capable of interacting and communicating with these markets much more effectively than some other developed economies.

Why does this matter? A young and growing population means there will be people around to produce the goods and services for Canadian companies. Also, and most importantly, there will be consumers to purchase those goods from Canadian exporters. A sizeable middle class and lower middle class are present in all those markets. Moreover, the fact that Canada has some unique internal strengths through FIPAs and its local multicultural labor pool, positions ourselves on the forefront of collecting the benefits of global integration.

CHINA: THE FUTURE IS TODAY

Some North American economists are even suggesting if you don’t have a strategy to deal with China in the longer term, you might not have a long-term strategy at all.

Anyway you look at the Chinese economy, you see superlatives: highest GDP growth base, third largest world trading country and highest market capitalization rate. The fact is, China has been preparing its growth platform for some time and it will become one of the main global economies in the next decade. Its shift from an agricultural based economy to global manufacturing platform began in 1978. Although agriculture still represents an important economic sector (and a major employer), China is solidly based on a growing manufacturing and services economy. An important factor that has propelled the Chinese economy into the secondary (manufacturing) and tertiary (services) sectors in such short term has been its ascension to the World Trade Organization (WTO) in 2001. China is ready to eliminate all import license requirements and import quotas by end of this year. This will create incredible export sales opportunities for Canadian companies. Also, the relaxation of some foreign investment restrictions on the services industry in 2006 is likely to create increased opportunities for Canadian financial institutions interested in operating in the country.

China presents as well an incredible opportunity to reap the benefits of selling to a middle class that grows by some estimates at 30 million people a year. In areas such as biotechnology, space and aeronautics and industrial and agriculture machinery, where Canadian companies still hold some competitive advantage, and where the Chinese government is prioritizing investment opportunities, it is important to secure alliances with counterparts in China before other foreign companies secure first-mover advantage.

MANAGING RISKS

There is a strong correlation between oppo rtunity and risk. It is virtually impossible to secure double-digit revenue growth rates in markets such as Brazil, Russia, India and China without incurring in an increased level of risk. Risk management plays a pivotal part of Canadian companies’ growth plans when going global.

One risk requiring further attention from Canadian exporters when selling outside of North America is marine and cargo shipment. For example, will my container arrive on time and with goods in perfect condition according to the specifications of my buyer? Another area of increased risk for exporters venturing outside North America is what is referred to as trade credit – or accounts receivable – risk. Will my new buyers in China or Brazil pay me on time, or pay me at all? Many companies counter that risk by demanding new buyers to post letters of credit guaranteeing payment. However, in a world where competition is omnipresent, selling on credit sometimes defines winning or losing a big order.

For investors in some of those markets – investors in a joint venture with a local company or in a fully-owned subsidiary, for example – typical risks relate to business interruption following political actions or natural disasters. There is also the risk of loss of intellectual property.

Especially in joint ventures, significant due diligence on the foreign partner is necessary to minimize the risk of loss of intellectual property. China has been pressed in recent years by many Western governments to investigate more seriously the many cases of piracy and industrial espionage. Brazil, Russia and India also offer some degree of risk in that area.

As for political risks, the four BRIC countries have different levels of political progress and stability. While one can make the case that Brazil, Russia and India are large democracies, the degree of government intervention in business in those countries is far from ideal. In China, the increased difference in living standards between the population in the sprawling urban manufacturing centres and the increasingly depressed agricultural countryside provides a reason to be concerned about the country’s medium-term political stability.

The good news is that there are many ways to mitigate, manage or eliminate such risks and proactive risk managers are working closer with operations managers and financial experts to deal with these issues.

Daniel Galvao is a Senior Vice President with Marsh Canada Limited and heads up the Financial Products practice responsible for helping clients in managing international business risks.