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Profitability in emerging markets

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  • Introduction

    Weak economic recovery in the U.S. and Europe has meant lowered valuation of emerging markets, making them an attractive investment. Businesses are concentrating their attention accordingly, but that focus is rightly focused on profitability, not just expansion. Such scrutiny demands the eye of the CFO more than ever.

    Achieving profitability in emerging markets – find out more

    EY - video still of Chip Tsantes (Cybersecurity leader, Advisory Services, EY), Adam Cohen (Forensic Technology & Discovery Services, EY), and Terry Jost(Advisory Services, EY)

    Achieving profitability in an emerging market is an evolving challenge. This video explores the strategies a CFO should consider to reach profitability within these emerging markets. [See a transcript of this video]

    The CFO role in driving profitability

    Developing these markets as engines of profitability is increasingly difficult due to robust competition and costs of growth. It’s no longer simply a matter of “Get in and get your share.” But more about being strategic around considering valuations, determining if your company is able to focus on more long term, considering joint ventures, etc.

    As stewards of capital, CFOs must champion shareholder growth – profit plays a critical role. Though growth and deals will continue to originate from mature markets, the M&A pipeline will swell with emerging markets and frontier emerging markets (non-BRIC).

  • Strategic and operational focus

    To successfully unlock profitability, CFOs must combine local knowledge with a deep understanding of strategic and operational considerations.

    Strategically:

    Timing is everything.

    In emerging markets, go long. Profitability is a long-term proposition. This approach balances the volatility inherent to developing economies, volatility that erodes short- and mid-term returns.

    Differentiate

    Entering emerging markets should differentiate a CFO’s organization. Consider that emerging markets should broaden enterprises, not simply make them bigger.

    Location, location, location

    Geographically, center emerging market operations where it makes industry sense, not necessarily in capital cities. Just as Houston makes sense for Oil & Gas and Detroit for Automotive stateside, China, India and Brazil have their sector concentrations as well.

    Operationally:

    Plan cost structure well.

    CFOs must understand the true cost structure including local labor costs, taxes and logistical/transportation costs. Without that, investments can quickly turn an investment into a loss.

    Manage cash pragmatically.

    Without historical data, forecasting in emerging market is challenging. Often growth expectations are too high.

    Consider too the importance of strategic alliances and partnerships when entering emerging markets. Getting a product or service to market in emerging economies is complex. So developing relationships locally – with local manufacturers, distributors, labor pools and government – is critical.

    Ask whether the right local alliances are in place. Understand the rule of law. Understand how you manage your investment, what liquidity, what governance, what exit rights you get with it. These considerations will fully inform your point of view.

  • Non-financial factors

    Profitability: far more than finance

    Non-financial risks in emerging markets

    EY - Non-financial risks in emerging markets

    Achieving profitability in an emerging market is an evolving challenge. This video explores the non-financial risks a CFO should consider to reach profitability within these emerging markets. [See a transcript of this video]

    CFOs must consider non-financial factors, such as access to natural resources and reputational risks, when working to achieve profitability in emerging markets. Three things that CFOs should consider about profitability in emerging markets:

    • Capitalize on what works in your organization
    • Establish and maintain a clear, long-term, strategic vision
    • Seize first-mover opportunities

    Have courage in your convictions, be prudent in how you underwrite, be prepared for volatility and have good governance.

  • Tax implications

    Tax at the table

    Emerging markets are becoming more assertive about tax. Consider the tax implications of transactions during planning, not after. CFOs can facilitate this shift in thinking, contributing to a sound tax strategy that takes advantage of available incentives while ensuring compliance with an ever-shifting labyrinth of rules. To do otherwise may allow tax to erode profit margins.

    Consider tax implications when seeking profitability in emerging markets

    EY - Consider tax implications when seeking profitability in emerging markets

    Kate Barton, Americas Vice Chair – Tax Services, explains in how companies that plan for taxes upfront when entering emerging markets are more likely to earn profits. [See a transcript of this video]

    Because emerging markets require people on the ground, CFOs must anticipate the immigration, tax and regulatory issues of your mobile workforce.

    Many CFOs don’t grasp the importance of tax when it comes to profitability in emerging markets. Any lack of understanding the emerging market’s tax landscape potentially results in an inaccurate understanding of the true cost of doing business. This can turn what looks like a profitable model into an unprofitable enterprise.

  • Profits and people

    Consider profits and people

    To maintain profitability in emerging markets, CFOs must be aware of the role social compliance and human rights play in their supply chains. Many companies are unaware that emerging markets may likely expose them to socioeconomic issues that translate into reputational risks. Child labor, unsafe working conditions and migrant labor are endemic to developing economies.

    It’s very instructive for CFOs to look at other companies’ historical involvement in emerging markets. Typically, their efforts to mitigate risk are similar. And they tend to start with stakeholder engagement.

    Shareholders demand attention to environmental and social issues. According to EY research, E+S proposals comprised the largest category of all shareholder proposals filed in 2013 , at just under 40%. Knowing – and acting on – shareholder concerns can boost long-term profitability.

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