Emerging markets

CFO: need to know

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Why profitability in emerging markets is a must for CFOs

Most multinational organizations have made moves to capture some of the growth potential of emerging markets in recent decades. Few, however, have been successful at turning the growth they have achieved into profit.

In today’s increasingly competitive emerging markets, profitability is more difficult to achieve than ever. Here are some of the reasons why CFOs need to focus their organizations on achieving profitable growth, and not just growth, in emerging markets.

Video icon  Profitability in emerging markets - find out more

EY - EMEIA Profitability in emerging markets - find out more
 

EMEIA Profitability in emerging markets - find out more. [See a transcript of this video]

Emerging market performance is becoming more visible. In a recent EY survey, 69% of corporate respondents said that they expected the emerging markets to be their main source of profit and growth in the next three years. However, only 20% are managing to achieve the balance between investing enough to realize their growth potential while also being profitable. As emerging market investments become an increasingly significant proportion of the overall portfolio, they are becoming far more visible on the balance sheet than they once were.

Costs are increasing. In a recent EY survey, over a third of CFOs said they had underestimated the cost and time it had taken them to enter emerging markets. As the standard of living gets higher in many emerging markets, so do labor costs, commodity prices and the cost of capital. Annual labor inflation in India has reached as high as 15% according to the Federation of Indian Chambers of Commerce and Industry. These increasing costs are squeezing the profitability of all investments in emerging markets, so they need to be tightly managed.

Competition is becoming more intense. In many emerging market locations, the competitive landscape is made up not only of multinationals, but an increasingly large number of regional and domestic players. Companies now need sophisticated strategies to achieve the top-line growth that was more easily achievable in the recent past.

Six questions for CFOs on achieving profitability in emerging markets

Achieving profitable growth in emerging markets requires CFOs to strike the right balance between many opposing forces. But while the answer on where to sit on these spectrums will vary across sectors, markets and companies, the questions CFOs should be asking themselves are largely the same.

Are you planning for profit? CFOs are increasingly recognizing that while an initial loss may be necessary in the early stages of an emerging market investment, a clear plan for when, and how, to become profitable is essential. When CFOs have a clear path toward profitability with associated metrics, they can spot the early warning signs when an investment has switched from being a short-term loss leader to a long-term drain.

Are you investing at a higher rate than margin is being earned? Once your initial investment has been made, CFOs should consider moving quickly to a “pay as you go” model whereby investment in growth is made only as margin is generated. This ensures the investment becomes self-sufficient quite quickly.

Do you have the data to identify current and future profit pools? In a recent EY study of investors, two-thirds of respondents said that inadequate data and a lack of transparency in emerging markets made it difficult to evaluate investments. Producing detailed and accurate data can be expensive to start with. But, without it, CFOs cannot carry out the analyses and decision-making needed to make emerging market operations a success. With it, companies can create a competitive advantage.

How are your markets different? And how are they the same? Emerging markets often need to be evaluated from city to city, rather than from continent to continent. CFOs need to understand how emerging markets are distinct, and ensure their approach is adapted accordingly. But CFOs should also consider similarities between markets. There may be more commonalities between certain urban populations on different continents, than between two towns in different regions of the same country. By recognizing and adjusting for these commonalities, CFOs can create scale and efficiencies.

Have you got the right balance between local and central decision-making? To react to the rapidly changing business environment, emerging market managers need autonomy to make decisions. If they are to make the most of local opportunities to drive costs down and respond to market demand, speed is of the essence. They must be empowered to make many decisions without seeking approval from head office.

However, to ensure that these decisions are consistent with company strategy, CFOs have a key role to play in establishing a clear governance framework, and setting KPIs and targets to match.

When it comes to costs, how low should you go? In a recent EY survey of CFOs and other senior executives, 44% said that a high number of fixed costs was one of the top three barriers to profitable growth. And yet many multinationals continue to adopt entry strategies that involve putting a large amount of fixed costs into the investment location.

CFOs need to consider alternatives to fixed costs, such as third-party manufacturing, to support profit generation. However, it is important that cost cutting is not at the expense of product quality or the customer experience.