EY - The Master CFO Series: What lies beneath?

High Performing CFO

The hidden costs of rapid-growth investing

The Master CFO Series - What lies beneath?

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The long-term outlook for these economies is extremely bright. But growth at this rate inevitably means there will be bumps along the way. Accepting that these will happen is part of investing in rapid-growth markets.

Among our survey respondents, 36% say that the overall cost incurred in their recent investments in rapid-growth markets was higher than expected. A bigger problem than cost however, is time, with more than four out of ten reporting that they spent more time than anticipated.

Everything took much longer than we expected,” says Mr. Brooks, of Experian. “The sheer bureaucracy meant that the licensing process alone involved multiple government agencies, then there would be a change in the individual handling it and everything would be set back again.

Chart 3: Thinking about recent investments that you have made in your main rapid-growth markets, how would you assess the overall level of cost incurred in the following areas?
EY - Thinking about recent investments that you have made in your main rapid-growth markets, how would you assess the overall level of cost incurred in the following areas?

Six areas of concern for CFOS in rapid-growth markets

The hidden costs and risks facing companies that invest in rapid-growth markets are many and varied. From our research, we have identified six in particular that are likely to cause problems for investors.

Chart 4: Thinking about recent investments that you have made in your main rapid-growth markets, how would you assess the overall level of cost incurred in the following areas?
EY - Thinking about recent investments that you have made in your main rapid-growth markets, how would you assess the overall level of cost incurred in the following areas?

  • Financing costs: rising inflation and currency fluctuations are becoming key concerns for foreign investors

    Surging capital flows into rapid-growth markets are stoking inflation and pushing up currency values. Although policy-makers in these markets are trying to cool their economies by tightening monetary policy, the potential for currency risk remains a key source of unexpected costs for foreign investors.

    International policy is creating another source of currency risk. Growing pressure on the Chinese Government to further revalue the renminbi and allow it to appreciate more quickly could raise costs substantially for exporters and alter the rationale for investment in China.

  • Mode of entry costs: choosing the right mode of investment is considered the most critical decision, with valuation a key challenge

    When asked to advise their peers on where to pay most attention in relation to investing in rapid-growth markets, respondents point to the mode of entry as the most critical decision that must be made, even more so than the investment destination.

    It pays also to take a long-term view. Over time, given increased market liberalization in many markets, the mode of investment may need to change. Companies planning an investment should consider whether this will be possible and what the implications will be.

    When acquiring companies in these markets, survey respondents consider valuation to be the key challenge they face. Although the situation varies from market to market, investors may find it difficult to extract accurate data on which to base a valuation.

    Another common problem is that disclosure levels may be poor, either because of regulatory shortcomings or a lack of cooperation from the seller. These challenges highlight the importance of obtaining data from multiple sources and using a combination of valuation methods to improve accuracy.

  • Operational costs: those related to R&D and finance function integration are the main operational concerns

    Anything that increases the cost of production is a critical concern for CFOs, in markets that rely on very high volumes and very low margins to make profit. The highest unanticipated costs relate to R&D investment which, particularly for high-performing* companies, is on the rise.

    The increasing importance of rapid-growth markets is encouraging a growing number of companies to set up R&D centers in these economies to serve populations with fast-rising per capita incomes. Another key area of overspend relates to the integration and harmonization of reporting frameworks, IT systems and local finance talent to meet global reporting obligations.

  • Regulatory costs: evolving regulatory systems and high levels of bureaucracy are the main areas of unbudgeted cost

    Obtaining the right licenses and permits is a particular challenge for survey respondents. As regulatory systems evolve, these costs may be streamlined but other compliance costs will rise as regulation becomes more demanding. Foreign investors should ensure that they “future-proof” their investments by anticipating future regulatory change and building that into their overall business case.

  • Human capital costs: attrition levels are the main reason for human capital overspend

    Rapid economic growth and rising demand for a finite pool of skilled workers are pushing up wages and creating high levels of employee turnover in many rapid-growth markets. To counter this problem, foreign investors need to build a brand as employer of choice, ensure that they build strong relationships with local communities and pay close attention to training and compensation policies.

  • Political costs: fear of expropriation has been replaced by bribery and corruption

    The recent upheaval in the Middle East and North Africa has brought political risk back to the top of the agenda. Political risk management forms a critical part of the pre-entry planning but should also stay on the radar throughout the life cycle of the investment. Although some political risks, such as expropriation, have diminished, others, such as bribery and corruption, remain a key concern.

    While acknowledging that local competitors and partners may be used to bribery as part of the normal course of doing business, zero tolerance is argued as critical by those CFOs interviewed, and a key consideration when determining investment destination.

* Those companies with EBITDA growth of above 11% over the last 12 months.