Expansion of Large Food Retailer into Emerging Markets

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Table of Contents

Why Expand Into Emerging Markets
Summary
Reference List

Why Expand Into Emerging Markets

Emerging Economies have the Numbers

The United state, European countries like UK, Germany and France and Canada have already reached the saturation point in terms of the retail domestic market for food products whereas the emerging economies’ food market remains relatively untapped.

Over the past 15 years, many large food companies from the developed nations like the US and the UK have expanded to foreign nations through franchises, acquisitions and opening of independent stores (Hoffmann & Preble, 2003, pp. 189).

The emerging markets have been found to account for 80% of the total world’s population (Pacek & Thorniley, 2008, p. 3) and at the same time these nations provide over 60% of the global natural resources. As a result, these nations present a very dynamic platform for future long-term expansion of multinationals generally, and to food companies, specifically (Pacek & Thorniley, 2008, p. 4).

Even the US commerce department has approximated that in the next two years, the growth of the international trade will be driven essentially by the emerging markets which at a rate of over 75%.

The largest emerging markets which also account for about half of the world’s population are now becoming major players in the international business because they are experiencing the fastest growing economies hence target for the investors (Hoffmann & Preble, 2003, pp. 189).

Several surveys conducted in the food industry have revealed that more and more food production and processing companies are still searching for opportunities in these markets

As the pace of globalization rapidly influences business in the new markets, the larger, the resource rich emerging economies are now proving to be too significant to overlook (Hoffmann & Preble, 2003, pp. 192). Wal-mart and Tesco are among the top food retailers in the world because of their extensive global presence coupled with their strong international corporate strategies (Marr & Reynard, 2010, p. 112).

Currently, the developed nations’ markets are well served and as a result of the numerous food retailers, the markets are very competitive thus making it extremely difficult to increase sales and earn a good profit margin (Pacek & Thorniley, 2008, p. 4).

Conversely, the emerging markets, as the definition suggests, offer an opportunity where the increasing number of consumers who are will to spend on the premium products offered by the modern food retailers instead of visiting the smaller outlets and market places in the neighbourhoods.

Most Targeted Emerging Economies by Food Retailers

The leading food retailers in the world are constantly seeking for more opportunities to expand their markets and they are now focusing on certain emerging markets which are the best grounds to achieve these goals.

Asia seems to be the best place to seek for prospects because it has China, India and Russia as very strong countries in terms of fast economic growths (Marr & Reynard, 2010, p. 112). Brazil is another country that is doing well where Wal-mart and Tesco have ventured to exploit the market (Marr & Reynard, 2010, p. 112).

International retailer basically look at the rising incomes of people from these nations, the domestic demand based on the increasing populations of these countries, and also the infrastructure development of the rate of urbanisation witnessed in these nations (Pacek & Thorniley, 2008, p. 6). Together, these factors suggest the future ventures would definitely be beneficial hence worth investing in.

The term BRIC was advanced to refer to the top four emerging market and have been used for over 20 years to refer to emerging economies hence making consumers and retailer overlook other countries that fall in the emerging markets category (Pacek & Thorniley, 2008, p. 6).

The word BRIC refers to Brazil, Russia, India and China, which are essentially the top emerging markets but there are many other countries that present great retail growth potential (Marr & Reynard, 2010, p. 112).

Characteristically, the emerging economies are middle-income nations that are also witnessing very high population growth rate, faster urbanisation and industrialization as well as socio-economical lifestyle change. These factors are already implied are crucial for attracting the interests of global food retailers since improving sales depends on the population demand, ability and willingness to buy (Marr & Reynard, 2010, p. 113).

It is for such reasons that China, Russia, Brazil and India have been on the minds of global food retailers with crucial players like Tesco and Wal-mart selectively seeking to secure a niche in these markets. Of course, as indicated earlier, there are many other crucial markets but they are not as big as the BRIC in terms of population or infrastructure development (Pacek & Thorniley, 2008, p. 7).

Brazil has a good number of food retailers already and has not experienced the type of economic growth as its counterparts but still remains crucial (Marr & Reynard, 2010, p. 113). The other three nations of the BRIC have ample of room for investment for instance the disparate regions of China.

Other emerging markets exist in South East Asia, Latin America (Argentina to be specific), Central Europe and Mexico (Welsh et al, 2006, p. 133) but none can compare to what India or china has to offer. Furthermore, they present few opportunities since some larger food retailers and local suppliers already dominate these markets operation.

This leaves the BRIC as major opportunities that every large retailer wishes to secure a niche and become dominant. Even though the economic crisis had different impacts on these nations, it is expected that, their growth and progress will still outpace other countries.

While the impact of the 2008 recession was short-lived in Brazil, Russia was hard hit but India and China suffered little impact and pushed forward (Welsh et al, 2006, p. 133).

The Middle East is promising to become another fasters growing retail market because of the faster changes that are talking place in the socioeconomic setting, infrastructure, tourism, oil business and increasing purchasing power. For global retailers, Middle East will be a key market to watch.

Retail Expansion Spurs Economy

Over the past two decades, there has been increased expansion of food retailers into the developing and emerging economies and this has raised concerns of these multinationals on the emerging market economic systems. Many researchers and analysts are seeking to find out whether these retailers will in the long run have a positive or negative impact on the economy (Welsh et al, 2006, p. 133).

Those who think it would be positive argue that the expansion causes increased productivity, creates new jobs, offers low-priced products and allows investments in capital stock. However the adversaries argue that these expansion strategies promote monopolistic activities and disrupt the local economies and culture (Welsh et al, 2006, p. 135).

Modern international retailers including Wal-mart, Carrefour, Home Depot, Metro and Tesco are seen as putting the domestic retailers in a disadvantaged competition and eventually to those unable to adapt out of business.

Bearing in mind the potential threat the international retailers pose on the economies of the emerging markets, these nations have taken precaution measure that support positive economic drivers and address the plight of the local retailers (Welsh et al, 2006, p. 136).

The benefits of the multinational food retailers on the emerging economies are not the same as those in the developed nations even though the detractors still come up. The advantages that have allowed host nations to allow emerging economies to invest in their market include;

Jumpstarting food retail business – the multinational retailers have been observed to spur changes in the marketplaces of the target countries where they introduce crucial productivity improvement.

For instance, Brazil’s production changed drastically between 1995 and 2000 when it experienced greater market entry of retailers from abroad (Welsh et al, 2006, p. 137). Prior to that the productivity was more stagnant but has since improved by 4%. China has recorded the greatest improved considering that it has allowed greater FDI ventures at about 30%.

The low cost of operation experienced in the emerging markets is past to the consumers through cheaper goods which in turn can counter inflationary impact. The consumer price index of Brazil was observed to have reduced from 7.4% to 4.5% when the rush of international retailer came by between 1995 and 2001.

Increasing Export markets – international retailers can open export markets and the export volumes will surge. For instance, China has policies that ensure they exploit these benefits. China is essentially open to FDI’s and this has lead to an average of $60 billion exports annually with Wal-mart alone exporting products from China estimated to be $20 billion (Welsh et al, 2006, p. 139).

Comparing this to the India’s policy where it is very restrictive and closed to FDI, its exports is precariously at $1 billion annually. These statistics are about the success of the market overall permeability to international retailers rather than individual success of individual firms (Clark et al, 2000, p. 293).

Positive Social Change – the multinational retailers create job opportunities and this usually causes a shift from the traditional retail type of jobs. For example, the venture of Wal-mart into China will hire 150,000 workers as it increased the number of its stores. This is going to cause labour displacement when the job market shifts from rural traditional type to the modern retail type.

The disruption is not as bad as fear, but the income will be higher and more people will be employed (Clark et al, 2000, p. 293). Plus the production of other local competitors will improve to international standards in order to keep up the pace rather than stick to traditional family owned type in India and rural retail in China.

Theories for Multinational Corporations Expansion

This chapter is aimed at addressing the international diversification benefits that the multi-corporations seek by investing in emerging economies. The corporate international diversification theory hypothesize that MNCs seek to reduce risk and financial leverage compared to domestic companies (Grosse, 2005, p. 103).

The alternative upstream-downstream theory is the principle upon which the internationalization on risk and leverage of the MNC differ with domestic and target economies.

Much of the literature in the past has highlighted that MNCs venturing into the emerging markets was basically for diversification benefits, lowering the risks and subsequently increasing the level of debts utilization (Grosse, 2005, p. 103).

Recent studies have on the contrary found out that risks were consistent with the internationalization. There, this study deduces that increasing a company’s risk was consistent with corporate internationalization.

Upstream-downstream Hypothesis

In the same line, the upstream/downstream hypothesis purports that changing the cost of capital by foreign direct investment (FDI) was a product of the relative risk between the two countries in question. (Kwok & Reeb, 2000, p. 615) suggested that a company with headquarters in a developed market and investing in an emerging market is said to have reduced company risk.

The inference of this is that the cost of capital for the emerging market based company with FDI will reduce because of the reduced risk. In contrast, a firm based in the developed market like the United States will face larger cost of capital with internationalization (Grosse, 2005, p. 103).

According to this theory, the net effect of the cost of capital as a result of internationalization is an indistinct factor and depends on the relative risk two countries i.e. the developed nation or home country and the emerging market or the host nation.

According to the argument given by Kwok and Reeb, 2000, p. 616, when companies from stable economies invest internationally, there is increased risk and this lead to reduced debt usage. Firms from weaker economies investing internationally causes reduced risk and this allows more debt utilization.

Figure 1: Upstream-Downstream

The principle behind this concept is basically the characteristics of every type of economy. For instance, the emerging markets present bigger infrastructure risks, payment risks, political risks and consumer risk among others (Coe & Hess, 2005, p. 451).

The infrastructure risks are the type of risks that are as a result of the development of the public infrastructure like when a country is developing its transport system, power lines and telephone systems. The impending delays in transport, communication and power shortages that come with these developments are the infrastructure risks.

Labour risks entail the differences that exist because of the education, living standards and health of the potential employees (Kwok & Reeb, 2000, p. 616). Instability of the workforce performance and absenteeism are due to the labour risks. These additional risks from the lesser stable economies explain the general impact of globalization on a company’s leverage and risk.

Geographical and Industrial Diversification

Empirical proof has shown substantial negative impact on the shareholder value that is linked to the company’s diversification across a number of activities; nonetheless economic theory offers a number of arguments that suggest that geographical diversification who greatly benefit the company value (Bodnar, et al, 1997, p. 123).

The average value effect of the geographical diversification is similar to the average value of industrial diversification but opposite hence this brought Bodnar et al to a conclusion that the generally discussed negative value effect of industrial diversification is connected to positive value effect of geographical diversification.

The country, currency variation and industry factors on global scene are very crucial for international business (Grosse, 2005, p. 107). The factors behind covariation in stock returns among nations like regulatory, cultural differences, trading costs and political risk pose a challenge to the professionalism and education.

Analysts purport that the gins come from the diversified economic circumstances that underlie the foreign capital markets due to different monetary and fiscal policies, country’s national growth rates, changes in interest rates and deficits in the budget (Bodnar, et al, 1997, p. 123).

Portfolio managers usually seek to invest abroad, but they ought to understand the industrial composition of their product portfolio so as to attain the most effective risk reduction (Meyer, 2004, p. 263).

The country factors usually dominate the international stock returns, however industrial characteristics of the international investment offer explanation of the 38% of the total returns variation characteristic of country factors (Coe & Hess, 2005, p. 452).

MNCs v Domestic Companies

The Foreign Direct Investment has been proven to be a very pertinent characteristic in the progressively more globalized international economy. Globalization f production and markets over the last ten years has caused increased international trade – imports and exports and the FDIs.

As many nations strive to reduce the trade barriers among them (Coe & Hess, 2005, p. 452), they realize that they can attain efficient production and market to the world market. The multinationals are the key players in the FDIs contributing to over 90% of them on the international scene (Meyer, 2004, p. 263).

Many education theories posit that global capital markets are wholly integrated when the transaction expenses are cheap, and when the investors are cogent and risk reluctant then they will not benefit from diversification intrinsic to the MNCs. This could not be obtained by shareholders investing directly to other countries where the MNC would otherwise work (Solnik, 2000, p. 134).

This also draws the conclusions that perfect financial markets do not offer systematic advantage to the shareholders of the MNCs against owning the domestic firms in another country’s company. When markets are imperfectly integrated, the MNC is performing a valuable role to the shareholders (Solnik, 2000, p. 134).

There are a number of things to note about the performance of the MNCs compared to the domestic companies. First, the domestic companies seem to have greater risk-adjusted, market performance (Meyer, 2005, p. 6). Second, the MNCs have considerable capital than domestic companies.

Third, the average equity deviation of the local companies is considerably greater than the MNCs (Bekaert & Harvey, 2000, p. 567). The average systematic risk of the MNC is much lower compared to local companies. Finally, the MNC are significantly larger the domestic firms but this does not have an effect on the observation (Meyer, 2005, p. 6).

Efficient Markets

Globalization takes place because companies are seeking to generate more profits and exploit opportunities. The real MNCs are after all assumed to maximize their proceeds at a global level. This zealous search for profits is a consequence of the perceive opportunities deduced from the transaction cost theory, location advantages and market power issues (Bekaert & Harvey, 2000, p. 567).

There are two basic issues that emerge from this; the first presumes that the market inefficiencies exist and that opportunities which can be pursued and exploited via FDI. Second, is that the market are efficient and it is the efforts of the shareholders to seek to exploit benefits of increased diversification through investments in a diversified portfolio assets.

The question that emerges from these arguments is that whether the MNC are actually more profitable when they are adjusted for risk (Bekaert & Harvey, 2000, p. 567).

Based on the idea that maximization of profits as an investment strategy will increase the dividends and the prices of common stock, studies have shown that the rates of return increased (Solnik, 2000, p. 134).

Capital Structure

The international diversification of the multinationals results into decreased risk of going bankrupt according to measures of the capitalization ratio, return on assets, industry characteristics, the company size, and standard deviation of equity (Bekaert & Harvey, 2000, p. 567).

According to previous researches, the average risk of the domestic company measured by the standard deviation of equity is consistently greater than that of the MNCs. The return on assets for both Domestic firms and MNCs have minimal differences hence the MNC are considerably more capitalized.

Therefore, even though the profits may not be much different between the two firms (domestic and international) the risk for the MNC is much lowered (Bekaert & Harvey, 2000, p. 567).

Summary

It is important for the emerging economies governments to work with the managers of these multinational retailers to ensure that they get into deals that are good for both parties. This would make sure that just as there is rush for the international retailers to pursue new markets, the emerging markets will also strive to attract these global retailers.

As much as the international retailers will have the say when it comes to decisions as to when and how they will enter the foreign markets and also when a necessary when to increase the stake, the emerging market will have policies to ensure that the decisions are to their advantage. Eventually, the outcomes of the companies and the markets would be of mutual benefits since the benefits come to both the parties involved.

This paper looks at the food retailers specifically because statistics show that a considerable number of retailers that have gone global are food retailers particularly those from Europe seeking opportunities in emerging markets. There was a good reason for these ventures to do so. The European markets experienced increasingly regulatory constraints in their home countries.

Hence this was a very strong incentive to send them to the global market and seek opportunities in foreign countries. Additionally, emerging markets were observed to have lesser purchasing power because of poverty rates. As a result the foreign companies sought mainly to provide the basic needs instead of discretionary products.

Food retailing was the main industry that could survive in such conditions and it therefore went global. Currently, the change is rapid as the world; specifically the emerging markets are witnessing the increase of the middle class hence helping in the progression of the food industry and recently discretionary.

Reference List

Bekaert, G., and Harvey, C. R., 2000. ‘Foreign Speculators and Emerging Equity Markets,’ Journal of Finance, 55, 565 – 613

Bodnar, G.M., Tang, C., and Weintrop, J., 1997. ‘Both sides of corporate diversification: the value impacts of geographic and industrial diversification” National Bureau of Economic Research, Working Paper 6224

Clark, G.L., Feldman, M.P., and Gertler, M.S. 2000. The Oxford Handbook of Economic Geography, oxford: Oxford University Press

Coe, N.M and Hess, M., 2005. ‘The Internationalization Of Retailing: Implications for Supply Network Restructuring In East Asia’, Journal of Economic Geography, Vol. 5: 449-473

Grosse, R., ed. 2005. International Business and Government Relations in the 21^stCentury, Cambridge: Cambridge University Press

Hoffman, R. and Preble, J., 2003. ‘Convert to Compete: Competitive Advantage through Conversion Franchising,’ Journal of Small Business Management, 41(2), 187-204

Kwok, C.Y and Reeb, D.M. 2000. ‘Internationalization and Firm Risk: An Upstream-Downstream Hypothesis’, Journal of International Business Studies, 31(4): 611-629

Marr, J and Reynard, C. 2010. Investing in Emerging Markets: the BRIC Economies and Beyond, New York: John Wiley and sons

Meyer, K., 2004. ‘Perspectives on Multinational Enterprises in Emerging Economies,’ Journal of International Business Studies, 34(4), pp. 259-277

Meyer, K., 2005. ‘Foreign Direct Investment in Emerging Economies,’ Policy Discussion Paper, Emerging Markets Forum, Templeton College, Oxford, pp. 3-29

Pacek, N and Thorniley, D. 2008. Emerging Markets: Lessons For Business Success and the Outlook for Different, New York: Bloomberg Press

Solnik, B., 2000. International Investments (4^th Ed), New York: Addison-Wesley Longman

Welsh, D.H., Alon, I and Falbe, C. 2006. An Examination of International Retail Franchising in Emerging Markets, Journal of Small Business Management, Vol. 44, Issue 1, pp. 130 -149

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