Why Foreign Investors Need to Look at Political Risks in India - Essay Example

?Investing in Emerging Markets Introduction Emerging markets are the new development strategy of almost all multinational corporations at present. Several rounds of crisis in the western countries, uncertainty on the future of developed nations, and other economical and demographical issues at the developed countries had resulted in the companies looking for opportunities in the emerging economies. Some of the emerging markets that have captured the attention of intellectuals around the world are China, India, Brazil, Russia, Mexico, Indonesia and Turkey. Among the above list, China and India are the markets with the greatest potential. These are the markets where companies enter for quick return on investments. “Even though emerging markets generally do not have the level of market efficiency and strict standards in accounting and securities regulation like advanced economies -- such as the United States, Europe and Japan -- they are most sought after by investors for the prospect of high returns, as they often experience faster economic growth as measured by GDP.” (Rediff Business, 2011) China’s economy is the fastest growing economy in the world at present. Similarly, India’s growth rate is expected to surpass even that of Japan. Studies by various organisations show that the emerging market economies are set to overtake all the G7 economies by 2020. Such studies do have enough reasons to substantiate their views. This essay will deal with the strategic expansion of IKEA with its Greenfield operations in India. India had recently opened up its market for 100% Foreign Direct Investment (FDI) in the retail sector. IKEA did not waste even a day after the decision, the company has started framing board room strategies for the Indian market. Company IKEA is undoubtedly the world’s largest furniture retailer. Though furniture is its flagship product, it is also one of the largest home furnishing retailers in the world. The Company which was established in 1943 is headquartered in Leiden, Netherlands. What make IKEA different from the competitors are its modern and unique furniture designs. Moreover, IKEA designs are also eco-friendly compared to the competitors. When it comes to managerial efficiency and vision, IKEA is a benchmark for any businesses. The company gives extreme focus to cost control and product development because of which they are able conquer new markets without much effort. Cost control gives them an edge over the pricing. The continuous product development helps them to keep pace with the changing trends. IKEA has been on a continuous growth path ever since its inception. The story is no different in 2012 too. “Net profit at the privately-held Swedish firm, known the world over for low-price, self-assembly, flat-packed furniture, rose 10.3 percent to 2.97 billion euros ($3.8 billion) in the year to last August.” (Reuters, 2012) Russia, China and Poland were the countries that contributed more to the overall sales of the company. This huge increase in profit is despite of the hike in raw material prices. Even at a very high raw material cost the company did not pass it on to the customers. It continued supplying products at lower prices as it used to be. The company is planning for about 3 billion euros of investments worldwide in the coming years. IKEA has constituted its product portfolio in such a way that even during a slump in demand due to economic problems, there are products that are focussed on the cost conscious customers. Because of this, IKEA is able to maintain sales and market share even during a slump in the economy. IKEA is now focussed on its strategy for the emerging markets such as China, India and Russia. Investment Unlike many other companies, IKEA wants their business units to be under their sole ownership. They are not ready for partnering with a domestic player which is why they backed out from Indian market entry years before (India permitted only 51% FDI in retail then). They enter the market with a careful study and examination of the market from all perspectives. Now that the Indian market is opened up for 100% FDI in retail sector under condition that 30% of the products should be sourced from the domestic market “The euro 25-billion Swedish furniture company, IKEA, has taken the first crucial step in starting the India business. Even before it gets the government clearances on setting shop here, the group has appointed its India head.” (Mookerji, 2012) IKEA is planning to invest around Euro 1.5 Billion in India. The company is expecting to take around two to three years to start its operations in the country. Delhi, Hyderabad, Mumbai, Bangalore and Chennai are the cities that the company is focusing on at present. Once they establish themselves in these cities, expansion to other cities will be taken forward. IKEA is adopting the strategy of supporting social causes for better market expansion and brand value. IKEA is partnering with the Handicraft’s Department of India in order to develop designs. This is a win-win situation. IKEA is already involved in a woman empowerment program in India along with United Nations Development Program (UNDP). Women from rural areas are trained to produce various household items which are then exported to various foreign markets. Though the Indian market is different from all the major markets of IKEA in terms of the product aspirations and spending habits, IKEA is planning to adopt its same design philosophy in India rather than modifying it for the Indian market. Most of the products of IKEA are the ones that can be assembled by the customers. That is the way products are sold across all its major markets. IKEA will adopt the same in India too with additional features that will customer participation in design development. Thus the company is planning to offer the customers with unique designs or designs as per the customer’s choice. “To enter India with Indian designs would place us in a crazy position competition-wise. If we stay Scandinavian and do what we do best we will be unique in the market”, said an official from IKEA (Ringstrom, 2012). As a first phase, IKEA will be investing around Euro 600 million in India. Expansion into a country like India is not as easy as it is in the developed nations. This is in fact the second coming of IKEA into India after it wound up its initial plan in 2008. As per the government norms, IKEA will have to source 30% of the products sold from their stable to be sourced locally from the small and medium scale enterprises of India. Once the final approval for operations is given by the government, the initial two to three years will be focused on building the supply chain and distribution system. IKEA usually has a large store format that covers 50,000 or more square feet. Sources also say that the company may also plan for anchor stores within a mall. But the typical IKEA way is an exclusive property of its own. Therefore, it may not be possible for the company to set up the outlets at the heart of any cities as the property prices therein will be much higher. IKEA is planning to look for outskirts of a city which is a much more viable option for them. The one global strategy of IKEA that will work perfectly for India is lower price without deterioration of quality. The decision of IKEA to start Greenfield project in India rather than inorganic or acquisition project is a part of its global strategy as per which they want to the sole owner of their brand. This strategy is supposed to work well in the India market too. But unlike other established markets and emerging markets, IKEA will have to face many uncertain operational issues in India. Some of these will be discussed in the later part of the essay. Motivating factors IKEA is foraying into India as part of their global expansion plan. IKEA’s potential investment in India is driven by the following motivating factors. 1. Higher disposable income 2. Aspirations of the customers 3. Better economic growth 4. Develop manufacturing hub 5. Reduce cost of production Higher Disposable Income: India is witnessing higher growth in its disposable income especially at the younger generation. Higher disposable income means that the population will have better purchasing power. IKEA is seeing this as a potential factor for their growth in India. Moreover, the middle class population of the country which currently forms merely around 5% – 6% of the total population is about to grow up to 25% by 2025. Such higher growth means that the companies like IKEA have better future in India. Aspirations of the customers: The Indian customers are not the ones that settle down for domestic products anymore. They are becoming quality and brand conscious for every penny of their spending. This is the reason why several luxury goods manufacturers have seen immense success in India. “A typical upper middle class young consumer is beginning to look beyond the utility aspect of a product to seek intangibles like brand and lifestyle statement associated with the product.” (KS Oils, 2008) Customers are very much concerned about the value of the products. IKEA being an international brand will be well accepted by the Indian customers. Another notable feature is that Indian customers are also cost and quality conscious. IKEA has an edge over both of these areas. Better economic growth: Indian economy is growing at a rate of 7% - 8% every year. This growth rate is witnessed when several other developed nations are struggling hard to reach even a 1% or 2% growth rate. As discussed earlier, by 2025, India’s economy is expected to overtake many other developed nations. A higher economic growth rate will benefit both the domestic and foreign companies as there will be better markets for the products. Develop manufacturing hub: IKEA has plans to develop India as its manufacturing hub. The company has been exporting goods from India for its global markets for more than 25 years now. “The company sources $600 million worth of goods from here every year, primarily textiles and carpets, and plans to increase this to $1 billion annually. It has 70 suppliers and 1,450 sub-suppliers here supporting its global operations.” (Kaushik, 2012) Therefore, once they establish their presence here with retail outlets, it can increase the number of suppliers in India. This will ultimately help the company to source more products from India to serve its Indian as well as global markets. Reduce cost of production: IKEA already has a well-established supplier network in India. The company is currently utilising this network for its global operations. Once they start their retail operations in India, IKEA will be able to achieve economies of scale due to larger sourcing. This can be utilised by the company to increase the profit margin as well as to command an edge over pricing. These were some of the motivating factors that forced IKEA to decide on entering the Indian market. The industry need to wait for another couple of years to see how the Indian market pays back to IKEA. Meanwhile, the company will have to face many issues and risks in the country. One of the main risks that can cause troubles in the operation is Political Risks. Political Risk Political risk is the major issue that IKEA will face in India. Political risk is an inherent feature of Indian market. All big companies, domestic as well as foreign would have had some bitter experiences with the political system of the India. Some of the major political risks that the company will have to face are as follows: 1. Political instability 2. Labor issues 3. Corruption and bureaucracy 4. Strong oppositions 5. Social unrest 6. Currency, inflation and interest rate fluctuations (Business Foundations, 2012) Political instability: Political instability is the major political risk in India. Indian is even ranked as one of the most politically unstable countries in the world. Unlike many other nations, there are a lot of political parties in India. Therefore, the ruling government itself will be a coalition government that consists of several smaller groups. This system is complex because any governmental decisions will be passed on only after its acceptance by the sub groups. Labor issues: Labor unrest is another major issue in the democratic India. Though India is an emerging market and introduces reforms that are investor friendly, the labor unions are very much reactive in the country. The labor unions are also backed by major political parties. A few months back, the HR Manager of Maruti Suzuki was burned alive in the plant during labor unrest. Corruption and bureaucracy: Corruption and bureaucracy has become synonym to Indian government. During the current term of the ruling party itself, a several rounds of scams by them were uprooted, the 2G scam being the costliest scam ever in the Indian history. The government system is also highly bureaucratic. “Indian bureaucracy is the worst in Asia with a 9.21 rating out of 10, according to a report by a prestigious consulting firm based in Hong Kong.” (India Today, 2012) Strong oppositions: The opposition parties in India are always very strong that no new policies can be implemented in a short span of time. Even the 100% FDI in single brand retail is approved in 2012 when the actual discussions started way back from 2008. The opposition parties are generally concerned about their survival. Therefore, they will usually be repulsive to any new policies that are introduced by the ruling party. Social Unrest: Social unrest is also higher in India. The Indian society is very much reactive to the governmental policies. Such unrests will be backed by the opposition political party. The general uproar raised as part of the movement by the person called Anna Hazare had acted as a threat to the political system of India. Even the stock markets reacted badly during those times. Currency, inflation and interest rate fluctuations: The recent months have shown the currency, inflation and interest rates fluctuating badly in India. Indian currency is now at the lowest level ever in its history. Even during the worst economic crisis, the Indian currency did not fall to the level as it is in now. Inflation is also at a very high rate at present. Fuel price is one of the major contributors to this scenario. India imports more than 80% of their fuel requirements from other nations. Therefore, any fluctuation in the global fuel prices will immediately impact the Indian economy. “A substantial proportion of senior finance executives in India identify exposure to volatility in foreign exchange rates as the biggest threat to their company’s growth prospects in the coming year.” (Srivats, 2012) Measures to minimise risk Even if the political risk is higher, there are certain strategies that the company can adopt in order to minimise the risk. Some of the strategies that can be adopted are as follows: Negotiate terms of compensation: IKEA should negotiate terms and conditions on a timely basis with the government just as it did regarding the 30% sourcing of materials. Initially, the government insisted that 30% of sourcing of material should be done from the small and medium scale industries of India. But IKEA made it clear that considering the scale at which IKEA operates, it would be difficult for them to source it only from the small and medium scale industries. As per the explanation, the policy was then modified by the government. Political risk insurance: “Whilst at a macro level political risk and catastrophes are very difficult to manage, at the company level; political risk can be defended against for a premium.” (Cranfield, 2011) IKEA should find an insurance vendor that can provide a good coverage to the company from political risks. This will come at a very high cost. But, considering the huge size of the investment that is planned for India, having political risk insurance will not be an unwanted overhead cost. Risk officer: It is better to appoint a risk officer for the company. IKEA should appoint a risk officer who is entrusted with only the task of identifying any potential risks and frame strategies well in advance to manage the risk. Such duty is usually performed by the CEO’s or MD’s. The risk officer should act as a relationship person between the company, opposition government and the company. Conclusion India will be a very promising market for IKEA. Considering the economic condition and market demand, IKEA will be able to become the number one player in the organised furniture retail market in the country. Though, currently a mere 10% of the sector is in the hands of organised brands, the percentage share will go up very high in the years to come. There were certain views that the entry of IKEA will act as a threat to the domestic furniture retail industry. But studies as well as the industrial sources says that IKEA’s presence will only boost up the market to open doors for bigger players and improve the quality of goods available to the customers. Customers will also benefit through lower prices with the entry of many players in the segment. For IKEA, the Indian investment will be a game changing move. This market is entirely different from all its present markets in terms of demographic, economic and political factors. Though IKEA was planning to maintain the Scandinavian design philosophy for India, sources now say that the company is re-thinking to customise designs for the Indian culture. This will be good for the company as it will help them to avoid the likes of risks that McDonald’s faced in the initial years when they introduced the hamburger. McDonald’s later has to withdraw all its hamburger products from India and spend a lot on advertisement to restore the customer interest. But for IKEA, the product being furniture, it will not face any culture related issues. The one potential issue that can arise is from the environmental activists regarding the usage of woods for furniture. But IKEA, being known for eco-friendly practices across the world will have enough strategies to respond to any potential blame on that regard. References Rediff Business, 2011. The world’s top 10 emerging economies. [Online] Available at: [Accessed 7 November 2012] Reuters, 2012. IKEA posts record profit, gains in almost all markets. [Online] Available at: [Accessed 7 November 2012] Mookerji, N., 2012. IKEA kicks off plan with top appointment. Business Standard. [Online] Available at: < http://www.business-standard.com/india/news/ikea-kicks-off-india-plantop-appointment/190362/on> [Accessed 7 November 2012] Reuters, 2012. IKEA furniture to retain Scandinavian Style in India. [Online] Available at: [Accessed 8 November 2012] KS oils Limited, 2008. Indian Consumer Market. [Online] Available at: [Accessed 8 November 2012] Kaushik, M. 2012. Home Run. Business Today. [Online] Available at: [Accessed 8 November 2012] Business Foundations, 2012. Why Foreign Investors Need to Look at Political Risks in India. [Online] Available at: [Accessed 8 November 2012] India Today. 2012. Indian bureaucracy rated worst in Asia, says report. [Online] Available at: [Accessed 8 November 2012] Srivats, K.R., 2012. Exchange rate fluctuations troubling Indian CFOs: Survey. Business Line. [Online] Available at: [Accessed 8 November 2012] Rajwani, T., 2011. How Should Firms Deal with Political Risk. [Online] Available at: [Accessed 8 November 2012] Read More