Expanding Your Business in an Emerging Market?

There's no question that businesses are looking for every competitive advantage they can find these days. From seeking to expand the customer base to lowering production costs, management is always mindful of the bottom line. Consequently, expanding to emerging markets and all the potential they hold has become increasingly attractive for many companies. With these opportunities, of course, come challenges, particularly the concern about escalating compliance and integrity-related risks. In fact, executives are not confident that their companies have effective processes in place to identify and manage these risks when making investments or engaging third parties in emerging markets.

These are some of the key findings of Deloitte Financial Advisory Services LLP's fifth annual Look Before You Leap survey, which solicited the views of 126 business executives on the approaches their companies are taking to address compliance and integrity-related risks in emerging markets. Survey participants represented a wide range of industries including financial services (29%), manufacturing (25%), and information technology and telecommunications (12%). Roughly 75% of participating companies were headquartered in the United States, with other companies headquartered in Canada, Europe, Asia and Latin America.

Many companies are investing in emerging markets through mergers and acquisitions as well as by locating company-owned facilities in those markets (“Greenfield investment”). In addition to expanding their footprint directly, many companies are increasingly engaging third parties located in emerging markets ' such as vendors and a variety of other third parties including service providers, sales agents, distributors, channel partners, and intermediaries.

Compliance and Integrity Concerns

There was a very high level of concern among those surveyed. Seventy percent of the executives stated they were extremely or very concerned about compliance- and integrity-related risks when their company conducts business in emerging markets, while 71% believed these risks had grown over the last two years.

According to the Deloitte survey, bribery of government officials was the issue ranked as the greatest compliance- and integrity-related risk by 40% of executives, while 26% placed commercial bribery or kickbacks as their top concern.

These concerns are well founded as well as troublesome. There were a record number of settlements in 2011 for FCPA violations as well as a record number of enforcement actions against non-U.S. individuals charged in the United States. See Shearman & Sterling LLP, FCPA Digest of Cases and Review Releases Relating to Bribes to Foreign Officials under the Foreign Corrupt Practices Act of 1977, (Jan. 3, 2012). In addition, the whistle-blower provision of the Dodd-Frank legislation is another likely major source of concern.

Executive Confidence

Most executives surveyed were not very confident in the ability of their company to manage compliance- and integrity-related risks. A mere 38% of executives were extremely or very confident that their company had effective processes to identify and mitigate these risks when conducting mergers and acquisitions. When their company made a Greenfield investment, only 34% of respondents had this level of confidence. With regard to third-party relationships, only 40% of executives were extremely or very confident in the ability of their company to manage these risks when engaging vendors, and 36% were this confident when their company worked with third-party agents.

Due Diligence

Due diligence is more common when companies consider investment than when they engage third parties. Seventy-one percent of executives said due diligence is always or almost always conducted by their company before conducting an M&A transaction or making a Greenfield investment. In contrast, only 43% of executives said their company always or almost always conducts due diligence before engaging vendors, while 49% said this was the case when engaging third-party agents.

Initial risk assessments were fairly commonplace according to the Deloitte survey, as 72% of executives said their company employed these tools to determine the appropriate level of due diligence. There is a significant drop-off in diligence at that point, however, as only about half of the executives said their company conducts an extensive examination during due diligence of the possibility of bribery of government officials or of commercial bribery when considering M&A transactions or Greenfield investments in emerging markets or when engaging third parties.

Challenges

The primary difficulty executives cited when engaging third parties in emerging markets was adequately verifying information provided by business partners and third parties (45%). Other issues that were each ranked among the top three challenges by roughly one-third of executives were conducting timely and sufficient due diligence, lack of required skills and knowledge among employees, and securing qualified local professionals and firms to gather relevant information.

These concerns and challenges are very real, as many respondents stated they are likely to invest in emerging markets in the coming years. Of the companies surveyed, 41% indicated they are “extremely” or “very” likely to complete an M&A deal in an emerging market in the next two years. This number increases to 56% for companies with $1 billion or more in annual revenue. Greenfield investments were expected to be somewhat less common with 28% of executives believing it was “extremely or very likely” their company would open a company-owned facility in emerging markets over the next two years, including 44% of executives from companies with $1 billion or more in annual revenues.

Conclusion

Expanding into emerging markets can significantly lower costs, tap a wider pool of skilled labor, improve the ability to respond quickly to changes in demand, and gain access to new customers. The compliance and integrity-related risks, however, are not to be overlooked. Prior to investing or engaging third parties, companies should implement sound and defensible processes to manage risks such as corruption, money laundering, terrorist financing, connections to organized crime, criminal activity, and violations of economic and trade sanctions. In addition, companies should carefully conduct due diligence before making investments or engaging third parties, and should perform ongoing due diligence of existing business relationships and third parties. The opportunities in emerging markets are attractive, but only if your market strategy is carefully executed and monitored.

Adam Schlagman is editor-in-chief of this newsletter.

There's no question that businesses are looking for every competitive advantage they can find these days. From seeking to expand the customer base to lowering production costs, management is always mindful of the bottom line. Consequently, expanding to emerging markets and all the potential they hold has become increasingly attractive for many companies. With these opportunities, of course, come challenges, particularly the concern about escalating compliance and integrity-related risks. In fact, executives are not confident that their companies have effective processes in place to identify and manage these risks when making investments or engaging third parties in emerging markets.

These are some of the key findings of Deloitte Financial Advisory Services LLP's fifth annual Look Before You Leap survey, which solicited the views of 126 business executives on the approaches their companies are taking to address compliance and integrity-related risks in emerging markets. Survey participants represented a wide range of industries including financial services (29%), manufacturing (25%), and information technology and telecommunications (12%). Roughly 75% of participating companies were headquartered in the United States, with other companies headquartered in Canada, Europe, Asia and Latin America.

Many companies are investing in emerging markets through mergers and acquisitions as well as by locating company-owned facilities in those markets (“Greenfield investment”). In addition to expanding their footprint directly, many companies are increasingly engaging third parties located in emerging markets ' such as vendors and a variety of other third parties including service providers, sales agents, distributors, channel partners, and intermediaries.

Compliance and Integrity Concerns

There was a very high level of concern among those surveyed. Seventy percent of the executives stated they were extremely or very concerned about compliance- and integrity-related risks when their company conducts business in emerging markets, while 71% believed these risks had grown over the last two years.

According to the Deloitte survey, bribery of government officials was the issue ranked as the greatest compliance- and integrity-related risk by 40% of executives, while 26% placed commercial bribery or kickbacks as their top concern.

These concerns are well founded as well as troublesome. There were a record number of settlements in 2011 for FCPA violations as well as a record number of enforcement actions against non-U.S. individuals charged in the United States. See Shearman & Sterling LLP, FCPA Digest of Cases and Review Releases Relating to Bribes to Foreign Officials under the Foreign Corrupt Practices Act of 1977, (Jan. 3, 2012). In addition, the whistle-blower provision of the Dodd-Frank legislation is another likely major source of concern.

Executive Confidence

Most executives surveyed were not very confident in the ability of their company to manage compliance- and integrity-related risks. A mere 38% of executives were extremely or very confident that their company had effective processes to identify and mitigate these risks when conducting mergers and acquisitions. When their company made a Greenfield investment, only 34% of respondents had this level of confidence. With regard to third-party relationships, only 40% of executives were extremely or very confident in the ability of their company to manage these risks when engaging vendors, and 36% were this confident when their company worked with third-party agents.

Due Diligence

Due diligence is more common when companies consider investment than when they engage third parties. Seventy-one percent of executives said due diligence is always or almost always conducted by their company before conducting an M&A transaction or making a Greenfield investment. In contrast, only 43% of executives said their company always or almost always conducts due diligence before engaging vendors, while 49% said this was the case when engaging third-party agents.

Initial risk assessments were fairly commonplace according to the Deloitte survey, as 72% of executives said their company employed these tools to determine the appropriate level of due diligence. There is a significant drop-off in diligence at that point, however, as only about half of the executives said their company conducts an extensive examination during due diligence of the possibility of bribery of government officials or of commercial bribery when considering M&A transactions or Greenfield investments in emerging markets or when engaging third parties.

Challenges

The primary difficulty executives cited when engaging third parties in emerging markets was adequately verifying information provided by business partners and third parties (45%). Other issues that were each ranked among the top three challenges by roughly one-third of executives were conducting timely and sufficient due diligence, lack of required skills and knowledge among employees, and securing qualified local professionals and firms to gather relevant information.

These concerns and challenges are very real, as many respondents stated they are likely to invest in emerging markets in the coming years. Of the companies surveyed, 41% indicated they are “extremely” or “very” likely to complete an M&A deal in an emerging market in the next two years. This number increases to 56% for companies with $1 billion or more in annual revenue. Greenfield investments were expected to be somewhat less common with 28% of executives believing it was “extremely or very likely” their company would open a company-owned facility in emerging markets over the next two years, including 44% of executives from companies with $1 billion or more in annual revenues.

Conclusion

Expanding into emerging markets can significantly lower costs, tap a wider pool of skilled labor, improve the ability to respond quickly to changes in demand, and gain access to new customers. The compliance and integrity-related risks, however, are not to be overlooked. Prior to investing or engaging third parties, companies should implement sound and defensible processes to manage risks such as corruption, money laundering, terrorist financing, connections to organized crime, criminal activity, and violations of economic and trade sanctions. In addition, companies should carefully conduct due diligence before making investments or engaging third parties, and should perform ongoing due diligence of existing business relationships and third parties. The opportunities in emerging markets are attractive, but only if your market strategy is carefully executed and monitored.

Adam Schlagman is editor-in-chief of this newsletter.