Chapter 1 The Management Challenge WHAT IS DIFFERENT ABOUT MANAGING IN DEVELOPING COUNTRIES? The fundamental difference is the distinctive nature of the business environment, which varies considerably from that of the more developed nations. This carries significant managerial implications. A few examples will illustrate. When Cummins Engine Company set up one of its first overseas operations to manufacture diesel engines in India, it encountered a host of new problems: government controls, production difficulties, financial restrictions, and market disruptions. The government required that Cummins incorporate as a joint venture with a local partner. Manufacturing problems arose because of difficulties in transferring technology, difficulties in training employees in new techniques, and the local partner's different perceptions of and attitudes toward quality. Further complicating production was the inadequacy of the industrial infrastructure: Local parts suppliers were technically unable to meet Cummins's quality standards, yet the government required Cummins to use local inputs anyway. The required types of steel were not locally available and had to be imported. Import financing was restricted by the scarcity of foreign exchange in the country and cumbersome bureaucratic procedures to obtain import licenses from the government. This caused long delays that further disrupted production schedules. Initial sales projections were based on the expected demand for diesel engines that would result from the government's emphasis on heavy industry in its national development strategy. But demand collapsed when the government shifted priorities and resources away from industry and toward agricultural production. The government also tightened credit to counter rising inflationary pressures, which reduced the financial resources needed by the buyers of engines (several of which were state-owned enterprises). Finally, Cummins was faced with intensified competition from lower-priced Japanese imports after receiving assurances f rom the government that such imports would be prohibited. For Cummins, the Indian startup clearly was not going to be a case of doing business as usual. This was a very different environment. The macroeconomic environment also poses special problems. In Mexico a local family-owned company had operated a very successful electrical appliance distribution business for many years. But in the 1980s its success and even its survival were threatened when double-digit inflation broke out. Its traditional policies for pricing, consumer credit, supplier payables, and bank financing began causing losses and decapitalization. The changing macroeconomic environment in Mexico also battered foreign companies, such as the successful Pepsico subsidiary, Sabritas. The government unexpectedly devalued the peso, which, in dollar terms, wiped out the company's peso profits. Furthermore, the acute balance-of-payments problem led the government to require Sabritas and other firms to begin exporting as a condition for continuing to import their production equipment and inputs. In many developing countries the macroeconomic situation and business environment are significantly affected by loans and economic aid provided by developed country governments and such multilateral agencies as the International Monetary Fund (IMF) and the World Bank. Egypt, for example, received in 1989 about $2.8 billion in aid from the United States, an amount equal to Egypt's budget deficit. Such aid often comes with requirements for policy changes, e.g., fiscal austerity or devaluations. Such actions can dramatically affect the operations of firms as well as disrupt political conditions. IMF agreements that led to reductions in government subsidies and food price increases triggered bread riots in Egypt in 1977. Many Egyptian officials feared a repeat, if cuts were too severe in 1989 and 1990. Thus, dependence on external aid complicates the political economy of less developed countries (LDCs). At the same time, the additional capital resources often create business opportunities related to the development projects they fund. A tumultuous political environment often confronts companies. The management of Standard Fruit, the Castle & Cooke subsidiary in Nicaragua, found itself in 1978 in the middle of an armed insurrection, with pressures coming from both the existing government and the revolutionaries. Standard later had to develop strategies for dealing both with the new revolutionary government, which had different conceptions of private property and the societal role of business, and with workers, whose expectations about sharing the control and benefits of companies were dramatically changed by the revolution. Socioeconomic conditions in the Third World can create distinct marketing environments. Nestlé and other manufacturers of infant formula came under intense attack for their use in developing countries of their developed country marketing practices that stimulated the consumption of infant formula. Unsanitary living conditions, lack of potable water, and low levels of education and incomes of poor consumers of the infant formula greatly increased the chance of product misuse and possible injury. Pervasive poverty requires of managers a heightened social sensitivity and responsibility. Cultural diversity in the Third World also dictates the need for distinct strategies. In some Islamic countries, for example, the charging of interest is prohibited by religious norms, so different approaches to financial transactions are called for. In some countries sharp differences in social class and language among groups and areas within a single country demand drastic adjustments in, for example, marketing messages and personnel management. Distinctive business environments derive directly from differences in development levels and processes between the LDCs and the more developed nations. Those differences significantly affect all functional areas of management as well as overall strategies. Many of the firms mentioned so far were able to deal effectively with the problems they encountered and to reap corresponding financial rewards; others were not and suffered the economic consequences. A distinguishing feature of more successful companies in developing countries is their superior ability to understand and interact with their business environment. A key to formulating effective business strategies in LDCs is the capacity to analyze and comprehend thoroughly the firm's external environment. Management's challenge is to devise a systematic approach to environmental analysis that enables effective managerial response. The purpose of this book is to present such an approach. It will set forth an analytical framework for environmental analysis and techniques for applying that framework to issues of strategic importance to a firm's viability and success. The book is both conceptual and applied. The goal is to enhance managers' capacity to deal with the distinctive challenges of management in developing countries. WHOM IS THIS BOOK FOR? This book is primarily for current and future managers involved in or interested in doing business in or with developing countries. It is particularly oriented toward individuals from more developed nations who wish to learn more about the LDC business environment; my teaching experiences at Harvard Business School and in various Third World nations, however, indicate that managers from developing countries will also find the framework and techniques relevant and useful. Readers of this book will differ considerably in their knowledge and experience of developing countries. The more experienced will find some portions of the book to be familiar terrain; the value-added for them is in the analytical framework and techniques. For the less experienced, in addition to the value of the analytical approach, the book tries to provide a basic understanding of the business environment in developing countries. Lastly, although government officials and public policy analysts are not the direct target audience of this book, my teaching experiences suggest that they too will find the book relevant to their tasks involving interaction with businesses. I have also prepared with Tomás Kohn a companion volume, Strategic Management in Developing Countries (The Free Press, 1990) that contains over thirty case studies of companies operating in developing countries. That book will be particularly suited for classroom discussions but would also give practitioners more detailed views of business situations to which the analytical framework and techniques in this book can be applied. HOW IS THE BOOK ORGANIZED? We shall now present the "map" of how this book will provide an understanding of the complex and diverse LDC business environment. This introductory chapter provides an overview by discussing the importance of the developing countries to the global business economy and by describing the diversity among Third World nations. The remainder of the book is divided in two parts. Part I, "Analyzing the Business Environment," provides an analytical approach for examining and understanding the distinctive nature of the LDC business environment. Part II, "Managing the Functional Areas," focuses on how to deal with critical issues in each of the core functional areas of management. Part I (chapters 2 through 5) presents the components of what I have labeled the Environmental Analysis Framework (EAF). Chapter 2 provides an overview of the EAF. Chapter 3 discusses the first component of the framework, the four kinds of environmental factors by which the salient characteristics of a developing country can be systematically identified and the distinctive nature of its business environment understood. Those readers experienced in developing countries will find much of this chapter's information familiar, but its organization may provide additional insights; others will find in it a useful organizing framework and information base for building an understanding of the LDC context. Chapters 4 and 5 discuss two other components of the EAF. Government's strategies and policies are a fundamental force shaping the business environment, so Chapter 4 presents the analytical approach for understanding this phenomenon. A firm's immediate competitive environment is its industry, and Chapter 5 provides a way of viewing the distinctive nature of industry structure and competitive dynamics in developing countries. Part II (Chapters 6 through 10) discusses special management issues that arise in the functional areas of business -- government relations, finance, production, marketing, and organization. Management control issues are dealt with as a dimension of each of the other functional areas rather than in a separate chapter. The chapters are selective rather than exhaustive; they focus on those issues considered to be of particular strategic importance to successful management in LDCs. Part II extends and applies the EAF through analytical techniques and guidelines for dealing with these key management issues. Given the strategic importance of government's actions to company success, I consider managing the business -- government relationship to be as fundamental as the traditional functional areas; Chapter 6 examines key aspects of this relationship. Chapter 7 discusses three problematic and challenging finance issues facing LDC managers: how to manage in a high-inflation environment, how to handle foreign exchange risks, and how to deal with capital scarcity. Chapter 8 focuses on the production issues of technology management as it relates to technology transfer, choice, adaptation, and supplier development. Chapter 9 examines adjustments in the marketing mix required in the LDC environment. Chapter 10 is concerned with organizational strategy in three areas: the choice of a foreign firm's mode of entry into a developing country, issues surrounding joint ventures, and the effect of culture on organizational structure and processes. Chapter 11 concludes the book by briefly discussing trends affecting the future business environment in developing countries and delineating some management capabilities deemed critical to success in that future environment. HOW IMPORTANT ARE DEVELOPING COUNTRIES TO THE INTERNATIONAL ECONOMIC AND BUSINESS SYSTEM? A basic management reality in today's economic world is that businesses operate in a highly interdependent global economy, and the 142 developing countries are very significant actors in the international business arena. They are buyers, suppliers, competitors, and capital users. It is important for managers to recognize the magnitude and significance of these roles. The economic importance of the Third World is great and becoming even greater. As Buyers The bulk of the world's consumers live in the developing countries. About 77%of the world's 1990 population resided in the Third World: 4.1 billion out of the 5.3 billion total. The LDC population is expanding at an annual rate of almost 2%, while that of the more developed countries is growing at around 0.5%. Population-driven demand growth is primarily a Third World phenomenon. These populations, of course, contain most of the world's lower-income consumers. Consequently, their effective demand and their share of the world's economic pie is disproportionately lower. The LDCs produce about 20% of the output of the world's market economies. Nonetheless, since 1960 these economies have been growing at a faster rate than those of more developed nations. As can be seen from Figure 1.1, Third World economic growth rates in real terms have been consistently higher and are projected to continue so in the future, despite declines in the 1980s. Thus, Third World demand is driven by rising incomes as well as population growth. It is likely that their aggregate share in the global market will grow in importance. The higher population growth rates in developing countries, however, hold down growth in per capita GNP and therefore the ability to close the income gap between developing and developed countries. Table 1.1 reveals differences in GDP growth rates among Asia, Africa, and Latin America and the Caribbean. Asia, particularly East Asia, has been the high-growth region, and Africa one of low growth. Latin America experienced high growth during the 1970s, fell off during the early 1980s, and then began to recover. Table 1.2 shows the growth rates of economic categories of LDCs. During the 1980s the low-income countries have been growing faster than the middle-income nations, and the exporters of manufactured goods have fared better than the oil exporters. The highly indebted nations have also grown relatively more slowly. The developing countries satisfy a significant portion of their domestic demand through purchases in the international market. In 1987 they accounted for 25% of the world's imports. Their main imports in order of importance are machinery, manufactured goods, fuels, foods, chemicals, and other raw materials. The more developed nations supplied nearly 60% of these total imports; between 1978 and 1984 sales to the Third World amounted to 40 -- 45% of the total exports of the United States, Japan, Germany, and Britain (excluding intra-EEC sales). Developed nations supplied 91% of the LDCs' machinery imports, 88% of the chemicals, 77% of other manufactured goods, and 57% of the raw materials. For some product categories and companies LDCs are critical markets. For example, for papermaking machinery the developing countries will constitute 41% of the world market demand for the 1986-96 period. Forty percent of the Caterpillar Tractor Company's worldwide sales in 1981 were to developing countries, and the trend was strongly upward. As Suppliers The developing countries are also important suppliers in the international marketplace. By the mid-1980s they accounted for 28% of the world's exports, with 70% of their sales going to the more developed nations and 30% to other LDCs. The industrial countries, in turn, depended upon the Third World for about 22% of their total international purchases in 1987. For certain products the developed nations' dependence on the developing countries as suppliers is even greater. For example, in 1986 the United States depended on the Third World for 87% of its fuel imports, 57% of its food imports, and 39% of its raw material imports. The developing countries have also become important suppliers of manufactured goods; manufactures rose from 38% of LDC exports in 1965 to 60% by 1980. Figure 1.2 shows the dramatic increase in manufactured exports from developing countries into the U.S. market; they have risen fivefold between 1978 and 1987. The Third World is increasing not only the absolute value of its exports to the United States but also its share of total U.S. manufactured imports (nearly 30%). In their trade with other developing countries, LDCs tend to export their more capital-intensive goods to countries that are less developed and less abundantly endowed with capital than themselves; their exports to the developed countries tend to be more labor-intensive. Pushing the trend of more manufactured exports from LDCs has been the strategic decision of many major companies from the developed countries to move their production of components or entire products offshore. For example, Nike started out by importing running shoes from Japan; it also had a small U.S. production operation. As labor costs and the value of the yen rose, Nike shifted to Korea and Taiwan; in search of cheaper sources, it added the Philippines and Thailand. Finally, it set up production contracts and operations in the People's Republic of China, which Nike's chairman saw as the world's last great supply of cheap labor. In 1988 AT&T began investing $40 million in production facilities in Thailand to produce up to 5 million phones annually, mainly for the U.S. market. This new facility would allow the company to shift its existing production of cord phones from Singapore to Thailand, so that the Singapore facilities could concentrate on the more sophisticated cordless phones. Almost all U.S. semiconductor companies have shifted assembly operations to the developing countries, making Malaysia the world's largest semiconductor exporter. More than half the workforce in Malaysia's electronics industry is employed by U.S. multinationals. IBM made a major investment in Mexico to manufacture microcomputers, mainly for export to the United States; other computer firms have also established export-oriented production operations in the developing countries. All U.S. television manufacturers have moved offshore. By 1978 Taiwan had become the world's largest producer of black-and-white TV sets, then was surpassed in 1981 by South Korea, which by the mid-1980s had also become the third largest produce r of color TV sets. In the Caribbean a large assembly industry, particularly for apparel, has emerged. Fabric is imported from the U.S., often into duty-free export zones, and re-exported to the U.S. Such exports from the Dominican Republic, Haiti, and Jamaica expanded at a 20% annual rate throughout the 1980's. European and Japanese multinational firms have also increased their sourcing and exporting from LDCs. Third World countries are an integral part of global sourcing systems. As Competitors As the industries of developed nations mature, particularly more labor-intensive ones, their costs relative to those in the Third World tend to rise and their technologies become more internationally accessible. Developing nations, with their lower labor costs, increasingly gain comparative economic advantage in these industries and foster them as part of their industrialization. By the 1980s, for example, Brazil's manufacturing output exceeded Britain's. In 1986 Taiwan exported $36 billion of manufactures and generated a trade surplus exceeded only by Japan and West Germany. The developing countries have become fierce competitors in various manufactured products, capturing market shares from producers based in the developed nations. In the aggregate, developing countries have increased their share of manufactured imports by developed countries from about 11% in 1960 to about 25% by the mid-1980s. Early inroads were made in apparel and textiles: By 1984 almost half of the world's clothing exports came from developing countries. Of the world's top thousand companies ranked by sales, seventy-three were from the Third World. The Munjal company in India is the world's largest manufacturer of bicycles, producing seventeen per minute; it forecasts exports of 1 million bikes per year. More recently, electronics has been the growth area, with the Third World's share of global exports reaching 12% by 1980 and rising. This is not just the offshore operations of multinational corporations already mentioned. Indigenous companies such as Korea's Samsung and Gold Star or Taiwan's Sampo and Tatung are significant forces in the international consumer electronics markets. By 1988 Samsung Electronics had captured 20% of the U.S. microwave market and 13% of the VCR market. The competitive presence of LDC companies is being felt in other sectors as well. For example, Brazil's EMBRAER, the government's aeronautic enterprise, has successfully exported its turboprop airplanes to the United States, to Europe, and to other LDCs. Korea's Hyundai penetrated the Canadian auto market in 1983 with its fast-selling, low-priced Pony model; the $3,300 price tag generated about $8 million in sales the first year and $80 million the second. Hyundai then repeated its success in the U.S. market with its Exc el model. Faced with the growing competitiveness of LDC companies, many multinational corporations are creating joint ventures and other strategic alliances with them; for example, General Motors joined with Korea's Daewoo to produce subcompacts. Becoming international class competitors has required heavy capital outlays by the developing countries. The inherent scarcity of domestic capital has required that they tap foreign capital sources. As Capital Users As can be seen from Figure 1.3 and Table 1.3, the developing countries receive external capital from three main sources: private creditors (mainly the international banks), foreign direct investment (mainly multinational corporations), and official governmental assistance (foreign governments and multilateral agencies). Total net capital flows to the LDCs more than doubled in real terms between 1970 and 1981, reaching $136 billion. They declined during the 1980s, particularly because of the drop in commercial bank lending and the decline in the value of the dollar. Important shifts among the capital sources occurred during the 1970-86 period. In 1970 private lending supplied 16% of the capital, foreign direct investment (FDI) 18%, and government assistance 61%. By 1981 private lending had risen to 38%, FDI dropped to 12%, and governmental flows fell to 47%. By 1986, however, the private lenders' share had plummeted to 10%, while direct investments provided 14%, and governmental assistance reached a high of 67%. We shall now examine the bank lending, foreign direct investment, and official assistance flows. Bank Lending. The principal change in the mix of annual capital flows during the 1970s was the dramatic increase in bank lending. In 1970 it constituted 15% of total flows to the developing countries and 39% of the private flows; by 1981 it had increased to 37% of total flows and 70% of private flows. By 1988 nearly 60% of the developing countries' long-term debt was owed to private creditors. The Third World's total external liabilities passed the $1 trillion mark by 1985 (see Table 1.4). With this huge debt overhang, private bank lending to the LDCs declined dramatically to only 6% of total flows by 1986. What fueled the extraordinary expansion of international lending during the 1970s and early 1980s was the pressure on banks to recycle petrodollar deposits, along with the existence of attractive interest-rate spreads and the LDCs' insatiable demand for capital. A further incentive to borrow was the fact that real interest rates were negative -- that is, the London InterBank Offered Rate (LIBOR) was less than the annual percentage change in export unit values of the borrowing LDCs; for 1973-77 the real rates were - 14% and for 1978-80 -5.3%. Additionally, governments in developed countries often promoted such private lending to help stimulate their exports to the developing countries. The enticements for LDC governments and businesses to borrow were attractive, and too many developing countries overborrowed. By 1987 Latin America's external debt was more than twice as large as its domestic bank liabilities. Initially these LDC loans were a major source of profit growth for the international banks. However, many observers contend that the banks failed to analyze adequately the LDC environments and overlent. The banks and countries were exposed to the harsh effects of market changes. LDC commodity prices plummeted in 1980-81, real interest rates soared to 18% in 1981-82 (and the dollar rose) and to 13% in 1983-85, and LDC exports fell as recession in the industrial nations reduced demand. The drop in foreign exchange earnings left the LDCs unable to service their dollar-denominated, variable-interest foreign loans. The resultant international debt crisis saddled banks with serious default risks and led to extensive debt reschedulings. Between 1975 and 1980 there were about five reschedulings per year; by 1984 the number soared to 30. These reschedulings caused the export credit agencies in the developed nations (such as the Eximbank in the United States or the ECGD in the United Kingdom) to pay out large claims on insured supplier credits and guaranteed bank credits. LDC loans as a percentage of total bank assets in 1985 were 14% for Bank of America, 13% for Citicorp, and 9% for Chase Manhattan, and many times greater than their equity capital. By 1987 Citibank and other international banks began a process of writing off some of these loans. Even the World Bank increased its bad debt reserve levels in 1988 for the first time in its history. As Table 1.5 reveals, the financial burden of the debts on the Third World economies has increased significantly. Outstanding debts rose from 28% of GNP in 1980 to 50% in 1987. The debt-servicing burden for public and private foreign loans increased in 1987 to 6.2% of GNP; 26% of export earnings were needed on the average to meet the debt-servicing obligations, and interest payments alone amounted to 12% of exports. For some countries the debt-servicing burden was much higher. The need to find foreign exchange to service the debts will influence significantly the shape of government policies and, therefore, the business environment in the upcoming years. In 1987 ten developing countries accounted for almost half the Third World's trillion-dollar debt, with Brazil and Mexico's combined $194 billion constituting 18% of the total. The first column in Table 1.6 lists the top ten debtor nations in 1987. The bigger countries tend to have bigger debts. The plight of some of the smaller countries is revealed when the top ten debtor list is constructed in terms of external liabilities per capita, as shown in the second column. Still another perspective is gained when the ranking is made using the ratio of GNP per capita to liabilities per capita, which relates the burden of the debt to the country's resources available to service it (see third column). According to this measure, the ten countries least able to pay their debts include eight African nations whose low per capita incomes greatly weaken their debt-carrying capacity. This circumstance was the main reason why the Western developed nations at their 1988 Economic Summit recommended that adjustments be made by creditor nations to alleviate the poorest African nations' debt burden. Servicing these foreign debts has become an increasingly severe drain on the developing countries' capital and foreign exchange resources. Since 1984 debt-service payments from the Third World on their long-term debt have exceeded new loan disbursements coming into developing countries. Long-term lending has been declining since 1982. In effect, through their repayments developing countries have become net capital suppliers to the developed nations. Most of the largest debtors, except for Korea and India, are in this position. However, about 62% of the developing countries are still receiving more long-term funds than their debt-service outflows, and thus continue to be net capital users. Developing countries will remain important actors in the international credit system, for both new borrowings and repayments. The debt-servicing burden will heighten the priority that governments place on foreign-exchange generation and saving, and this will place special demands in this direction on companies. Foreign Direct Investment. Governments sometimes prefer direct equity investments by foreign corporations over loans, because, in addition to capital, they bring technologies and, sometimes, access to international marketing networks. Furthermore, if the project fails, the government does not have any loan to pay back. Although there is considerable diversity in foreign investment strategies, there does appear to be an evolutionary pattern related to a product's life cycle that holds for many firms. Production begins in the developed country and is marketed there. Next, exports to developed and developing countries are added to increase volume and achieve economies of scale. As the product advances in its life cycle, foreign manufacturing operations are set up in developed and then developing countries to serve the local markets previously handled by exports. Often this move has been prompted by governments erecting tariff walls to keep out imports and to stimulate local production in the protected markets. (This, for example, was part of the motivation that led Cummins Engine to set up its production facilities in India.) After operations have stabilized, exports are added to the domestic sales, with the target market often the foreign investor's home market. While this cycle is occurring, the parent firm is often developing new products, which then start the cycle again. More recently, firms are becoming more flexible and devising strategies and production systems that are more global. These involve developing and developed countries in an integrated network that tries to use various countries' comparative advantages to achieve global economies of scale or to make preemptive moves to achieve competitive advantage. This can in effect short-circuit the traditional life-cycle pattern and create a more complex set of strategic considerations and foreign direct investment configurations. Foreign direct investment rose throughout the 1970s, although its share of total capital flows dropped to about 9% by 1980, as bank lending surged. However, as the international banks retrenched in the face of the international debt crisis, FDI's relative importance increased, with its share rising to 14% in 1986. In absolute real terms the FDI levels peaked in 1981, hit a low in 1985, and began to recuperate in 1986. The global recession in the 1980s cut LDC subsidiaries' profits and retained earnings, a key source of FDI. Developing country governments have been increasing their efforts to attract foreign investors. More than twenty African countries and several Caribbean nations have liberalized the foreign investment codes; the Andean Pact nations loosened their restrictions on FDI; several Asian developing countries have opened up new sectors to foreign investors (e.g., 80% of Korea's industrial sector is now open); new fiscal incentives have been offered by China, Ghana, Guinea, India, Madagascar, Thailand, and Yugoslavia; still others have reduced restrictions on capital repatriation. Prospects of good profits and favorable returns attract the foreign investor to the Third World. Latin America and the Caribbean captured two-thirds of the FDI to LDCs in 1965-69, but their share fell to about one-half in the 1980-83 period; Asia and the Middle East's share rose from 17% to 41%; Africa dropped from 17% to 11%. FDI has been heavily concentrated in a small number of countries having large domestic markets or providing material resources or serving as export platforms; more than half the FDI during the 1973-84 period went to Brazil, Mexico, Indonesia, Malaysia, and Singapore. About 80% of the Japanese trading companies' foreign manufacturing investments are in developing countries, with over 50% in Asian nations. The annual outflow of profits of foreign direct investment in developing countries averaged $22 billion during 1980-83. During this same period the reported rate of return on United States FDI in developing countries averaged 18.3%, as against 11.3% on direct investments in other developed countries. Return on equity in foreign joint ventures in Korea, for example, was about 20% in 1978. Of the five hundred largest U.S. companies, 55% reported having assets in developing countries in 1985; of the top two thousand, 27% had investments in the Third World. As Table 1.7 shows, these investments were principally (over 50%) in the energy sector and in the machinery, electrical, and other manufactured goods industries. These were followed by transportation equipment and communication, services, and agriculture and food processing (about 33%). Metal industries, paper and related products, and construction constituted about 17% of the investment areas. Smaller firms also invest abroad. Half of the 1,949 U.S. firms with foreign investments in 1982 had fewer than two thousand employees. Firms with less than five hundred employees established 17% of their overseas affiliates in LDCs and companies with 501-2,000 employees set up 24% there. Larger firms chose LDCs for about 36% of their foreign operations. Expansion of direct foreign investment in the Third World is expected in the future. Multinational corporations will remain important economic actors in developing countries, and developing countries will remain an important business environment for the MNCs. For local LDC firms the increased MNC presence is double-edged: It can mean the threat of increased competition or the opportunity for productive partnerships. Governmental Assistance. Governments and multilateral agencies, such as the IMF and the World Bank, are important sources of shortand long-term loans for the Third World. Historically there has been a de facto segmentation of country recipients in terms of the sources of capital flows. Higher-income, more industrialized developing countries tend to be served more by private lenders and foreign investors, while lower-income countries rely more on official sources for their external capital flows. However, recently some of the highly indebted industrial developing countries have also had to rely increasingly on official sources. As the poorer countries develop, it is likely that they will increasingly attract private capital. As of 1986, official sources provided two-thirds of the net flows to the Third World, an all-time high. Public-sector entities have partially filled in the capital flow void caused by the reduced lending of the international banks. In 1986 31% of the net flows were in the form of government-to-government bilateral aid from the developed countries. OPEC bilateral aid accounted for another 4%, down from its high of 10% in 1975. Aid and nonconcessional lending from multilateral agencies such as the World Bank accounted for 21%. Even on the aid side, however, funds have been declining in real terms, falling from $63 billion in 1981 to $47 billion in 1986. (Part of this decline reflects the fact that official assistance is reported in dollar terms, and the value of the dollar fell during this period.) It is clear from the foregoing sections that the developing countries play a significant role in the global economy as buyers, suppliers, competitors, and capital users. Understanding their business environments is critical for international business managers. That understanding requires an appreciation for the diversity among LDCs. HOW DIVERSE ARE DEVELOPING COUNTRIES? Any manager who has traveled to several developing countries will quickly point out that they differ considerably one from another. Although in this book we use the terms developing countries, Third World, and less developed countries interchangeably to refer to this large category of 142 nations, no two are alike. A basic premise of this book is that the distinctive business environments in developing countries are due to the different levels and processes of development, not just between the developing and developed but also among the developing countries themselves. These business environments are inherently unstable because countries continue to develop; rapid or significant change is the constant. LDC diversity can be revealed by differences in levels of development. The literature on economic development is filled with debates about what development is and how to measure it. Several development indicators commonly used by international development organizations are discussed below. Our objective is not to find the "correct" one; we shall instead point out how each indicator can give the manager a different perspective on how the business environment is likely to vary among LDCs with different developmental characteristics. We shall also point out some of the limitations of these indicators. Gross National Product per Capita This is the most common development indicator, with countries grouped by income ranges. Appendix A ranks countries by per capita GNP. The categories used by the World Bank are shown in Table 1.8. The GNP per capita indicator reveals a country's output and national income in relation to its population, thereby partially showing the level of effective demand. One of this indicator's weaknesses is that as an average it does not reveal income distribution or real standards of living. For example, in 1983 the United Arab Emirates (UAE) had the highest per capita income in the world at $22,870, far above Switzerland, the highest industrialized nation at $16,290. Yet few would claim that the UAE or other Persian Gulf states are developed nations. Although they have made important gains, on the average only 50% of their populations are literate, and they have infant mortality rates averaging over 70 per thousand live births (versus 99% literacy and infant mortality rate under 10 in industrial economies). Furthermore, with the decline in oil prices the UAE's 1986 per capita GNP had fallen to $14,680, behind Switzerland, the United States, and Norway. Another limitation of the GNP per capita figures is that they do not reveal living costs; these are often lower in LDCs, thereby allowing higher living standards in terms of goods and services acquirable than the absolute levels of GNP might imply, that is, the purchasing power of the same income levels can differ between countries. For example, in 1987 Japan's average income was $23,022 and in the United States it was $18,163; however, in purchasing power terms the Japanese income was 19% less than the American's, reflecting the considerably higher costs of food and housing in Japan. Total GNP The absolute magnitude of a country's economy is indicative of aggregate demand and market size. There are ten giant LDC economies, which in total constituted 50% of the Third World's combined 1987 gross domestic products (see Table 1.9). These larger economies tend to create more diverse and complex business environments. The magnitude of their markets permits production economies of scale. The smaller economies are often more vulnerable to economic disruption and cannot support large production volume for the domestic market, although they can serve as high-volume export bases. Degree of Industrialization Generally, as a country develops, its industrial sector contributes a growing percentage to the nation's gross domestic product. The industrial sector includes mining, manufacturing, construction, and energy. This measure can be useful to companies as an indicator of a country's current level of industrial infrastructure and technology. The phrase "industrialized nations" is often used to refer to the developed nations of Noah America, Europe, Scandinavia, Oceania, Japan and Russia. Some of the upper-middle-income countries with higher levels of industrial and technological development and of human resources and infrastructure are referred to as the Newly Industrializing Countries (NICs). Among these, the "Four Dragons" -- South Korea, Hong Kong, Taiwan, and Singapore -- have drawn special attention for their exceptionally high annual growth rates and success in exporting manufactured goods. Appendixes A and B rank developing countries by percentage contribution of industry to GDP. This indicator can be misleading because it does not reveal the scope, quality, or technological sophistication of the industrialization. Oil countries tend to have a high industrial percentage contribution to GDP, but their infrastructure in many instances is related mainly to the oil sector. In 1987 in the People's Republic of China, industry constituted 49% of GDP and in South Korea it was 43%, yet the level and breadth of industrial sophistication in Korea clearly exceeded that of mainland China. To assess the development level, one should look at the industry share in conjunction with the other sectors' shares. As industry's share rises, agriculture's declines and services' increases. At the higher levels of industrial development the supporting services in the financial, telecommunications, commercial, and professional areas expand even more rapidly, thereby decreasing industry's share. In the industrial countries the sectoral proportions in 1987 were 37% for industry, 60% for services, and 4% for agriculture; the corresponding figures for low-income countries (excluding India and China) were 27% for industry, 40% for services, and 33% for agriculture. Thus, as countries develop, companies can expect infrastructure and business opportunities to rise in the industrial and service sectors while the agricultural sector will decline in relative importance. Within these sectors important shifts also occur. In industry generally, manufacturing rises and mining falls. Agricultural products experience greater degrees of processing. For example, in low-income Bangladesh agriculture accounts for 53% of GDP and food processing industries 4%, while in the upper-middle-income country of Argentina agriculture's share was 11% and the agroindustries' share was 32%. GNP Growth Rates Another measure is how fast the country is moving along the economic development spectrum, rather than where it lies on it. This can be ascertained by measuring growth rates of either GNP or GNP per capita. The growth rate indicates one aspect of demand behavior and possible market dynamics. The business environment in a high-growth versus a low-growth market can be quite different. The causes of these growth rates can vary significantly even among the countries in the fast or slow groups. Understanding the business environment requires a probing of the underlying factors shaping these diverse growth patterns. Table 1.10 lists the six fastest and six slowest growth countries in terms of average annual GDP growth rates for the 1965-80 and 198086 periods. Appendixes A and B rank the LDCs by growth rates. Physical Quality of Life Indicator (PQLI) The PQLI measures development in noneconomic terms. This is a composite index based on a country's literacy rate, infant mortality rate, and life expectancy. In 1981 the average PQLI for developing countries was 61; it was 96 for developed nations. The PQLI rank of a country can diverge considerably from its rank based on economic indicators. For example, Sri Lanka, with a 1981 per capita income one-seventh of Brazil's, had a PQLI of 85 compared to Brazil's 74. The PQLI is useful in suggesting the quality of human resources that a business will encounter. Appendixes A and B provide a PQLI ranking of the developing countries. Income Distribution Countries can also be characterized by the degree of skewedness or inequality of its income distribution. One indicator of income distribution is the Gini coefficient, which measures the percentage of income going to each income bracket. In a "perfectly equitable" distribution each 1% of the population would earn 1% of the available income, and the Gini coefficient would be zero. In a completely inequitable economy the top percentile of the population would earn all the income, and the Gini coefficient would be one. For example, in 1970 the Gini coefficient for Ecuador was.63 and for South Korea. 35, indicating a more equal distribution of income in South Korea. This coefficient can indicate economic narrowness or concentration in the consumer market. It may also reveal some pressure for political change. Appendix C lists the Gini coefficients for several countries. Other Diversity Indicators One can also characterize countries according to types of political systems, such as military governments, single-party regimes, and multiparty democracies. The stability of the regime could also be used as an indicator. Another dimension is culture. The cultural richness of developing countries is extraordinary. Culture is sui generis and thus difficult to use as a categorizing parameter. Nonetheless, certain shared belief systems, sometimes stemming from a common religion, can be used to group countries. For example, Islamic countries have certain beliefs and practices that influence business customs in a distinctive way. Certain Asian nations have shared cultural roots that create special attitudes toward group loyalty and individualism, which in turn affect business organization and behavior. The social, political, and economic structures of many African nations are influenced by tribal systems and customs. Demographically one can categorize nations according to size, for example, the "megapopulation" countries of China, India, Brazil, Indonesia, and Nigeria, which account for about 45% of the world's population, or the thirty-two"minipopulation" LDCs with less than a million inhabitants. Countries can also be categorized according to population growth rates or degree of urbanization. These demographic variables create very different market environments. Geographical location is also used to categorize countries and can capture cultural and climatological similarities, for example sub-Saharan Africa. However, considerable economic diversity exists even within regional groupings; for example, the Côte d'Ivoire (Ivory Coast) had a 1987 per capita GNP of $740 and Gabon $2,700, as contrasted to an average of $330 for the rest of the sub-Saharan region. The foregoing indicators reveal the significant diversity among developing countries. Our analytical framework will help to identify the variables that create that diversity. But along with their diversity, the developing countries share many similarities. To highlight these salient general characteristics that give rise to a distinctive context for doing business, we shall make generalizations throughout the book about developing countries in the aggregate and their "business environment." Generalization is integral to conceptualization and the distillation of critical variables. It allows us to create a more usable managerial framework. However, when we make these generalizations, the reader is urged to remember the diversity and exceptions that surround them and to adjust for that reality. CONCLUSION As we move toward and into the twenty-first century, developing countries will become even more important in the global economy. Improvement in the well-being of four-fifths of the world's population rests on the ability of the Third World to develop. And that development will depend, to a significant extent, on the capacity of managers in developing countries to operate the productive apparatus in an efficient, effective, and equitable manner. This book aims to contribute to that management challenge. Copyright © 1990 by James E. Austin
