The road less travelled

Published: May 2013

Between 2016 and 2020, impressive trade growth is expected for the markets of Vietnam, Malaysia, Bangladesh, Japan and Singapore. Economists are also predicting that trade and capital flows between emerging markets (EMs) could jump ten-fold in the next four decades; the International Monetary Fund (IMF) says that as advanced economies currently grow by less than 2%, their emerging and developing counterparts are well ahead at almost 6%. It also predicts that the 80/20 split between advanced and emerging economies in terms of share of world GDP in 2004 will, by next year, be more like 60/40.

As the competition gathers pace, international companies are expanding their trading activities into new regions. The practical implications of supply chain management when moving into these territories, especially the EMs, were brought to light at the ACT’s Annual Conference held earlier this month in Liverpool.

The shift of labour

Carl Pate is Group Finance Director of Quantum Clothing Group, a UK-headquartered supplier to retailer, M&S. It has no exposure to sales beyond UK but owns 70% of its production with facilities in Sri Lanka, India and Cambodia, with joint ventures in China and sourcing in Vietnam, Indonesia and Bangladesh. “The reason we will place units in a particular location is due to fabric and labour availability,” he states. Around 95% of Quantum’s raw materials come from outside of Europe. About ten years ago it employed around 10,000 in the UK; now there are just 250 with another 8,500 overseas. “Our challenge in the Asian region is inflation which would make it more difficult to be competitive on a cost basis,” he comments. China is currently facing rising inflation and the regional markets cannot help but react as wage-pressure forces businesses to consider their next move already.

Indeed, Charles Barlow, Group Treasurer of Coats, a 250-year old industrial thread and textile crafts business, says that the textile business has pretty much all shifted to EMs as companies look to find the cheapest sources of labour. More change is inevitable. In China, most of its production goes into the export market; but as the Chinese economy grows and the people become wealthier, he anticipates that the company will be able to shift more to selling local production in China rather than for export.

The company, which is present in more than 70 countries across six continents, has been operating in EMs for many years, says Barlow (it was a Coats employee who introduced football to Brazil). Even with operations in emergent economies such as Cambodia and Vietnam, it too has been forced into a labour contingency mode. “If we look at where the next pool of cheap labour is available for making textiles, then Africa is the place,” he comments. “Perhaps the reason it has not developed at the moment is the lack of solid infrastructure.” And, unlike India for example, parts of the continent do not yet have a solid legal structure to support corporate progress. He remains fairly optimistic suggesting that “this is potentially something that might happen in the next 20 years”.

Business models

The two Asian heavyweight economies, China and India, have developed very differently, says Barlow, this having a direct impact on business structure. The way in which the different provinces in China impose different rules, for example, “many find frustrating to this day”.

Coats initially entered China with a series of joint venture (JV) partners before gaining the confidence to go it alone. The structure which has in part been forced upon the company has necessarily created more than half a dozen legal entities. “It means the business in total in China is quite large but individual businesses can be relatively small.” This, he admits, “is now hampering expansion and consolidation”. The rationalisation and simplification of operations in China is an ongoing task. This contrasts with Coats’ business in India where it is able to have just one entity. “It is a very different process,” he concludes.

Quantum’s entry into EMs involves JVs too. However, in Bangladesh, Pate says the company had an initial “bad experience”. Having built a world-class manufacturing unit as part of a JV, it had to pull out within two years. “Maybe it was to do with us being control-freaks,” he comments, adding that “if both parties are not bringing the same thing to the table it can make it very difficult. We have approached manufacturing work in JVs which can make it quite challenging, but now, if possible, we are looking to do it on a 100% ownership basis.”

The spirit of an EM

“The EMs are a very important area for us and we look to place a subsidiary in every market into which we can sell our products,” states Craig Williams, Assistant Treasurer, FX, Markets execution at Diageo, a premium-brand spirits, beer and wine company with a turnover of £12 billion. Before 2011, Diageo, which operates in 180 countries, derived less than a third of its turnover from EMs. “As of December last year it was 42% and our CEO has set a target of 50% by February 2016.” This will be achieved through a mix of organic growth and acquisitions.

In terms of organic growth, Diageo’s 2013 interims claims EMs sales grew 14% year-on-year in the first half, compared with 5% for the overall group. There was strong net sales growth in Africa, the continent providing 11% of global operating profit and 13% in net sales for the period. This was attributed to the delivery of “innovations tailored to the emerging middle class” and by the implementation of a “within-reach pricing structure”, a clear sign that it is playing the marketing game.

Acquisition in the emerging economies sits at the heart of Diageo’s strategy. It has made five important acquisitions in the past two years. In Brazil, the integration of Ypióca is delivering “purchasing synergies”. It has also moved by acquisitions into Vietnam and Turkey, but China and India represent the biggest moves to date.

Diageo’s Asia Pacific business serves the established markets of Korea, Japan and Australia and the EMs of China, India and Southeast Asia (Thailand, Malaysia, Indonesia, Philippines, Singapore and Vietnam). “Most of what we do is importing global brands,” explains Williams. In China, for example, it invests locally and has been in the country since 1995 and has a long-standing JV – MHD – with Moët Hennessy. This relationship has enabled Diageo to build what it calls “brand extensions”, including the opening in Shanghai and Beijing of what it describes as “ultimate luxury space for high net worth Chinese consumers”. These, it claims, are its “most successful experiment in marketing and commercial innovation in Asia to date”.

The Chinese beverage market is worth about £45 billion to £50 billion a year, but international spirits make up just 2% of this so Williams believes that there is an opportunity for the company to “premiumise” some of the local brands and introduce international products. Acquisition is its main route in, given the restrictions on foreign companies investing in the country.

The local drink, baijiu, accounts for about half of all sales. In February 2011, after a five-year discussion with Chinese authorities, Diageo took a controlling (53%) stake of Sichuan Chengdu Quanxing Group; the deal also gave it control of ShuiJing Fang, a local producer of baijiu. This is significant in that it was the first foreign company allowed to invest in this product.

Despite reports on last week that sales of baijiu had dropped 40% in the first quarter of this year as a result of China’s “crackdown on conspicuous consumption” of alcohol, Diageo maintains its strategy of acquiring more equity in this business, and is keen to make other acquisitions, not least because ShuiJing Fang can be used as an acquisition vehicle in China.

With regulation and infrastructure playing a key part in the movement of companies into EMs, the move by Diageo on India’s United Spirits (USL) is a clear play for a new market. Initially it took 27.4% and then made an offer for a further 26%. The move gives it increasing access to USL’s own international alcohol brands but also importantly supplements Diageo’s own small local distribution system in India with USL’s better established network, enabling Diageo to leverage its own brands into the country.

As in any market, an effective supply chain model is required and Diageo has established regional supply hubs in various locations. In March of this year, the company announced that it would be devolving supply chain operations down to country level, which it hoped would give annual saving of £60m after three years (having already done much the same with its sales and marketing operations).

Shifting the same product around the globe via one supply chain became expensive and as the EM operations and brand portfolio expanded it decided to move operations to where the actual demand exists, rather than ship it around the world. In Asia-Pacific, it uses its Singapore hub (which it has owned since 2006) to do market-specific labelling and packaging ‘at the last moment’, shipping goods out to each country market as needed. It is, says Williams, not only efficient from a pure stock-handling point of view but alcohol, as one of the most regulated industries in the world, often means that in the EMs duties are often payable the moment a consignment arrives in country. As Williams says: “Having excess stock in the market can be an expensive way to manage a business.”

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