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Managing Political Risk, Government Relations, and Alliances Chapter 10 Managing Political Risk, Government Relations, and Alliances

Learning Objectives Examine how MNCs evaluate political risk Present some common methods used for managing and reducing political risk Discuss strategies to mitigate political risk and develop productive relations with governments Describe challenges to and strategies for effectively managing alliances

Russian Roulette: Risks and Political Uncertainty Political uncertainty has long been a part of doing business in Russia Russia's unpredictable foreign policy actions have indirectly resulted in financial difficulties for MNCs

Russian Roulette: Risks and Political Uncertainty (continued) Many foreign companies have found themselves incurring huge losses due to lost business and frozen assets Internal rule-changing by the Russian government poses the potential to lead to major losses and frustration

Political Risk Unanticipated likelihood that a business’s foreign investment will be constrained by a host government’s policies Evaluation of the inherent risk of doing business in emerging economies involves: Policy and control mechanisms Awareness of the historical treatment of MNCs within certain nations

Macro and Micro Analysis of Political Risk Macro political risk analysis Reviews major political decisions that are likely to affect all enterprises in the country Micro political risk analysis Directed toward government policies and actions that influence selected sectors of the economy or specific foreign businesses in the country

Overseas Expansion MNCs need to be wary of the combative political environment that may exist MNCs must: Assess political risk Install modern security Compile crisis plans Prepare employees for possible situations

Expropriation Seizure of businesses by a host country with little, if any, compensation to owners Greatest risk - Extractive, agricultural, infrastructural industries Tend to occur in non-Western countries that are poor, unstable, and suspicious of foreign multinationals

Expropriation (continued) Strategies to minimize the chances of expropriation Bringing in local partners Limiting the use of high technology so that if the firm is expropriated, the country cannot duplicate the technology Acquiring an affiliate that depends on the parent company for key areas of the operation

Comprehensive Framework Identifies the various risks and then assigns a quantitative risk or rating factor to them Should consider all political risks and identify those that are most important Categories of political risks Transfer risks Operational risks Ownership-control risks

Figure 10.1 - Three-Dimensional Framework for Assessing Political Risk

Transfer Risk Government policies that limit the transfer of capital, payments, production, people, and technology in and out of country Tariffs on exports and imports Restrictions on exports Dividend remittance Capital repatriation

Operational Risks Government policies and procedures that directly constrain the management and performance of local operations Price controls Financing restrictions Export commitments Taxes Local sourcing requirements

Ownership-Control Risks Government policies or actions that inhibit ownership or control of local operations Foreign-ownership limitations Pressure for local participation Confiscation Expropriation Abrogation of proprietary rights

Nature of Investment Conglomerate investment Vertical investments Type of high-risk investment in which goods or services produced are not similar to those produced at home Vertical investments Production of raw materials or intermediate goods that are to be processed into final products Run the risk of being taken over by the government

Nature of Investment (continued) Horizontal investments MNC investment in foreign operations to produce the same goods or services as those produced at home Not likely to be takeover targets

Special Nature of Foreign Direct Investment (FDI) Relates to the sector of economic activity, technological sophistication, and pattern of ownership Sectors of economic activity Primary sector - Agriculture, forestry, mineral exploration and extraction Industrial sector - Manufacturing operations Service sector - Transportation, finance, insurance, and related industries

Special Nature of Foreign Direct Investment (FDI) (continued) Can be categorized as one of five types Type I - Highest-risk venture Type V - Lowest-risk venture Risk factor is assigned based on sector, technology, and ownership Primary sector industries have highest risk factor, service sector industries have next highest, and industrial sector industries have lowest

Special Nature of Foreign Direct Investment (FDI) (continued) Firms with technology that is not available to the government have lower risk than those with technology that is easily acquired if taken over Wholly owned subsidiaries have higher risk than partially owned subsidiaries

Managing Political Risk Some firms attempt to manage political risk through a quantification process Factors that are quantified reflect: Political and economic environment Domestic economic conditions External economic conditions Each factor is given a minimum or maximum score, and the scores are tallied to provide an overall evaluation of the risk

Techniques for Responding to Political Risk Relative bargaining power analysis Integrative, protective, and defensive techniques Proactive political strategies

Relative Bargaining Power Analysis MNC works to maintain a bargaining power position stronger than that of host country Gaining bargaining power depends on: Host country’s perception of the MNC’s size Experience Legitimacy

Integrative Techniques Help overseas operations become part of host country’s infrastructure Developing good relations with host government and other local political groups Producing as much of the product locally as possible with use of in-country suppliers and subcontractors

Integrative Techniques (continued) Creating joint ventures and hiring local people to manage and run operations Doing as much local research and development as possible Developing effective labor-management relations

Protective and Defensive Techniques Discourage the host government from interfering in operations Doing as little local manufacturing as possible and conducting all research and development outside the country Limiting responsibility of local personnel and hiring only those who are vital to operations

Protective and Defensive Techniques (continued) Raising capital from local banks, host government, and outside sources Diversifying production of the product among a number of countries

Proactive Political Strategies Leveraging bilateral, regional, and international trade and investment agreements Drawing on bilateral and multilateral financial support Using project finance structures to separate project exposure from overall firm risk

Specific Proactive Political Strategies Formal lobbying Campaign financing Seeking advocacy through the embassy and consulates of home country Formal public relations and public affairs activities Such as grassroots campaigning and advertising

Managing Alliances Partners may be: Current or former state-owned enterprises Controlled or influenced by government agencies Alliance and joint ventures can significantly improve the success of MNC entry and operation Managing the relationships inherent in alliances can be challenging

Alliance Arena where both value-claiming and value-creating activities take place Value-claiming - Competitive, distributive negotiation Value-creating - Collaborative, integrative negotiation

Alliance (continued) Motivating factors to enter into alliances Faster entry and payback Economies of scale and rationalization Complementary technologies and patents Co-opting or blocking competition Challenge - Managing operations with partners from different national cultures Cultural differences may create uncertainties and misunderstandings in the relationship

Successful Management of Alliances Depends on situational conditions, management instruments, and performance criteria Success factors Partner selection, cooperation agreement, management structure, acculturation process, and knowledge management Important aspect - Preparation for the likely eventual termination of the alliance

Legal Issues Critical to Termination of Alliance Conditions of termination Disposition of assets and liabilities Dispute resolution Distributorship arrangements Protection of proprietary information and property Rights over sales territories and obligations to customers

Business Issues Critical to Termination of Alliance Basic decision to exit People-related issues Relations with the host government

Role of Host Governments in Alliances Are active in mandating that investors take on partners Require investors to share ownership of their subsidiaries with local partners Play a substantial role in the terms of formation and dissolution of alliances

Role of Host Governments in Alliances (continued) Having alliance or joint-venture partners may be advantageous to MNC entry and expansion Seen in highly regulated industries such as banking, telecommunications, and health care

Be the Management Consultant As an international management consultant, what advice would you give to a foreign company looking to move operations into Brazil?

Be the Management Consultant (continued) Do you think Brazil still holds the potential for future growth? As an investor, do you think that the "buy low" mindset applies to Brazil? If not, what changes would you like to see before making any investment in the country?

Review and Discuss What types of political risk would a company entering Russia and France face? Identify and describe three How are these risks similar? How are they different?

Review and Discuss (continued 1) Most firms attempt to quantify their political risk, although without specific weights Why is this approach so popular? Would the companies be better off assigning weights to each of the risks being assumed? Defend your answer

Review and Discuss (continued 2) How has terrorism impacted foreign interest in Iran and Saudi Arabia, considering the vast oil reserves that are there? How have terrorist attacks affected political relationships between countries such as the United States and Russia?

Review and Discuss (continued 3) If a high-tech firm wanted to set up operations in Iran, what steps might it take to ensure that the subsidiary would not be expropriated? Identify and describe three strategies that would be particularly helpful How might proactive political strategies help protect firms from future changes in the political environment?

Review and Discuss (continued 4) What are some of the challenges associated with managing alliances? How do host governments affect these?