Wholly foreign owned enterprises are one of the options available to local business in order to access emerging markets. Jeremy Butler, of KPMG, looks at the pros and cons of this approach.
For many, setting up a wholly owned operation in a new market is a daunting, but sensible option. It could be argued this approach not only enables the company's corporate identity to stay intact, but offers the luxury of a great degree of control.
However, a decision to take this approach should not be taken lightly and a number of factors will come into play, all of which need careful consideration.
There is no doubt there are a number of advantages in deciding to enter through a wholly owned foreign entity. The overriding issue for many businesses is developing the maintenance of control. The company is not only able to manage how and with whom it does business, but also to maintain as much control as possible over its intellectual property.
It has been widely reported that emerging markets are keen to copy, reproduce and then sell products developed and sold by western companies, who are often more technically advanced. As a result, many businesses have become increasingly cautious of involving third parties, such as those required for joint ventures or strategic alliances. Setting up a business that will negate the necessity for this, could limit the threat of intellectual property being stolen.
In addition to this, the wholly foreign owned enterprise approach also allows a business to demonstrate a commitment to the local marketplace. It shows that the company respects the country as a 'must be in' marketplace and isn't merely trying to make a 'quick buck' by limiting its exposure - it is in it for the long haul. For many of the emerging markets, this is becoming increasingly important as they look to regenerate, develop and grow their economies.
Financially the wholly foreign owned enterprise also offers similar benefits to those of a joint venture. For example, by taking this approach the business can look to raise debt in the local market and therefore offset the interest of this debt against profit. This could create a substantial tax saving.
The wholly foreign owned enterprise will generally only be taxed on its own profits and tax holidays and other financial incentives are often offered by local governments.
While these and other upsides exist, any company considering this option must also bear in mind the disadvantages before deciding on whether this is the right approach for them, especially as it loses one of the key benefits of third party involvement.
One of the greatest benefits of opting for a joint venture or a strategic alliance is that local culture, knowledge and set up are already complete and in place. Being advised by local people who know their marketplace inside out is valuable. All the support networks, distribution, advertising and so on, can all be handled by an experienced operator. However, when setting up your own entity within a foreign market, all of this will have to be learnt, researched and implemented - all of which will be fundamental to survival.
The costs of doing this ground work can be significant. While these could be deemed as a basic business necessity which will require an initial outlay, managers must not underesti-mate the importance of local knowledge in these emerging markets.
Contacts within Government and other public bodies are often important, and this can be a crucial element of the local presence.
Creating a separate entity also brings with it extra administrative processes. Transfer pricing rules will come into play, requiring the application of prices charged for goods and services provided by the parent, including management charges.
Whether a company feels issues such as these negate the benefits of a wholly foreign owned enterprise will largely depend upon a company's long term strategy and its risk profile. Making the right decision is crucial to success or failure in an emerging market. With so many companies now looking to countries such as China and India to achieve growth, competition is high and planning will be vital.
* Jeremy Butler is director of KPMG's new and emerging markets group based in Birmingham.