can telegraph to domestic firms an earlier and clearer assessment of customer needs—the guidance from home demand is more important than its size. The best home demand arises from discerning and sophisticated customers. Here, the focus of the M&A analyst is less on aggregate demand than on segments and key customers (size, trends, and pressures within the customer group for cost, quality, and service). Thus, Porter says, “Sophisticated, demanding buyers provide a window into advanced customer needs; they pressure companies to meet high standards; they prod them to improve, to innovate, and to upgrade into more advanced segments.” (Page 82)
Related or supporting industries. No industry resides in a vacuum; instead, each depends on others for upstream or downstream assistance. The strength of these related industries will influence the success of an industry. Internationally competitive suppliers “deliver the most cost-effective inputs in an efficient, early, rapid and sometimes preferential manner.” (Pages 82–83) Close working relationships spur innovation and change through better information flow and technical exchange. Porter argues that this type of exchange within industrial “clusters” explains the dominance by countries of certain industries, such as leather footwear (Italy), chocolate confections (Switzerland, Belgium), machine tools (Italy), software (U.S.), and biotechnology (Denmark). The M&A analyst should consider the character of supplier industries: pressures for productivity improvement, internal competition, and key suppliers.EXHIBIT 5.11 Porter’s “Diamond” of National Competitive AdvantageSource: Porter (1990).
Domestic rivalry and the strategy and structure of the competitors. Competition tends to strengthen the international competitiveness of local industries. The nature of that competition and the strategies adopted by individual rivals shapes the ability of that industry to withstand competition across borders. Cozy oligopolies created by high industry entry barriers will tend to stifle innovation and productivity improvement. Therefore, the analyst should assess the structure of competition in selected industries (e.g., by means of concentration ratios), evaluate the significance of entry barriers (especially barriers erected by governments), map the conduct of competition (e.g., familiar patterns such as leader-follower or territorial dominance by geographical area or industry subsegment), and look for the presence of “national champions.” Porter writes, “Conventional wisdom argues that domestic competition is wasteful: it leads to duplication of effort and prevents companies from achieving economies of scale. The ‘right solution’ is to embrace one or two national champions, companies with the scale and strength to tackle foreign competitors, and to guarantee them the necessary resources, with the government’s blessing. In fact, however, most national champions are uncompetitive.” (Page 85)
These factors are self-reinforcing; they form a system. Dramatic improvement or deterioration in one factor will radiate through the others. This underscores the cluster nature of microeconomic strength in a country: the interlinkage of these factors amplifies industrial strengths (and weaknesses). Industrial clusters tend to arise in geographical proximity and from shared customers, technology, distribution channels, resources, and suppliers.
From the microeconomic vantage point, all national strength has local origins. Frameworks such as Porter’s can help guide the analyst toward the identification of these sources.
Institutional View
The field of institutional economics emphasizes the important role played in national economic growth by a range of institutions that may not themselves be the direct producers of growth but that provide important economic infrastructure for development. In developed countries, these institutions are taken for granted. But in earlier stages of development (see Exhibit 5.10), the presence or absence of these institutions and the health of the institutions will affect the attractiveness of the country for foreign direct investment and acquisition. Institutions worth studying include these:
Banking. In the 150 developing countries of the world, banks are practically the only means by which firms can acquire nonequity funds to grow. And within the developed world, the number and health of banks vary greatly. Measures of activity and soundness of banks (and thereby the banking system) include: loan growth, deposit growth, loan losses, capitalization (and especially in comparison with capital requirements imposed by country regulators and supranational organizations such as the IMF), return on equity, return on assets, and operating ratio (operating income divided by operating expenses).
Stock market and investment regulations. The local stock market is a bellwether of integration from local markets to the global market. Indicators of stock market conditions are the number of listings, the daily trading volume, the number of initial public offerings, the height and trend of stock prices (especially the local stock market index), presence of sophisticated institutional investors, breadth of share ownership among households within the country, and concentration of share ownership of firms. Of vital importance to integration is the presence or absence of controls on the cross-border movement of capital, restrictions on share ownership by foreigners, and generally the adoption of market regulations in harmony with world market standards.
Watchdogs: auditors, free press, opposition political parties. Transparency of financial reporting and the adoption of accounting principles by active professional auditors in the local country are foundations of strong banking and stock market systems. But the country analyst should broaden the assessment to include other institutions that also play a watchdog role such as journalists and opposition politicians. Issues of particular importance are the suppression of governmental and corporate corruption. Some international business organizations publish corruption indexes.
Independent judiciary, rule of law, respect for contracts and property rights. Expropriation of wealth by government or by a private mafia is the nightmare of foreign direct investors. One measure of relief from these risks is the soundness of the system of justice in the local country. Failures of the judicial system often parallel failures in watchdog groups; therefore, information in the public domain may not give a clear indication of the strength of local justice. Here, interviews with local foreign investors will be indispensable. Respect for civil rights is another indicator of the integrity of the system of justice. Give careful attention to freedom of speech, freedom of religious observance, and respect for the rights of minorities and women.
Educational system. Literacy rates, schooling requirements, and the number and health of educational institutions give demographic backing to conclusions about the likely strength of the workforce, of human capital, and of the possible generation of new intellectual property.
Cultural View
Economic growth may also be culturally determined by factors such as work ethic, leadership, and entrepreneurship. Great ingredients do not guarantee a tasty dinner—such an outcome depends importantly on the cook. The M&A country analyst needs to assess the ability of the local culture to nurture these important attributes. Any scientific effort to do so borders on organizational psychology and anthropology, disciplines well beyond the scope of this book. But one can start a rich process of observation by focusing on inflection points in the foreign culture: selection of leaders, treatment of upstarts, tolerance of risk and of failure, and appetite for profit.
Exhibit 5.12 summarizes these factors and graphically suggests that the four categories (macroeconomic, microeconomic, institutional, and cultural) jointly complete the mosaic of assessment. A view about
