critical challenges for developing and developed countries

Wolfgang Lehmacher

Critical challenges for developing and developed countries over the short and medium term

January 2010

Agenda

- 1 -

Overview

Macroeconomic Challenges

Microeconomic Challenges

Critical Success Factors

Executive Summary

- 2 -

As the broader global economic climate evolves, emerging, developing and developed markets are facing critical challenges. By understanding these global economic and business challenges, the necessary strategies can be employed to reduce or mitigate their impact.

The initial focus of this presentation is on the macroeconomic challenges impacting businessesThis has been largely determined by the global recovery following the financial crisis in 2008 and the impact of governments’ temporary stimulus measures

This has manifested into short and medium term challenges for emerging, developing and developed markets

The next section goes on to consider how these macroeconomic challenges have shaped the microeconomic context, particularly for emerging and developing markets

Emerging and developing markets continue to show strong growth exceeding those of developed markets and provide a large financial opportunity for investors and business entrants

Despite this market attractiveness investing in these markets poses unique challenges such as fragmented industries, underdeveloped infrastructure and skills shortages

Finally, the strategic approach and critical success factors needed in these developing markets to address these challenges, is explored

The core challenge for businesses is to grow in a cost-effective and profitable way given the vast size of these markets, the differing economic and infrastructure capacities and the variations in the markets' cultures and customs

Agenda

- 3 -

Overview




Context

- 4 -

The global economic recovery from the GFC has been complicated due to the temporary nature of the stimulus it has received

Global RecoverySince the global economic crisis, the world has largely stabilised, and is expected to grow in 2010

Temporarily StimulusHowever, growth has largely been driven by temporary stimulus♦ Fiscal Stimulus♦ Central bank support of credit markets♦ Production driven by restocking (due to the falls in inventory which occurred in the hight

of the GFC)

Therefore, the current situation presents emerging, developing and developed economies with a series of challenges

Overview of Macroeconomic Challenges

- 5 -

The challenges facing the global economy can largely be split into short term and medium term challenges covering demand, financial and policy issues

Short TermShort Term

GrowthGrowth will continue to be weak with increasing unemployment, particularly in developed economiesHowever the BRICs and other developing markets are expected to quickly rebound to strong positive growth in 2010

FinancialDeveloped economies face the challenge of a deleveraging financial system, which is still at risk of credit deteriorationExcluding China, emerging economies face the challenge of having their growth tied to the stability/resurgence of FDI flows

PolicyPolicy makers face the challenge of when to remove their stimulus packages

GrowthGrowth will continue to be weak with increasing unemployment, particularly in developed economiesHowever the BRICs and other developing markets are expected to quickly rebound to strong positive growth in 2010

FinancialDeveloped economies face the challenge of a deleveraging financial system, which is still at risk of credit deteriorationExcluding China, emerging economies face the challenge of having their growth tied to the stability/resurgence of FDI flows

PolicyPolicy makers face the challenge of when to remove their stimulus packages

Medium TermMedium Term

Financial System ReengineeringReengineering the financial system (banking and markets) to continue to support economic growth and minimise the risk of another GFC in the future

Global Demand RebalancingImprove domestic consumption of export intensive economies (many emerging and developing markets) and reduce the reliance of developed economies on domestic consumption to fuel growth

Financial System ReengineeringReengineering the financial system (banking and markets) to continue to support economic growth and minimise the risk of another GFC in the future

Global Demand RebalancingImprove domestic consumption of export intensive economies (many emerging and developing markets) and reduce the reliance of developed economies on domestic consumption to fuel growth

Agenda

- 6 -

Overview

• Short Term

• Medium TermMacroeconomic Challenges



Growth (1/2)

- 7 -

-5%

0%

5%

10%

2007 2008 2009 2010F

World OutputAdvanced EconomiesEmerging and Developing Economies

World Economic Outlook Projections% Growth in world output2007 – 2010F

Growth will continue to be weak with increasing unemployment, particularly in developed economies

Although global economic growth is expected to rebound to ~3% in 2010, this is still well below pre crisis growth of ~5%

Developed economies are expected to resume growth in 2010, however this is expected to be relatively weak ~1%

Due to the low level of economic growth, many countries are expected to experience a further increase in unemployment

World Unemployment Rate Projections% Unemployment2007 – 2014F

Source: IMF

Growth (2/2)

- 8 -

However the BRICs and some developing markets are expected to rebound to strong positive growth in 2010

-0.10%

4.10%

-5.70%

3.80%

5.50%6.60%

9.60%10.10%

-1.70%

2.20%

-2.10%

2.10%

-6.10%

4.10%

0.40%

4.90%

-1.60%

0.90%

-1.30%

1.90%

-3.70%

2.00%

-3.30%

2.10%

Brazil Russia India China SouthAfrica

USA Turkey SouthKorea

UAE France Germany UK

GDP PPP2009 2010

China, India and Brazil have shown higher resilience than the developed economiesSource: IMF, GDP PPP (October 2009)

Financial (1/2)

- 9 -

Developed economies face the challenge of a deleveraging financial system, which is still at risk of credit deterioration

Due to deleveraging, lending capacity is expected to continue to fall ...

Due to deleveraging, lending capacity is expected to continue to fall ...

... While credit assets are expected to continue to deteriorate

... While credit assets are expected to continue to deteriorate

Bank Lending Capacity Growth% Growth in lending capacity2002 – 2010F

Realised and Expected Write-down / Loss Provisions for Banks by RegionBillions $US

These impacts are likely to mean that credit within the economy is likely to remain tight, making a sustainable recovery more difficult

Source: IMF

Financial (2/2)

- 10 -

Excluding China, emerging economies face the challenge of having their growth tied to the stability / resurgence of FDI flows

Projections for emerging economies assume that capital flows, which took a major hit over the past year, will again begin to grow broadly in line with GDP

Credit growth will continue to fall or stay at very low levels, and this will hold back investment, with the notable exception of China

Significant credit contraction is generally unlikely, except in parts of emerging Europe and the CIS, where debt markets are open only to some major corporations and banks and where financial systems are still early in the process of recovering from major credit busts

Policy

- 11 -

Policy makers face the challenge of when to remove their stimulus packages

Financial Stress Indicators1 & Major Policy InterventionsMany of the policy interventions which have occurred since the crisis have improved the stability of the global financial system

Nevertheless, these “temporary”measures will need to be removed over time (otherwise policy makers will risk distorting markets and cause inflation)

Therefore the challenge is to remove stimulus over time without impacting short term growth prospects

However, developed economies’ central banks can (with few exceptions) afford to maintain accommodative conditions for an extended period because, inflation is likely to remain subdued as long as output gaps remain wide

Source: IMF(1): Financial stress indicators consist of seven financial market variables, including the beta of banking stocks, the TED spread, the slope of the yield curve, corporate bond spreads, stock market returns, stock market volatility, and exchange rate volatility. BoE: Bank of England; BoJ: Bank of Japan; ECB: European Central Bank; Fed: Federal Reserve; GSE: government-sponsored enterprises; MBS: mortgage-backed securities; SNB: Swiss National Bank; TALF: Term Asset-Backed Securities Loan Facility.

Agenda

- 12 -

Overview

• Short Term

• Medium TermMacroeconomic Challenges



Financial System Reengineering

- 13 -

Re-engineering the financial system (banking and markets) to continue to support economic growth and minimise the risk of another GFC in the future

To ensure that the financial system has the ability support economic growth, financial institutions need to:

Increase capitalRepair balance sheets

The challenge is to do this in such a way, that:Clear exit strategies for any Government intervention are developed and articulated to help guide marketsPrograms need to be phased out gradually, using market-based incentives to encourage reduced reliance on public supportProvides clarity on new capital regulation, liquidity risk requirements, provisioning, and accounting standards to the market

The second challenge is to put in place financial reforms that reduce the risk of a similar crisis in the future

This will require a major overhaul of prudential policies, which must:

Not derail growing confidence that the crisis is passingNot be perceived to erode competitive advantagesBe seen to be an effective solution

The reforms will have to be:Broad enough to cover all systemically important institutions and provide incentives for institutions to not become “too big or too connected to fail.”Encourage effective market discipline through greater transparency and disclosure / financial institution governance reformMust induce banks to build more buffersPromote international collaboration and coordination

Global Demand Rebalancing

- 14 -

Improve domestic consumption of export intensive economies (many emerging and developing markets) and reduce the reliance of developed economies on domestic consumption to fuel growth

The significant imbalance between consumption / production between many developed and developing economies is not sustainable in the long term

The challenge for the global economy is to rebalance production / consumption

Developed economies will need to rely less on domestic consumption to fuel their growth (saving and exporting more)While many emerging and developing economies, will have to increase their domestic consumption, decreasing their reliance on exporting to developed economies

Global Imbalances1

% of world GDP

Source: IMF(1): US: United States; DEU+JPN: Germany and Japan; CHN+EMA: China, Hong Kong SAR, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan Province of China, and Thailand; OIL: Oil exporters; ROW: Rest of the world.

Agenda

- 15 -

Overview




Stages of Supply Chain DevelopmentEmerging/Developing Markets vs Developed Markets

- 16 -

Emerging, developing and developed markets exhibit distinctly different microeconomic features reflecting the needs of customers, level of competition and skills availability

JapanSingaporeAustralia

Hong Kong

South KoreaTaiwan

MalaysiaThailand

IndonesiaPhilippines

ChinaIndia

VietnamCambodia

Laos

Dev

elop

edEm

ergi

ng

Emerging Developing Developed

■ Underdeveloped infrastructure and distribution

■ Fragmanted industries

■ Low 3rd party capability

■ Low cost labor availability

■ Mix of traditional and modern distribution channels

■ More demanding customers

■ Increasing competition and consolidation of industries

■ Difficult to access sophisticated supply chain capabilities

■ Modern distribution channels

■ Intense competition

■ Demanding customers

■ Easier to attract skilled talent

■ Processes and infrastructure which supports collaboration

Source : Accenture

Challenge FactorsEmerging/Developing Markets vs Developed Markets

- 17 -

Within this environment there are key challenges faced particularly by emerging and developing markets in terms of geography, business and growth

Challenge Factors Emerging/Developing Markets Developed MarketsGeographically Dispersed Markets Geographically Condensed Markets

Low income buyers, small businesses High level of purchasing power

Immature Business Environment Developed Business Environment

Explosive Market Growth Slow Market Growth

Business Size

GeographicalLarge populations spread over a huge

geographical area Cultural barriers, life style and language

differences

Large populations in crowded big citiesSimilar culturesEnglish widely spoken as a business

language

Large base of low income buyers and small businesses

Fragmented market resulting in low standards and uncompetitive prices

Higher incomes compared to emerging markets

Saturated market with price wars and high cost

Business EnvironmentInsufficient distribution structureInsufficient technological structureLack of local knowledgeLow trust level between partnersNon-regulated customs clearance

processCorruption High DSO levels

Developed distribution infrastructureHigh tech availableStandardized customs regulationsLower DSO levels High Sustainability focus

Growth PotentialSales objectives and channels are

different from developed marketsProcesses, systems and policies are

underdeveloped

Both direct and indirect sales channels are available

Operating modals that are process driven rather than person driven

Agenda

- 18 -

Overview




StrategyEmerging/Developing Markets

- 19 -

There are several short and long term strategic approaches to address the challenges posed in emerging and developing markets

Challenge Factors Short Term Strategy Long Term StrategyGeographical

PopulationCulture

Respect cultural differences and local practices

Adapt the channel strategy according to rapid urbanization

Respect cultural differences and local practices

Business SizeConsumer typeMarket type

Know customer and market demographics

Segmentation of customer and industry

Business EnvironmentInfrastructureTechnologyKnowledge gapTrust between partnersCustoms ClearanceCorruptionDSO

Import know-how on technologyFight against corruptionLeverage 3rd party logistics providers Evaluate entry options: organic vs

acquisition Choose distribution partners carefully

Support development plans of infrastructure

Fight against corruptionLeverage 3rd party logistics providersAllow greater local control

Growth PotentialSalesPolicies

Import know-how on policies, procedures and sales technics

Focus on accelerated growth to meet competition

Invest in local talent for long-term growth

Build a local sustainable management team

Critical Success FactorsEmerging/Developing Markets

- 20 -

Four critical success factors have been defined to ensure successful entry and investment into emerging/developing markets given the economic and business challenges

Fast-growing economies, robust GDP growth projections and a growing middle class over the next few years represents a significant opportunity for companies eager to sell products in China, India and other emerging and developing markets.Sourcing talent, commodities and products in Asia will also continue to offer costadvantages.However, these markets are in flux. New challenges continue to arise alongside the long-standing challenges of understanding country-specific business practices and regulations, developing reliable partnerships and finding talent.

Rising labor costs, increasing shipping costs, the fluctuating value of the US dollar and shifting demographics are changing the equation in these markets.

Critical Success Factors1. Entry strategy

2. Sales channel strategy

3. Supply strategy

4. Workforce strategy

critical challenges for developing and developed countries

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