The disproportionately high levels of assets in relation to earnings (foreign assets, considered volatile by shareholders) is the big problem with MNCs, much unlike the case with 'only exporting' firms.

Steven Philip Warner | April 2017 Issue | The Dollar Business


Sometimes, a shocking incomprehension is a better teacher for change than a whiteboard marker-waving genius. And often, changes come about by questioning conventions, even those that have become traditions of thoughts. In an era of globalisation, one such tradition thrives – the ‘multinational company’ model. [You don’t need a referendum to conclude on that.] This dogmatism has come to characterise both market economics and society. It is understood to be the governing school of thought that ensures capitalistic success on both fronts – corporate and individual! In vogue, this dogmatic certainty has developed traits that makes it irrefutable as say, religion. How do you prove the existence of God? You don’t. You believe. Similarly, those who harp about how MNCs are doing justice to Friedman’s flat world, will go far as to throw Rene Descartes’ process of painstaking reasonings (to achieve absolute certainty) out of the window if the philosophy of MNCs having become a ‘soggy’ idea is put forth. But, as I said earlier, sometimes, a shocking incomprehension is a better teacher…

There is obviously little logic or science that can convince a dogma-drunk human, who spends hours buried up to his neck in sand to cure his rheumatism, that the beach isn’t really a hospital or the onlookers nurses. That’s not the effort here. My objective is not to challenge the therapy or slice out the inseparable. The idea is to present a better alternative – or talking about that man on the beach, suggest a reputed orthopaedic (over spending days in a process that was proven to be effective by Egyptians some centuries back). And in this case, not proving a concept of globalisation like MNCs to be flawed, but to present a better alternative to step onto foreign shores. Exports.

Talk about international trade, and acronyms like FDI and MNC come to mind; what after years of these concepts being drilled into our heads. But cracks have started appearing on the fortress walls of these popular corporations built on the ideologies of FDIs and MNCs. These mighty citadels of modern capitalism are now feeling vulnerable, and there are signs of distrust in the very ‘equity and investment-based’ model they have relied on for decades. In the past decade, cross-border investments by MNCs have stagnated ($2.1 trillion in CY2006 and CY2015). Actually, in ten years leading to CY2016, their investments in foreign assets have fallen by 40%. There is another problem. Over the years, profits of MNCs have been on a downslide. As per a McKinsey Global Institute report, for the big MNCs, “profits are not only shrinking but also becoming more uncertain. Since 2000, the return on invested capital has been about 60% more volatile than it was from 1965 to 1980.” McKinsey has estimated that corporate profits of the MNCs could shrink from the current 9.8% of global GDP and 5.6% of revenue to 7.9% and 4.7%, respectively by 2025. [That’s an oops moment for blind followers of ‘MNC priests’.]

Are we paranoid? Perhaps just practical. A few reasons. Powerful digital platforms brought alive by the “Internet of things” have been feeding a growing monster (monster for traditional brick-and-mortar firms, a friendly giant for consumers globally) called ‘e-commerce’. Profits are gradually shifting from heavy industry to idea-intensive sectors that revolve around R&D, IPR, services, software and algorithms (and which can be delivered without setting up local facilities). Costs have possibly bottomed out for MNCs – which makes their accountants pinch themselves at the harsh reality called lowered ROCE. Availability of low-cost labour is fast becoming a thing of the past (even in China, Vietnam, Bangladesh and India). Interest rates have fallen to historically low levels across most countries, leaving no further room for hammering borrowing costs deeper into the ground. Also, the big tax-rate decline that we’ve since across most nations since the 1990s seems to have bottomed out and most MNCs have already massaged their tax bills to give their profit muscles the maximum relief possible.

The return on equity (ROE) of the top 700 multinationals (as per FTSE) has dropped from a peak of 18% to 11% in a matter of a decade. “The returns on the foreign operations of all firms have fallen, too, based on balance-of-payments statistics. For the three countries which have, historically, hosted the most and biggest MNCs – US, Britain and the Netherlands – ROE on foreign investment has shrunk to 4-8%. The trend is similar across the OECD. Multinationals based in emerging economies, which account for about a seventh of global firms’ overall activity, have fared no better,” states an EIU-OECD research.

All these make grounds for an argumentative businessman that not too far into the future, ‘non-equity-based globalisation’ (pure exports minus FDI on foreign soil) may remain one of the most efficient ways to creating a global company. For profit-and-productivity focussed firms, this symbolises the re-emergence of the ‘international company’ at the cost of the MNC format.

The superiority of ‘exports-focussed’ firms over MNCs is also proven in academic research. In a extensive research by Harrison and Click (of the US Federal Reserve Board) lasting 14 years and involving over 42,525 firm years, the experts conclude using significance analysis that capital markets penalise MNCs by “putting a lower value on the equity of multinational corporations than on otherwise similar domestic corporations”. MNCs are valued at a discount of anywhere between 9% to 17%. And in stark contrast is the fact that 'only exporting' firms are valued at a premium of about 4% due to their higher market value and lower asset size! So the disproportionately high levels of assets in relation to the earnings they generate (“foreign assets” that are generally considered volatile by shareholders whose values are subject to vagaries of policy and other macroeconomic changes in both the host and parent nations) is the problem with MNCs, unlike the case with 'only exporting' firms.

Exporting firms are therefore far superior to MNCs in terms of efficiency and valuation, and that should serve a clear message to large companies and MSMEs around India.

But having made that comparison, is there proof that the ‘exports-focussed’ model is also superior to a company that focusses solely on the domestic market? This piece is not a suggestion to attempt an escape from the ambiguities and anxieties that accompany investments on foreign shores. It is also not to glorify everything that’s build around the business model of serving everything “domestically” mainstream. You would have read on Buddha’s realistic middle-path doctrine. Perhaps foreign trade today is much like what he preached. There is a downside to adoption of the MNC model. [Ever imagine why virtual offices are in fashion these days?] At the same time, keeping your business confined within national boundaries isn't wise.

There is some sort of reformist, capitalistic animus associated with exports. Does it boost profits? Recent history of domestic firms that have moved to exports confirm the obvious. 82% businesses experienced a positive impact on their bottomline (profits) after two years of exporting. Businesses that export, grow by almost 30% in just two years, claims a report titled, ‘Export to Expand’ by Prof. Robert Blackburn of the Kingston University, UK. A study conducted by Barclays puts it straightforwardly that, “Beyond business growth, almost nine in ten (87%) businesses identify other benefits to exporting, including having greater confidence in the longevity of the business (44%), increased productivity (37%), stronger innovation (28%) and a longer lifespan for their products and services (27%).”

There is enough literary evidence that firms that indulge greater in exports (or imports) have a higher greater probability of survival. After studying the participation of Indian firms in foreign trade, Prof. T. N. Srinivasan of Yale University, concluded that “exporting firms are significantly larger, more productive and more profitable than non-exporting firms.” A study by Megha Mukim of the London School of Economics, titled, ‘Does exporting increase productivity? Evidence from India’ that used data for about 20 years and covered over 8,000 manufacturing firms in India concludes that “Exporting is associated with a jump in productivity, both within industries and within firms… Entry into export markets has a positive effect on firm performance…”

There are many compelling reports that prove how export entrants become more productive once they start exporting and that the productivity gap between exporters and their domestic counterparts increases further over time. And the observations are not just confined to India. Across the world, economics continues to play a similar game; US, Denmark, UK, Sweden, Kenya, Vietnam, Spain, China, Portugal, Australia, Slovenia, EU…the list is long. It rewards those who avoid the bait of complacency (read: staying domestically-focussed) and overlook the lure of being over-ambitious to the extent of being ostentatious (read: jump to become an MNC without testing waters with exports first).

And in this lies a lesson for Indian MSMEs – Look before you leap. But do leap!

Modern economics is no religion. There is nothing as ‘blind faith’ in capitalism. There is no strategy that’s dogmatic and worth investing in at the same time. Don’t distrust the MNC model or foolhardily undermine domestically focussed businesses. But remember, there is always a third option – one that’s no sugar rush… try an export-oriented approach to test international waters. That’s what some of India’s exporters have done. It makes them deserving of a place on the cover of this issue. They're the 'Stars of a Globalised India'.