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

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PowerPoint slides by R. Dennis Middlemist,
Professor of Management, Colorado State University
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Managing Political Risk, Government Relations,
and Alliances
The specific objectives of this chapter are

• 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.

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The Nature and Analysis of Political Risk

• Political risk
• The likelihood that a businesss foreign
  investment will be constrained by a host
  governments policy
• Macro political risk analysis
• Analysis that reviews major political decisions
  likely to affect all enterprises in the country
• Micro political risk analysis
• Analysis directed toward government policies and
  actions that influence selected sectors of the
  economy or specific foreign businesses in the
  country

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Country Risk
Risk
Adapted from Figure 101 Country Risk
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Macro Risk Factors

• Freezing the movement of assets out of the host
  country
• Placing limits on the remittance of profits or
  capital
• Devaluing the currency
• Refusing to abide by the contractual terms of
  agreements previously signed with the MNC
• Industrial piracy (counterfeiters)
• Political turmoil
• Government corruption

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Perceptions of International Corruption
Adapted from Table 101 The 2003 Transparency
International Corruption Perceptions Index
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Perceptions of International Corruption
Adapted from Table 101 The 2003 Transparency
International Corruption Perceptions Index
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Micro Risk Factors

• Some MNCs are treated differently than others
• Industry regulation
• Taxes on specific types of business activity
• Restrictive local laws
• Impact of WTO and EU regulations on American MNCs
• Government policies that promote exports and
  discourage imports

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Expropriation Risk

• Expropriation
• The seizure of businesses by a host country with
  little, if any, compensation to the owners
• Indigenization laws
• Laws that require nationals to hold a majority
  interest in an operation

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Evaluation of Political Risk
Adapted from Table 102 A Guide to Evaluation of
Political Risk
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Operational Profitability

• Most MNCs are more concerned with operational
  profitability than expropriation
• Will they be able to make the desired return on
  investment?
• Requiring MNCs to use domestic suppliers vs.
  using supplies from other company-owned
  facilities or purchasing them in the world market
  
• Restricting the amount of profit that can be
  taken out of the country
• Wages and salaries that must be paid to the
  employees

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Managing Political Risk and Government Relations
Political risks
Transfer risks

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

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Managing Political Risk and Government Relations
Political risks
Transfer risks

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

Operational risks
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Managing Political Risk and Government Relations
Political risks
Transfer risks

• 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

Operational risks
Ownership control risks
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Assessing Political Risk
Special Investments
General Investments
Political Risks
Adapted from Figure 102 A Three-Dimensional
Framework for Assessing Political Risk
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General Nature of Investment

• Conglomerate investment
• A type of high-risk investment in which goods or
  services produced are not similar to those
  produced at home
• Vertical investment
• The production of raw materials or intermediate
  goods that are to be processed into final
  products
• Horizontal investment
• An MNC investment in foreign operations to
  produce the same goods or services as those
  produced at home

Click here to see slide 15
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Special Nature of Investment

• Three sectors of economic activity
• Primary sector, which consists of agriculture,
  forestry, and mineral exploration and extraction
• Industrial sector, consisting of manufacturing
  operations
• Service sector, which includes transportation,
  finance, insurance, and related industries

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Special Nature of Investment

• Special nature of foreign direct investments can
  be categorized as one of five types (see slide
  15)
• Type I is the highest-risk venture type V is the
  lowest-risk
• Risk factor is assigned based on sector,
  technology, and ownership
• Primary sector industries usually have the
  highest risk factor, service sector industries
  have the next highest, and industrial sector
  industries have the lowest
• Firms with technology that is not available to
  the government should the firm be taken over have
  lower risk than those with technology that is
  easily acquired
• Wholly owned subsidiaries have higher risk than
  partially owned subsidiaries

Click here to see slide 15
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Quantifying Variables in Political Risk

• Factors that are typically quantified
• 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
• Slide 20 provides an example of a quantitative
  list of political risk criteria

Click here to see slide 15
Click here to see slide 20
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Criteria for Quantifying Political Risk
Adapted from Table 103 Criteria for Quantifying
Political Risk
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Formulating and Implementing Responses to
Political Risk

• Three related corporate political strategies
• Relative bargaining power analysis
• The MNC works to maintain a bargaining power
  position stronger than that of the host country
• Integrative, protective, and defensive techniques
• Integrative techniques help the overseas
  operation become a part of the host countrys
  infrastructure
• Developing good relations with the host
  government and other local political groups
• Producing as much of the product locally as
  possible with the use of in-country suppliers and
  subcontractors
• Creating joint ventures and hiring local people
  to manage and run the operation

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Formulating and Implementing Responses to
Political Risk

• Doing as much local research and development as
  possible
• Developing effective labormanagement 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 the responsibility of local personnel
  and hiring only those who are vital to the
  operation
• Raising capital from local banks and the host
  government as well as outside sources
• Diversifying production of the product among a
  number of countries

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Formulating and Implementing Responses to
Political Risk

• Proactive political strategies
• Lobbying, campaign financing, a oraxy and other
  political interventions designed to shape and
  influence the political decisions prior to their
  impact on the firm
• Formal lobbying
• Campaign financing
• Seeking advocacy through the embassy and
  consulates of the home country
• Formal public relations and public affairs
  activities such as grassroots campaigning and
  advertising

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Use of Integrative, Protective and Defensive
Techniques
(11, 14) Low or stable technology
Integrative techniques
Unified logistic, labor transmission (16,6)
((7, 10) Advanced management skill
(14, 3) Dynamic high technology
Protective/defensive techniques
Adapted from Figure 104 Use of Integrative and
Protective and Defensive Techniques by Firms in
Select Industries
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Managing Alliances

• Alliances and joint ventures can significantly
  improve the success of MNC entry and operation,
  especially in emerging economies
• Motivating factors
• faster entry and payback, economies of scale and
  rationalization, complementary technologies and
  patents, and co-opting or blocking competition
• Preparation for the likely eventual termination
  of the alliance
• Legal issues (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 (basic decision to exit,
  people-related issues, relations with the host
  government)

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Role of Host Governments in Alliances

• Alliance or joint-venture partners may be
  advantageous to MNC entry and expansion
• Highly regulated industries such as banking,
  telecommunications, and health care
• Cope with emerging-markets environments
  characterized by arbitrary and unpredictable
  corruption
• May be required by host government
• Host government may be unwilling to permit the
  alliance to terminate