1998’s Alternating Business Climate Currencies: Whiplash Changes Leave Location Winners, Losers in Wake

The world economy’s business climates have seldom seen whiplash change like 1998’s: The ruble collapsed in ruins, while for many firms with Asian facilities, “the Pacific Rim became the pathetic rim,” says Sung Won Sohn, chief economist for Norwest.
The fallout has been ghastly for many expanding companies.

Just ask Credit Suisse First Boston (CSFB), which suffered the perils of Russian pioneering. Beginning in 1991, CSFB’s rapid expansion virtually created the Russian equities market. In late August, though, CSFB paid the piper a heavy tab, slashing some US$254 million from 1998 earnings due to losses in Russia and other emerging markets. Shares of Credit Suisse Group (CSFB’s parent) plummeted 25 percent from their 1998 high.

Even before Russia’s unraveling, Asia’s currency crisis had some multinationals for the first time questioning the wisdom of going global. “Asia’s currency crisis underscores the risks in being a global player,” says Greg Mastel, director of studies with the Economic Strategy Institute, a Washington, D.C.-based U.S. business think tank.

A Shaky House of Cards

Indeed, the currency shakeup has made the current world business climate picture a house of cards . . . on wheels. The site selection ramifications will be years in fully unfolding, with more major changes likely occurring even as these words are written. Nonetheless, part of 1998’s fallout for facility location strategy seems clear:

• Desperate for outside capital, many Asian nations have become substantially more receptive to new corporate facilities.
  
• In the long run, Asia’s major reforms in business practices, banking and finance will likely make the Asia-Pacific a more level playing field for facility locations. And after painful downsizing, many Asia-based firms will be more competitive.
  
• While the stock market plunge has dominated focus, some companies are capitalizing on substantial location opportunities in revamped world business climates, particularly the Asia-Pacific.
  

Currency Fluctuations Yield
Mixed
Fallout for Global Facilities

Currency fluctuations clearly play a vital role in shaping the global economy’s intricately interrelated business climates. In fact, the currency calamity’s undertow will strike a host of firms that haven’t gone global. Asia buys 25 percent of U.S. exports and almost 20 percent of the European Union’s exports.

That could inhibit the West’s championing of free-market business climates. Steep protectionist barriers could be re-erected, a major setback for global location prospects. In late July, for example, the United States upped its tariffs on Japanese steel.

For the moment, though, Asia’s economic turmoil has been a boon for firms with Asian subsidiaries selling to other world regions. Asia’s currencies have depreciated from 25-60 percent against U.S. and European currencies. That’s made the region’s goods and services far cheaper, facilitating competitive undercutting for companies with Asian manufacturing facilities.

Reports Willard Workman, U.S. Chamber of Commerce vice president for international affairs, “For U.S. companies that export, we’ve seen across-the-board drop-offs in orders. But U.S. subsidiaries are doing very well exporting from Asia.”

Case in point: Mattel, which has less than 5 percent of sales in Asia but manufactures 20 percent of its goods there. There’s also been a worldwide drop in demand for plastic resins, Mattel’s largest manufacturing cost component. Mattel’s strong brand equity has enabled it to pocket most of those cost cuts, say Merrill Lynch analysts.

At Hewlett-Packard, “Our extensive manufacturing operations across Asia have been our saving grace, helping offset some of the decline in U.S. export orders,” says spokesman Brad Whitworth.
In short, despite the second-guessing, going global has saved some firms’ business bacon.

Asia’s Managed Capitalism
Goes under the Gun

Asia’s currency crisis has triggered 1998’s most dramatic business climate changes. Struggling to stanch rapid capital flight, many Asian nations have liberalized entrenched systems of managed capitalism once virtually closed to outsiders.

For example, despite Prime Minister Mahathir Mohamad’s fervent warnings of Western over-reliance, Malaysian policy-makers increased foreigners’ equity stake in Malay trading companies from 30 to 51 percent (though “core industries” remain protected).

But Asia’s most substantial location opportunities are in Japan’s newly deregulated financial sector, which was largely a government-backed cartel since World War II. That insularity was particularly pronounced within the lucrative insurance industry, closely tied to Japan’s powerful keiretsu.

Shock waves began rumbling through Japan’s insurance sector last year: Nissan Mutual collapsed, and two keiretsu powerhouses, Nissan and Hitachi, said they wouldn’t make good on the $3 billion losses. Soon the shock waves were a sonic boom. Japan’s real estate and stock markets collapsed, and domestic insurers, with estimated fiscal-year losses topping $10 billion, began going belly up. On Apr. 1, financial-sector deregulation followed, creating what Commerz Securities analyst Yushiro Ikuyo calls “the Big Bang.”
Just how big a bang? Several years ago the Ministry of Finance rejected U.S.-based Chubb Corp.’s bid to insure Japanese racehorses.

Japan’s opening up of its insurance industry puts huge location stakes on the table. Japanese on average carry $170,000 in insurance, four times the U.S. rate. All told, the insurance industry controls $2.3 trillion in assets, some two-thirds of Japan’s gross domestic product.

Major Players Move In

Accordingly, many firms have swooped in to capitalize. Without Japanese competitors’ massive red ink, they have a striking advantage, analysts say.

Many have found very willing partners in cash-strapped Asian firms desperately seeking suitors, particularly ones with deregulation experience. Moreover, the Icarus-like plunge of the yen and other Asian currencies has turned acquisitions and joint ventures into virtual bargain-basement sales.

Consider GE Capital, which in late July acquired Osaka-based Lake Co., Japan’s fifth-largest consumer finance company, with 1.4 million customers and 564 branches. Once only a player in Japanese auto leasing, GE Capital earlier acquired an 80 percent stake in Ryoshin Leasing (then 52 percent owned by Mitsubishi) and formed a joint venture with Toho Mutual. Elsewhere in Asia, GE Capital acquired a Philippine insurance company and four Thai firms.

Another rapid Asian sortie has been mounted by the Travelers Group, which in the last two years acquired U.S. broker Salomon Smith Barney (SSB) for $9 billion and agreed to a $70 billion merger with Citicorp, the second-largest U.S. bank. The Travelers took a 25 percent equity position in Japan’s Nikko Securities and is opening a 1,500-employee brokerage joint venture. In addition, Nikko by yearend will close 20 overseas subsidiaries, transferring them to SSB.

Then there’s Merrill Lynch, which bought the 30 branch offices of defunct Yamaichi Securities, immediately hiring 2,000 former Yamaichi employees. Such immediately available labor is a major edge in fast-tracking operations in East Asia, where aging baby boomers are retiring after accounting for a third of the region’s 6.1 percent annual per-capita growth during 1965-90, according to a recent National Bureau of Economic Research study.
Foreign securities companies and fund managers have also flooded Japan’s changed climate.

Fidelity, the largest U.S. mutual fund player, has started selling funds to individual Japanese investors. With huge opportunities, others are certain to also set up Japanese facilities. Japan’s $10 trillion in savings has traditionally gone into banking or postal savings accounts paying only 0.5 percent interest.

IT Plugs In

Also moving to exploit Asian location opportunities are information technology companies like EDS, whose long-term plans call for the Asia-Pacific to supply one-third of revenues. Though it expects a short-term slowdown in its Southeast Asian growth, EDS this year took full control of its Thai joint venture, EDS/SVOA, and opened its first regional office in India in New Delhi.

A major factor in EDS’ push is Asia’s growing embrace of outsourcing.

“Stronger organizations tightening their belts in stronger economies like Hong Kong, Taiwan, and Korea will look to IT providers for assistance and recovery. When all is going well, they are not as focused on improvements,” says David Kost, EDS Asia financial controller.

But EDS’ long-term plans call for 90 percent local staffing in all Asian operations. With future currency falls, Asian operations wouldn’t rely heavily on staff paid in U.S. dollars.

Tiffany’s Unlikely Diamond

Players aiming products at Asian consumers are also staying aggressive.

U.S.-based Tiffany fashioned one of 1998’s most unlikely global expansion successes. Though Tiffany relies on Japan for 40 percent of pretax profit, its stock has risen as much as 20 percent during 1998.

Tiffany stock initially dropped, as analysts anticipated low Japanese demand. But Tiffany remodeled its business methods and marketing, and engagement rings and wedding favors now make up almost half its Japanese business, according to Globalt, an Atlanta-based investment advisor.

Toys R Us also plans to continue to open 12-14 facilities a year, expanding to a 200-facility network in Japan, where its sales remain strong.

Subtleties Remain

While Asia’s business climate reform is widespread, significant subtleties remain.

For example, South Korea has lifted the 55 percent ceiling on aggregate foreign stock ownership and the 50 percent ceiling on individual ownership. South Korea is also privatizing 11 state-run firms, including Pohang Iron and Steel (Posco), the world’s second-largest steelmaker.

But 42 years of Japanese rule (ending in 1947) have left South Korea with an abiding distrust of both foreigners and outside capital. Dow Corning cited such attitudes within Korea’s bureaucracy when it abandoned two years of thorny negotiations, instead siting its $2.8 billion silicone facility in Malaysia.
Outside investors are also wary of South Korean labor unrest, say LG Securities analysts. Thousands of striking workers carrying lead pipes and gas-filled containers blocked a Hyundai plant’s gate for a month. Seeking to lay off more than 1,500 workers, Hyundai cut only 277 jobs, two-thirds low-paying cafeteria positions.

Free Markets Less Free

While Asia’s crisis has liberalized many once-closed business climates, it’s spurred retrenchment in strong free-market climates.

Though damaged, free-market players like Singapore and Taiwan have fared comparatively well. But the yen’s nose-dive triggered major changes in the business climate of Hong Kong, ranked by Heritage Foundation as the world’s freest economy. The most drastic measures have centered around real estate, Hong Kong’s economic linchpin.
Hong Kong’s biggest landowner, the government in June blocked land sales until April 1999, effectively freezing real estate prices, which fell 40 percent in the preceding six months.

With unemployment at a 15-year high, Hong Kong has also returned $500 million in real estate taxes to property owners, lowered import and export duties and set up a $200 million credit assistance fund for small and medium-sized firms. Profits held in Hong Kong banks are also exempt from taxes.

Nonetheless, the currency crisis remains a stern challenge to Hong Kong’s dollar, pegged to the U.S. dollar at a 7.8-to-1 rate. When Hong Kong defended the dollar by raising interest rates, it shattered the property market, forcing the abandonment of long-held market principles. Says Jan Lee, Hong Kong Shanghai Bank chief economist, “Land prices had to give, or the U.S. dollar peg had to go.”

In the short term, the U.S. dollar link will remain intact, many analysts contend. Hong Kongers can immediately switch bank deposits into U.S. dollars. Devaluing the Hong Kong dollar would spur a switching stampede that would decimate the banking system.

Russia’s Bearish Impact

Far less certain is the world business climate impact of Russia’s economic meltdown, which began 13 months after Asia’s woes.

One major difference: While Asia’s crisis has spurred reforms, Russia’s breakdown may signal reforms’ end. As the ruble collapsed, Russia defaulted on $40 billion in short-term debt and devalued its currency, signaling that its major priority is internal stability, not meeting financial commitments to the outside world.

Some analysts feel Russia’s example may spur hard-hit Asian nations to also fend off the market forces. “Some countries are talking about getting out of the global economy, building protectionist walls with native ownership,” says Donald Ratajczak, director of Georgia State University’s Economic Forecasting Center. “But the fastest way to restore capital flows is to allow investors with access to credit to purchase or build resources.”

It all adds up to a complex world business climate scenario that must be negotiated as delicately as a minefield.

Says EDS Asia-Pacific President Edward Yang, “The Chinese word for ‘crisis’ comprises two characters, danger and opportunity. Our strategy is to minimize the danger and take advantage of the opportunities.” SS