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Steering a subsidiary through a political crisis.

Hidden behind the real-life drama being played out in Tiananmen Square early in 1989 was the predicament facing multinational corporations operating in China: the possibility of sweeping changes in China's political environment that could have serious implications on how a firm managed its business in that country.

A political crisis such as this poses a dilemma to a multinational's subsidiary. For instance, the company must determine whether it should continue on a business-as-usual basis as it watches events undermine the political and economic structure on which its business rests, or perhaps close up shop altogether. To cope with this dilemma, subsidiaries in developing countries must not lose sight of their objectives and of what is important for their continued survival.

Managing through a political crisis presents a formidable challenge to a multinational's subsidiary. For example, by the end of 1985, managers of subsidiaries in the Philippines faced the likelihood of a change in the country's administration but found it difficult to envision how change would come about. The administration of Philippine President Ferdinand E. Marcos had reached a critical turning point. The collapse of the 20-year-old regime before the national elections scheduled in 1987 was not unlikely. Yet how exactly would the change occur? Would President Marcos voluntarily step down? Coup d'etat? Who would rise to power? What type of government would survive?

A political crisis is essentially a juncture or a critical state of affairs that, for better or worse, could lead to a change in the political environment. This change may take the form of a new head of state, ruling faction, or system of government. The important characteristics of a crisis are that the change process is unplanned and that the eventual outcome is uncertain. While the company may have estimates of the likelihood of each possible outcome, no one knows exactly how a series of events will turn out.

Thus, predicting the events that could lead to and follow a change can never be done with certainty. Through periods of extreme uncertainty such as this, or a political crisis, the subsidiary's management must respond to events as they unfold, even as they attend to their regular business responsibilities. In order to do this effectively, these managers must know how to assess risks in a crisis and develop effective responses to the threats that may loom around the corner.

THE POLITICAL DILEMMA

The strategic question management must face during a crisis is whether to continue operations or consider a complete or gradual withdrawal. It must also be remembered that the resolution of a crisis is rarely completely favorable or unfavorable. Only in such extreme cases of political unrest as those involving outright confiscation are the results clearly unfavorable to the company.

The length of time required to resolve a crisis can affect the final outcome, provide a chance to implement strategies, and also increase the hurdles a subsidiary must overcome to meet its objectives. On the other hand, if a company withdraws from a country, a protracted crisis allows time to disengage gradually. Should the outcome prove favorable, with the worst fears unfounded, losses from missed opportunities can be expected. If a subsidiary decides to stay, and the crisis deteriorates to an unfavorable situation, however, there may be losses associated with such risks as expropriation and government controls on critical management functions.

No doubt, a political crisis can present opportunities for those who are willing to take risks. Thus a multinational may at the end of a crisis have less competition because other multinationals have withdrawn or local companies have closed. It may also encounter a more friendly administration. In either case, there is the chance for the subsidiary to gain significant advantage in market share by staying out the crisis.

ASSESSING THE RISKS

A company's response during a crisis should be based on its assessment of risk that follows the resolution (or non-resolution) of a crisis and the likely impact of these risk events. Forecasting political developments and their impact on a firm is a complex and difficult task, one that remains an art rather than a science. This process involves: identifying possible political crisis outcomes and their likelihood; identifying the possible scenarios that may occur and each given outcome; and evaluating the impact of change on the subsidiary, leading to the formulation of responses in anticipation of these developments.

A distinction should be made between the outcome or resolution of a crisis and potential developments that a subsidiary can consider risky. An unplanned change in the head of state (e.g., Marcos' departure from the Philippines) or the failure of an attempt at such a change (e.g., the student uprising in Tiananmen Square in 1989) are outcomes of a crisis. These, by themselves, are not risks to a subsidiary; they create the potential for further changes that threaten a subsidiary, such as reprisal attacks on expatriate employees or their families who live and work in the foreign country.

Management also must not forget that a subsidiary's profitability and survival are threatened as the balance of forces within its immediate industry is altered by changes in regulations, the economy and societal conditions due to a crisis. From 1983 to 1985, some managers of subsidiaries in the Philippines were apprehensive that a change in the administration could lead to a new system of government or an administration with different policies towards business. Maintaining the status quo need not necessarily lower risk, however. The ruling administration can decide action is required to strengthen its hold on power either by repressing those who initiated the crisis or by attempting to preempt further challenges to its power.

ECONOMIC UNEASINESS

No doubt, a crisis can lead to a weak economy. An unstable political environment makes the investment community hesitant and the consuming public jittery. The political instability in the Philippines contributed to a two-year decline in gross national product in 1984 and 1985. Alternatively, a weak economy can lead to a crisis since economic difficulties provide the conditions for opposing groups to challenge the incumbent.

These crisis situations actually lead to more serious long-term economic concerns, especially when the incumbent resists being ousted. Between 1983 and 1985, President Marcos refused to step down in the face of a recession and mounting opposition, Multinational subsidiaries and local Philippine businesses were uncertain as to how the political future would unfold and, thus, could not anticipate when or if business conditions would return to normal.

A crisis often involves some form of civil disturbance, as typified by the student riots in South Korea, the demonstrations in Panama, the work stoppages in the Philippines and the sympathy strikes in Chinese cities outside Beijing. These have the effect of slowing down production and consumer expenditures and dampening the interests of investors who, in particular, react negatively to disturbances that mean a reduction in the inflow of precious investment capital for a developing country. Consumption also may decrease as consumers withhold large expenditures in anticipation of a prolonged conflict.

The difficulty for a company's management is deciding in which areas of a country to anticipate disturbances or acts of violence. Obviously, they must assess what form of disturbance can be expected in the area where its major facilities or business transactions are located. Management must also distinguish between disturbances that can become national in scope and those likely to remain local.

On the other hand, pockets of opportunities may become available to a subsidiary during turbulent periods. Local banks tend to favor multinationals in a slow economy because of their perceived financial strength. Most markets open as competitors withdraw. Furthermore, some markets remain robust during a crisis. For example, subsidiaries selling consumer nondurables reported continuing growth in the Philippines during the years that the economy was declining.

INDUSTRY ENVIRONMENT

The risks in a crisis are identified based on how the general business environment affects an industry and the company's position in that industry. The objective of a subsidiary in its host market determines what situation a subsidiary considers too risky. in the case of the Philippines, the last years of the Marcos administration were of less concern to a company that wanted to take advantage of low labor rates for an export market than to one organized to compete in the Philippine consumer market. The Marcos administration encouraged export companies and discouraged labor agitation. In the case of companies established to serve the Philippine market, the economic problems that accompanied the last years of Marcos' rule cut into profits. The Aquino government's labor policies, on the other hand, were of more concern to the export-oriented subsidiary. Thus a company's objectives in its host country determine which of the factors driving its revenues and costs -- customers, suppliers or competitors -- can be most affected by a political crisis.

In addition, a subsidiary may also have objectives of a more global nature. The local facility may be established as a means of protecting a company's trade name in that country regardless of the size of the market or as part of a global competitive strategy. These subsidiaries tend to focus more on long-term risks rather than the immediate effects of a political crisis.

ELEMENTARY ATTRIBUTES

There are four common elements important for risk assessment within a subsidiary: its general manager, its longevity in a country, its network or channels of information, and its environmental assessment activity. The analogy of a person controlling a ship's rudder and a person reporting from the crow's nest is useful to describe what managers should do to navigate through a crisis. The crow's nest provides the view of the horizon, the location of rocks and other perils, and the sight of land and safe harbor; the person at the helm steers as the person in the crow's nest communicates what lies ahead. Developing effective responses to a crisis starts with assigning someone to man the crow's nest.

The character and experience of the general manager become important when one considers the question of familiarity. How long has the general manager been in the country? How long has the general manager been operating outside his or her native country and in developing countries? The general manager's ability to understand a political situation is crucial because of his or her role as the major link in the flow of information about a crisis from the host country, to the subsidiary, and finally to the head office.

Longevity and an experienced general manager often lead to an established network of information sources. These include entities with which a subsidiary transacts business, such as customers, bankers, and raw material suppliers, as well as local management. The managers in the Philippines relied on locals in senior management positions or on their boards for information and support in establishing communication links. By the time the Marcos administration began its precipitous decline, these managers were firmly entrenched in Philippine business with extensive networks of suppliers, local and international bankers, customers, industry associations, and friends in the local community. This network was also utilized to develop communication channels with the new administration.

The majority of managers in the Philippines who were interviewed regularly sought information on political and regulatory developments from all possible sources -- well-placed friends and acquaintances, trade associations, chambers of commerce, colleagues in the expatriate community, locals within the company and political risk units in their head offices. One executive, a Filipino running a Japanese-Filipino joint venture, had texts of Japanese newspapers translated for him. A European subsidiary regularly scheduled a discussion of the political and economic situation as part of its management meetings in order to surface and interpret information and involve senior management.

PROTECT THE CORE

Once it is decided that a subsidiary will remain in a troubled country, management must focus particular attention on protecting the core of the organization's human resources. Valuable personnel -- the same ones who will be needed should the economy return to normal -- can otherwise be lost to retrenchment, resignations due to a lack of growth in the company, or emigration to a more developed country. In addition to focusing on human resources, subsidiaries should be concerned with maintaining control of their productive assets. A major threat in a changing political environment is the possibility of regulations or actions by political entities that reduce a subsidiary's ability to effectively manage these assets.

Managers of subsidiaries should seek to protect operations that are at risk, including emergency procedures at the plant or branch level in response to local law and order conditions. Subsidiaries in the Philippines established contingency procedures in regions where rebels or labor unions were active and increased security in certain offices in the financial district when radical elements threatened to disrupt business operations and inflict harm on targeted companies. The major concern in these cases was to ensure the safety of personnel, facilities, and the continued flow of goods to and from these areas.

A major risk in this regard is a direct attack on expatriate personnel. As a rule for subsidiaries in the Philippines and China, expatriates were counseled on measures to prevent acts of violence and what to do should violence erupt. Most expatriates and their families were issued plane tickets to enable them to depart from the country should trouble arise. A more extreme precaution was that of the U.S. embassy in Manila, which had evacuation plans available for nationals that included routes to the embassy, safe houses and access to warships stationed in Manila Bay. The most common, and practical, advice given expatriates was to stay close to home during a disturbance.

MANAGE RELATIONSHIPS

Subsidiary employees must carefully manage many relationships between their firm and various external constituents to ensure that their operations function smoothly. The potential rewards of being closely associated with the administration can be tempting. However, those associated with an administration that has just been dethroned can become vulnerable to interference from the new administration.

And today's influential friends or joint venture partners can also become tomorrow's liabilities. A subsidiary flirts with danger if it allies itself too strongly with entities close to those in power for its own gains. For instance, a few subsidiaries had allied themselves with cronies or friends of President Marcos. One of the Aquino government's actions after seizing control was to confiscate the shares owned by Marcos' friends and appoint its representatives to the board of directors of the particular corporation on the basis of these confiscations. Some subsidiaries, therefore, found themselves having to deal with new, and at times hostile, board members.

Managing relationships with the head office is important to keep the operation viable. The parent company determines the final decision on whether or not the subsidiary continues to operate in that country. It is therefore crucial that political developments are interpreted and communicated to the head office in a manner that affords an accurate view of the true risks of the venture.

The experience of subsidiaries in the Philippines suggests some examples of companies that weathered the crisis and succeeded. One American subsidiary obtained research and development funds for developing raw materials locally to reduce dependence on foreign exchange. Another, flush with cash, accelerated its equipment acquisition before the period when inflation and devaluation peaked, thus hedging its assets in equipment that saw its replacement value appreciate. Perhaps the most forward-looking was the U.S. subsidiary that invested in projects aimed at improving energy self-sufficiency. The Philippines imports most of its crude oil, making energy expensive. Regardless of their activities, these subsidiaries sought to turn what otherwise could have been threats into advantages. Management must also remember that catastrophe is merely one possible outcome of a crisis, and that it must continuously seek to improve the subsidiary's competitive advantage because the worst need not materialize.

POLITICAL RISK STRATEGIES

These strategies will reduce a multinational subsidiary's potential exposure in a crisis: * Dispose of holdings. * Close operations. * Seek guarantees from government. * Obtain higher percent of raw

materials or components locally. * Increase market share. * Increase sales to affiliates/parent

company. * Increase procurement from

affiliates/parent company. * Transfer manufacturing processes to

another country. * Consider duplicate operations in

another country. * Transfer control of critical operation

to affiliates. * Reduce number of expatriates. * Borrow more from international

lenders. * Borrow more local currency-denominated

loans. * Increase number of locals on board. * Seek local joint venture partner. * Develop financial assets in foreign

currencies. * Retrench. * Avoid new investments, projects, or

expansion. * Initiate more discussion with

government. * Withdraw from politically sensitive

products. Source: K. Eiteman and A. I. Stonehill, Multinational Business Finance, 4th ed.

Manolete V. Gonzalez is an assistant professor of management at the College of Business, Oregon State University in Corvallis, OR, and Edwin B. Villanueva is president of Sun Hung Kai Securities (Phil.) Inc. in Makati, Metro-Manila, Philippines.
COPYRIGHT 1992 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

Article Details
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Title Annotation:Global Risk
Author:Gonzalez, Manolete V.; Villanueva, Edwin B.
Publication:Risk Management
Article Type:Cover Story
Date:Oct 1, 1992
Words:2784
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