For the past few decades, companies looking to grow have frequently turned to overseas expansion. Executed well, such a move can provide a company with access to new markets, customers, and revenue streams. Occasionally the gambit fails quickly, and these high-profile exits make headlines, like when Dunkin’ Donuts left South Africa after two short years and Walmart pulled the plug on Brazil after a 20-year struggle. Other times, the results are merely lackluster, and companies can accumulate a portfolio of so-so geographies that slowly and subtly erode profitability.
But these notable exits obscure a broader point. Many companies underestimate a key element of success in their due diligence: the complexity of operating in target countries. We have carefully researched companies operating across the globe through the lens of complexity and how this affects the success or failure of multinationals. We found that expanding to countries with high complexity profiles has a direct negative impact on a company’s operating profit.
With a possible recession looming, it’s a good time for companies to assess their country portfolios and rethink strategy. In fact, many companies have passed the point of diminishing returns and are already operating in too many countries. The path forward will often require a tighter configuration of core countries in order to reduce operational complexity and become more profitable.
Applying Machine Learning to Global Market Complexity
Our research began with a new framework for understanding the complexity of doing business in 83 different countries around the world. We scored each country on 31 data points to assess the level of regulatory, operational, and market complexity. We then used machine learning techniques to divide them into eight groups, each with a unique complexity profile. The result is our Global Markets Complexity Index (GMCI). (See “Eight Groups Identified in the GMCI.”)
In the index, Group 1 (MVPs) comprises countries with very low complexity across the board and encompasses many of the world’s most advanced economies, including the U.S., the U.K., Australia, Germany, Japan, and the Nordics. Group 8 (Only the Brave) is at the other end of the spectrum, with high complexity in every area. This group includes Nigeria and Pakistan, which are both relatively large economies that represent viable market opportunities for the right business with the right approach — but these markets are challenging for businesses unprepared for such levels of complexity.
One of the use cases for the GMCI is discovering analogs. Think of it like a Netflix recommendation: If you’re already successfully operating in a Group 5 country, such as Morocco, then your company has already learned to thrive in a market with high operational complexity, and you may do well in other Group 5 countries, such as Tunisia or Vietnam. Of course, when you move into groups with different complexity profiles, the opposite is true. You are taking on new and different management challenges that are outside your core expertise. Adapting to these challenges comes at a cost, but failing to close the gap leaves you operationally disadvantaged.
To quantify how much complexity impacts the economics of an organization, we created a new metric known as a footprint complexity score (FCS). FCS is a simple measure of how far afield (in terms of the degree to which they are operating in an environment different from their home group) companies have expanded into countries with different complexity profiles. The FCS is calculated by multiplying the percentage of a company’s operating countries in each GMCI group by how many “complexity steps” the group is from the home base. For example, let’s consider Unilever. Although it originated in the Netherlands (a Group 1 country), 21% of Unilever’s operating countries are in Group 4, three groups away and three steps more complex. These countries contribute 0.63 (obtained by multiplying 0.21 by 3) to Unilever’s FCS.
We then identified close competitors across a range of industries, using apples-to-apples comparisons where possible — Coca-Cola and Pepsi, UPS and FedEx, Hilton and Marriott, and so on. We wanted to understand whether two close competitors with similar product portfolios but different geographic footprint strategies would see different levels of profitability.
The answer is a resounding yes, and the data demonstrates a consistent trend. On average, we found that increasing the FCS by 0.25 reduces the operating margin by 4.35%. For a hypothetical example, again using Unilever, if the company were to add a country in Group 8 (or, for another analogous move, two countries in Group 5) to its portfolio, then we would expect to see Unilever’s operating margin decrease from 16.90% to 12.55%. This is clearly a big hit, and although myriad factors drive profitability, managers and boards must have plans for maintaining profitability when taking on major expansion plans.
This leads to the question of contraction. Can companies gain back operating profit if they shed their highly complex markets? The relationship between FCS and operating margin suggests that geographic footprint simplification may be one of the biggest untapped profit improvement opportunities for companies today.
British multinational Compass Group provides an excellent example with a clear before and after. In 1998, the contract food service and facilities management business operated in more than 100 countries, including East Timor, Eritrea, Costa Rica, and Swaziland. In 2007, rocked by profit warnings, Compass began a process of injecting greater focus and discipline into its business, which included exiting 50 countries. The decision to exit nearly half the countries in its corporate portfolio reduced Compass’s FCS from 2.21 to 1.24 and grew its operating margin from 4.5% to 7.2%. During the same period, free cash flow improved nearly 400% and revenues grew 60%.
Avoiding Geographic Portfolio Pitfalls
Given the impact of footprint complexity on profitability, why do companies frequently end up overextending into the wrong markets in the first place? The problem often begins by focusing due diligence on an incomplete set of factors or over indexing on a few. For example, the size of the potential market is a key factor in any decision to expand geographically, but it is rarely a good indicator of the level of complexity. So although market size indicates the potential revenue, it has little direct bearing on a company’s ability to capture that revenue.
According to our analysis, the 20 largest economies in the world are spread across six different GMCI groups. They range from countries like Germany and Japan, with low complexity across all categories, to countries like India, with high market and regulatory complexity. The allure of India’s large population, fast growth, and relative wealth is attractive to many Western companies, but there have also been high-profile retreats, such as Walmart and General Motors. Geographic proximity can be another red herring. The linguistic, cultural, and logistical advantages of moving to a nearby geography are an obvious enticement, but it can be easy to focus too much on similarities and overlook the very real differences. Even geographically close countries can vary significantly in the types and levels of complexity that characterize their markets, which can erode the more obvious benefits of geographic proximity.
For those committed to international expansion despite the challenges, we offer one more case study: Ikea. In its 76-year history, the furniture retailer has expanded into 52 countries, across five GMCI groups (and it is planning to enter a sixth). But it didn’t tackle all of these at once. Over its first 20 years, Ikea slowly built up operations within its home group, the low-complexity MVPs. (See “Ikea Market Entry by GMCI Country Group.”) From its home base in Sweden, it began expanding locally to Norway, Denmark, and Switzerland. However, during this first period of expansion, it also headed off to Japan, Australia, and Canada — entering countries on three different continents, but sticking to those with a low complexity profile. By its 20th birthday, Ikea was operating in 12 countries on four continents.
Having built this stable base, Ikea slowly began expanding outward, moving to countries with slightly more complex operating environments. Each time, it established a presence in several countries within a GMCI group and spent a decade or more building up its capabilities to deal with the incremental organizational, regulatory, and market complexities it encountered before moving on to the next group. At no point in its history did Ikea jump into a market with a dramatically different complexity profile.
There’s no doubt that Ikea is a unique player in the retail space. Its price point, design aesthetic, and store experience stand out in a crowded market. However, Ikea’s savvy expansion strategies are also a key part of what has made it one of the world’s most successful retailers. And these strategies stand in stark contrast to those of many other multinationals that may look back at their track records of expansions and see that they underestimated the complexity of a new market.
Charting a Path Forward
Given the past decade’s enthusiasm for international expansion, many companies now find themselves sitting on bloated portfolios — their country expansions haven’t paid dividends, but they also haven’t been bad enough to be excised. So for those managing corporate strategy, product expansions, and growth via M&A, and of course CEOs and their executive teams, we recommend three simple steps for looking at your country portfolio with fresh eyes.
- Identify your GMCI complexity profile. Using the index, you can map the countries in which your organization operates to the eight GMCI groups. You can also calculate your FCS and compare your operating profits with those of industry peers with different country portfolios.
- Assess high-complexity environments. Of the geographies where the company currently has operations, it’s important to identify which ones have much higher levels of complexity than the home country. These are countries that will drive your FCS up and your operating profit down. Consider whether you would have chosen to expand into each country knowing what you know today about the performance of that market.
- Make the hard decisions. Before recessions or downturns have their own impact, determine where you should really stop operating — where complexity has eroded profits and where expansion has failed to pay out. You can exit more gracefully and effectively when your hand isn’t forced.
The bottom line is that many international expansions do not deliver. If they fail quickly and obviously, we should be grateful. The most dangerous expansions are those that linger in the portfolio, quietly draining profit. Before recession hits, review your country portfolio and make sure your organization hasn’t overextended itself at the cost of strength and profitability.
Why Multinationals Should Consider Geographic Complexity First
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