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How to work better with headquarters.
Don Durfee, CFO Asia
July 3, 2008
The shining glass building that houses the offices of ICI India is an unusual sight. The structure itself is ordinary — it would blend in perfectly in a suburban London office park. But this isn't England. It's Gurgaon, India, the chaotic and dusty special economic zone more than an hour's drive from Delhi. On the sidewalks, vendors carry on a lively trade in the mid-day heat (over 40 degrees Celsius on a recent afternoon). A cow grazes in an empty plot across the street.
Inside the air-conditioned office, Sandeep Batra is explaining the peculiarities of the Indian paint business. "We don't sell our paints through big retailers as you would in Europe or the U.S.," says Batra, the urbane CFO of Imperial Chemical Industries' Indian operations (ICI is now owned by Dutch chemical company Akzo Nobel). "We sell through mom and pop shops in the markets."
Convincing the store owners to carry ICI's products requires a costly but essential investment: tinting machines that allow the store to mix the full range of ICI's paint colors. And because the company sells through hundreds of tiny shops instead of big home improvement centers, its distribution model is necessarily different. Instead of the one or two warehouses that ICI has in most countries, there are 60 in India. The number of sales staff is also many times bigger.
Such deviations from ICI's usual way of doing things cost money, of course, and expensive exceptions don't generally win the goodwill of corporate managers. But Batra and his colleagues in Gurgaon have learned how to overcome objections. "Our business situation is impossible to explain to someone who has never visited India," he says. "So when the CEO or any other senior visitors come, the first thing we do is take them to the market. We take them to the shops and to the warehouses where we sell materials — that's a very different India from what you see in this office. Once we do that, we never have any difficulty explaining about the need to put these tinting machines in, or the need to have feet on the ground, or whatever else is required to chase the opportunities we have here."
It's always been helpful for a regional CFO to build this kind of understanding with headquarters. But having informed advocates in the head office is about to become absolutely essential. The reason: as growth grinds to a halt in the United States and slows in other developed markets, CEOs are demanding that Asian operations grow faster to help make up for shortfalls in global earnings. CFOs find themselves squeezed between growing pressure from headquarters and the constraints of doing business in local markets. If those applying the pressure don't understand the limitations, they may well impose strategies that don't suit conditions on the ground and push for results that are out of reach for local operations.
There's another problem. The business world's attention is shifting to Asia at a difficult time for those operating in the region. The region's economies are still growing, but many businesses here are already seeing demand slow. Inflation is rising, currencies are volatile, and sky-high rates of employee turnover are undermining growth plans. Add to this Asia's new supply chain woes: natural disasters that have disrupted trade just as manufacturing costs in China begin a steep climb.
Many finance executives report that the challenges are starting to weigh on them. The China CFO of one American industrial company reports that because of poor business conditions in the United States, managers there are asking him to raise his forecast by 10 percentage points. But his division is already growing at a 30 percent annual pace, and he has difficulty getting his superiors to understand why even faster growth is difficult, if not impossible: high employee turnover, a product lineup that doesn't match local needs, and prices well above those of Chinese competitors.
"I've worked in the U.S. office," says the CFO. "When it comes to China, they have no comparisons and no good analysis. They have too many countries to take care of. All they can do is give you targets and track your performance."
Rebecca Norton, VP of finance, Asia Pacific, for software maker Business Objects (a unit of Germany's SAP), also feels the push for even higher results. "I get a little nervous that the pressure and expectations [from the home office] are not necessarily in line with actual market conditions out here."
The View from There
In part, misunderstandings can be traced back to corporate structure. During the 1980s and 90s, the balance in multinational companies tilted toward greater global integration, with an eye toward seizing opportunities across business lines and saving money by doing things in a common way everywhere. One manifestation of this was the global business unit, an arrangement that in many companies has replaced countrylevel units. But this structure has often led companies to unintentionally shortchange their emerging markets operations,says David Michael, managing director of the Boston Consulting Group's greater China practice.
"It gives you a global view on one hand, but when incentives aren't right the high-growth markets fall off the radar screen," he says. The reason is that the business units' heads may be focusing on short-term global performance indicators, and trying to hit their quarterly, one-year, or two-year targets. If most of the profit is coming from developed markets, it's tempting to allocate scarce resources to those operations first and neglect emerging markets that boast more potential than actual profit.
Exacerbating this head office bias is the common practice of putting expats in charge of local operations and then shifting them out after just a few years. While there are good reasons for relying on expat managers, the arrangement can encourage short-term thinking. "We have a lot of expats come to China, and since their service period is just three years they just want to make sure they do a good job for those three years, and then return to receive a promotion in the U.S.," complains the local China CFO. "But I want sustainable growth here, and that means a longer-term focus on people and investment."
Satish Shankar, a partner with Bain in Singapore, argues that if multinationals are to earn significant profits from their emerging markets operations, they must move away from a model that relegates emerging markets to second-tier status. "Most MNCs operating in Asia have built decent positions, but don't have the same market visibility and sustainability as they have in their home markets," he says.
Some big companies are indeed making such an effort, pushing responsibility back out to the country operations and building a full set of business functions. One is GE. According to Murali Narayanan, Singapore-based regional finance manager for GE Energy's repair business, the company is making the Asia-Pacific operations more self-sufficient. To that end, GE is expanding and deepening functions like manufacturing, supply chain and risk management, and talent development. Also, more commercial decisions are being made in Singapore rather than headquarters. "This enables us to respond to customers and conclude deals faster in the region," says Narayanan.
Such examples are still comparatively few, though. There is still often a gap between what headquarters knows and what it thinks it knows.
Exorcisms and Bank Drafts
In the late 1970s, Brian Kenny was visiting Jakarta, handling U.S. financial reporting for the Indonesian unit of chemical company W.R. Grace. The company was preparing to start a new plant, but the facility failed to start up on schedule. This created a variance in the monthly financials that Kenny had to explain back to his superiors in the United States.
The cause of the delay? An exorcism. Employees believed that malevolent spirits had taken up residence in the facility, and refused to pass through the gate until religious authorities declared the area safe. Kenny's explanation met with disbelief at the home office. "They said, 'That's a lot of baloney — you had start-up problems, didn't you?' I said, 'Well, yes, we had a start-up problem. The problem was evil spirits.'"
These days, Kenny is Grace's Shanghai-based CFO for Asia Pacific, a position he took up after a series of finance jobs at headquarters, including international CFO. Grace is one of those companies starting to see the need for a closer focus on Asia, and China in particular — the company's new corporate CFO was formerly the China CFO for Dell Computer.
Still, in a sign of how difficult it is for even a well-traveled corporate executive to grasp conditions on the ground, Kenny has discovered a range of issues he wasn't aware of before joining the Asian operation. "I'm no longer the guy who flies in on Monday and out on Friday," he says. "There is a lot that people have to do here — particularly in finance — that headquarters just doesn't see."
Credit terms are one example. "[When you work in the home office] you always hear the usual stuff about how we can't sell to customers on the usual 30 day terms in this or that market," he says. "Sometimes that's real and sometimes it's just salesmen not wanting to be tough with customers." Now he's finding that many of the company's customers in Asia do indeed consider a line of credit as a zero-interest loan. "They'll borrow against it and then say let's talk about what we're going to do over and above that."
There are treasury issues, too. Customers often pay Grace via bank draft — a common method in Asia, but almost unheard of in the United States. Depending on the country, bank drafts can be safer, since the draft carries the bank's credit rating rather than the customer's. But this payment typically means that a company gets its cash slowly, creating potential working capital problems. "If you sell to a customer on 30-day terms and on day 29 they give you a bank draft, that's three months more you'll have to wait," says Kenny.
Small matters, perhaps, but when companies rely on misconceptions to make big decisions, they can cause expensive disasters. One notable example was Ford Motor's decision in the late 1990s to combine its North American and European operations. The hope was to achieve cost savings by doing things in a common way across the regions. But as Harvard Business School professor Pankaj Ghemawat describes in a 1995 Harvard Business Review article, managers failed to appreciate the significance of a few key differences. One was the wide gap between the cost of gasoline in the United States and in Europe, which implied a difference in the kinds of cars consumers in each market wanted (i.e., big SUVs in the United States and more fuel-efficient cars in Europe). The merger hobbled the company's regional product development capabilities and led Ford to build cars that few Europeans wanted to buy. The car maker endured US$3 billion in losses in Europe and saw its regional market share shrink from 12 to 9 percent.
Similarly momentous decisions are being made in Asia today, and as companies ramp up for faster growth in the region, planners will have to address some challenges that are often hard to see from headquarters. Consider just a few: forecasting difficulty, human capital troubles, and the rising demand for localized products.
Predicting financial results is never easy in high-growth markets, since volatility is often a companion to growth. But the environment has become even more vexing for forecasters, who confront rising inflation, unstable exchange rates, and a host of political issues (such as China's upcoming Olympic Games) that can disrupt supply chains.
B. Suryanarayanan, CFO of Mindtrac, a Singapore-based supplier of commercial tires, says that he is not attempting anything beyond a three-month rolling forecast, and even that is unreliable. The recent depreciation of local Asian currencies against the U.S. dollar (a reversal of the prevailing trend over the past year) has made Mindtrac's imports more expensive. The rising cost of oil has increased the cost of tires and the fees for transporting them. Beijing's Olympics preparations have also complicated matters. Because the Chinese government has shut down a wide swath of factories around the capital — and required others to operate no more than four days per week — the company can't procure enough tires from its suppliers. That forces it to buy tires on the spot market, which — by definition — takes away predictability. Count on consistently high growth from Asia, and you could be disappointed.
Then there is human capital. The region's exceedingly tight talent market is leading to fast-rising pay levels and rapid staff turnover. Such employee churn can make it hard to achieve aggressive growth targets. Even if corporate managers acknowledge this, they may misattribute the cause.
"[At headquarters] they think that the turnover is happening because there's something wrong with our company or our culture," says Kenny. "Are we asking too much of them? Too little? Is there not enough training?" Those are good questions, of course. But during his time in China, Kenny has come to understand that the turnover is largely out of his control. In China, many employees are products of China's one-child policy who feel pressure not only to keep up with their peers, but also to earn money to support their parents during retirement. "In a sense, if the market is offering 25-30 percent pay increases, you aren't doing your family justice if you don't go for the money. This is something I've had to instruct the Americans about," Kenny says.
Companies seeking to expand in Asia also confront the rising desire of consumers — both retail and business — for products tailored to their needs. Bain's Shankar points out that for consumer products companies, for example, significantly higher growth means reaching a mass market that's increasingly well-served by nimble local competitors, who can often produce more cheaply than MNCs.
But developing localized products cheaply is no simple task: it requires a time-consuming overhaul of a company's value chain. Shankar provides the example of a Western food company in China that was having trouble selling its flour. The flour was high quality but expensive, and so reached only a tiny segment of the population. Reaching the mass market meant lowering the price significantly. When the company compared its business with those of its competitors, it found many differences: its packaging enabled products to stay fresh on the shelf for 12 months, but competitors used cheaper packaging that ensured freshness for just three months; the MNC used higher quality flour; and it sold its product in heavier portions.
Furthermore, Chinese food companies were using machinery that cost half of what the MNC was using but delivered between 70 and 80 percent of the quality. By adjusting its process and product, the company was able to expand its market share.
"There is a one- or two-year transition period to get to where you are profitable," says Shankar. "And that's a challenging period for local managers."
Helping steer the company through such a transition is an obvious job for the Asia-based CFO. Doing so obviously requires regular, clear communications with headquarters (See "Getting Heard" at the end of this article). Kevin Zhou, retail CFO for Luxottica, a US$6 billion Italian eyeglasses company, advocates complete transparency. "You have to always tell them the truth about what's happening in China, and keep updating them," he says. "Keep explaining, and before long people in headquarters will really understand what's going on in this market."
Luxottica, which owns brands such as Ray Ban and LensCrafters, is aggressively expanding in China. For the past ten years, the company has been manufacturing for export, but determined to make money in China itself, Luxottica has turned its attention to retail. To date, the strategy has been to launch its own stores and to buy up local chains and rebrand them. The company has 300 stores in China, a number it has said will increase to 1,000 in five years.
Managers in Italy recognize that getting to that position will require more than long-distance management of the business by non-Chinese executives. Retail, after all, demands an intimate understanding of local market conditions, operating constraints, and consumer preferences. The hiring of Zhou earlier this year was a step in this direction. Previously China CFO for the Direct Group of German publisher Bertelsmann, Zhou is taking the lead in helping Luxottica understand the financial and regulatory implications of the company's growing China business. These include treasury issues, such as how to manage cash flow in a country with tight currency controls, and updates on China's quickly evolving regulatory environment.
Zhou is also imparting operational lessons he's learned. One of these: avoid outsourcing local backoffice operations in China. Zhou believes that outsourcing — and centralization of finance efforts in general — is ill-suited to China-based operations. First, there's a lack of qualified service providers in the country. The savings aren't significant, since China is already low cost. And, significantly, a growing business needs close support from finance above all.
While at Bertelsmann, Zhou decided to counter the company's usual practice of consolidating finance along functional lines. "When I got there, I said, 'We need to decentralize.'" The company had four distinct business lines in China, and it was impossible for the central accounting manager, for example, to support all four, since each confronted very different challenges.
Such advice from those on the ground can be highly valuable. But only if those in charge are prepared to listen. The good news is that as the business world's attention shifts to Asia, some CFOs report having a more receptive audience. "Three or four years ago, it was hard to get senior management to come to India," says ICI's Batra. "But now, when India comes up in a board meeting or a management committee meeting, people will look foolish if they don't have a first hand perspective on the country. That makes them want to come here."
Don Durfee is managing editor for CFO Asia.
At a time when demands on Asian operations are escalating, it's time for local CFOs to brush up on an old skill: expectation management. David Hui, senior client partner with talent management firm Korn Ferry, says that the ability to be persuasive when speaking with superiors at the home office is one of the defining features of a successful local CFO. "When you are in headquarters you tell people they have to do things the way you do," he says. "But [when working in a local operation] you might have to say, 'I understand the global perspective, but from a local perspective, this is what's more important.' You have to be able to argue your case."
That requires regular communication. Most of the CFOs interviewed for this story speak with their boss at headquarters at least once a week. Rebecca Norton, VP of finance, Asia Pacific for Business Objects, makes it a point to participate in global conference calls as often as possible, in order to "wave the Asia-Pacific flag." That's necessary to ensure that overseas colleagues understand the conditions under which the business operates locally. In Asia, that includes great diversity of cultures and languages, and great distances between markets.
Be careful, however, of appearing to make excuses. "A possible downfall is that you can start saying that Asia's different," says Norton. "And the more you say it, the less people appreciate it." One solution is to encourage frequent visits from headquarters. "I'm a passionate advocate of making sure that the head office people are given every opportunity to be exposed to the issues we face in our market," says Simon J. MacKinnon, president, greater China, for Corning, a U.S.-based producer of fiber optics, pollution control devices, glass for LCD panels, and specialty materials. "You have to get them out of the five-star hotels and into the plants and out in front of customers. You have to help them really understand the issues."
To encourage more visits, MacKinnon suggests reviewing the company's travel expenses to determine whether most of the travel is done by Asian managers traveling to headquarters, or home-office staff coming to Asia. "It's a crude metric, but you provoke thought just by asking the question," he says. — D.D.