Prevalent regional economic volatility due to vulnerable and highly-elastic oil prices, the market size as well as swiftly-increasing competition within local markets might drive local family conglomerates to think about developing appropriate corporate strategies to address those challenges inherent in emerging markets. Successful strategies are easily achievable for local actors when market imperfections are high such as capital market imperfections (enabling faster growth for conglomerates with strong financial background, e.g. substantial cash reserves), imperfect human resource markets (gaining better qualified and inexpensive talent than others) and political capital granting unequally distributed privileged rights to only some incumbents). With increasing maturity and sophistication of the UAE market place, simple portfolio management (allocation of unrelated separate businesses/interests with none or minimal overall integration/synergies) does not suffice anymore for local conglomerates in order to remain competitive and ahead of other incumbents. Therefore, essential corporate advantage (exists if portfolio performance exceeds the sum of performance of individual activities) needs to be sought by other means such as diversification as one possible toolset of corporate strategy. Once a promising investment opportunity has successfully passed the three-prong diversification test (e.g. structural attractiveness of the industry, existing synergies – core competences – in view of the conglomerate business and gains from being in the business outweighs the cost of entry), further considerations, as outlined below, needs to be undertaken to safeguard a smooth implementation of developed diversification strategy.
a. Regulatory, legal and compliance aspects
Any inorganic growth (M&A), as part of diversification strategy, might have significant regulatory and licensing implications with regard to antitrust laws and protected activities for local nationals or governmental entities, widespread in many developing markets, which needs to be verified in advance during thoroughly performed due diligence process. Another risk which needs to be anticipated when investing in emerging markets are bureaucratic barriers and restrictions based on informal practice, which would require profound local jurisdictional knowledge and intelligence on how to efficiently manage such potential obstacles. As part of such process, naturally, a profound check of any pre-existing compliance or contingent litigation history is inevitable.
b. Target organisational culture and post-M&A integration
One of the greatest risks of a successful post-acquisition integration is the (non-) existing corporate governance structure and organisational culture. In order to successfully unlock synergies from the M&A transaction, well-managed integration and adoption of a new corporate culture is key in order to gain desired acquisition premium. In a comprehensive research conducted by King, Dalton, Daily & Covin the typical effect of M&A activity on firm performance has been well-documented, and, on average, M&A activity does not lead to superior financial performance. In fact, a stronger argument can be made that M&A activity has a modest negative effect on the long-term financial performance of acquiring firms. One of the potential reasons why certain M&A transactions are not able to achieve aimed acquisition premium is due to lack of skilled integration management.
c. Political and economic considerations
While political capital can be a source of competitive advantage and shield from global competition in imperfect markets, it poses also a significant risk in times of political changes, immanent in emerging jurisdictions. Therefore, not only for obvious compliance reasons, joint venture partners and alliances with local actors in target markets need to be selected prudently based on intensive background screening. Bear in mind the volatile and abruptly shifting political environment and resulting power imbalances dominant in developing markets. Scenario planning and having an appropriate crisis response plan in place are a must in order to navigate those jurisdictions. For long-term investments in ‘unsteady markets’ assessing the economic country risk profile is equally important as political assessments. Understanding the key drivers of GDP growth, dynamics of business cycles, monetary and fiscal policies as well as dependency on foreign capital or level of leverage of target economy is vital before taking any (long-term) investment decisions.