Investing in developing countries requires not only an in-depth assessment of the economic, political and cultural factors involved but also the reconsideration of the investor’s long-term strategies. Based on Sherritt International entry into Cuba, this case study analysis evaluates how Sherritt approached the Cuban government and how well it negotiated the terms under which the joint venture was signed. As the new venture is associated with numerous risks related to the political and economic systems of the country as well as to the Cuban culture, these will be carefully considered and possible recommendations for their mitigation, where possible, will be outlined.
However, as every new endeavour, Sherritt’s entry is a source of various opportunities such as expanding the business and adopting new management practices. These possibilities will be contrasted to the aforementioned risks further on in the case study analysis. Finally, the case study analysis will focus on recognising the kind of strategies multinational companies (MNCs) should adopt to operate effectively in emerging economies with authoritarian regimes.
In nowadays-globalised world, where competitiveness means more than just a word, internationalisation is a prerequisite for a competitive advantage. Thus companies of all sizes must acknowledge the importance of partnerships with foreign nations and more in particular with emerging economies as a source of potential growth. Creating an unified global market, however, goes hand in hand with numerous threats. Therefore, when contemplating to enter a fast-developing market firms should thoroughly assess the economic and political factors in the host country and implement a sustainable strategy for a long-term success.
The economic growth of a country is considered to be contributed not only to the combination of numerous interrelated economic, political and demographic factors, but also to the welfare of the country’s international partners. When the Soviet Union – Cuba’s largest trading partner – collapsed Cuba’s GDP decreased by 50% whilst its country investments fell by 57% leading the state to rethink its strategy towards attracting FDIs as a source of profit (Kaplowitz, 1995). It could be argued that land as a factor endowment is one of Cuba’s biggest competitive advantages. The abundance of natural resources, and in particular its ore mines, is what prompted Sherritt International to engage in a long-term joint venture with General Nickel Co. – a state owned enterprise.
WHY DID SHERRITT INTERNATIONAL CHOOSE TO INVEST IN CUBA?
According to Hill (2013), the attractiveness of a country as an investment destination depends on the balance between the benefits and risks of entering a foreign market, and the costs associated with it. Limited for options, Sherritt was forced to choose between two communist countries – Russia and Cuba – where the political and economic ideologies were distinct from the Western.
Firstly, although Cuba and Russia had equal advantage regarding the supply of ore, the Cuban government’s limit on salaries and office rents allowed for low labour and premises costs, which was not as a trade off to quality. The latest government investments in education greatly enhanced the skills and capabilities of Cuban employees. Since Cuba lacked an environmental policy, long-term costs incurred by Sherritt would include transforming the Cuban technology and premises into environmentally friendly work sites. However, considering Russia was geographically much further from Canada than Cuba, logistic costs would be substantially lower if invested in the latter.
Another issue concerning the Canadian firm’s choice was the potential threat of American companies suing Sherritt for expropriation of previously owned properties and the lack of protection of property rights in Cuba itself. However, Canada and Cuba have built strong diplomatic relationship, with Canada and Mexico being the only countries that kept its connection with Cuba after Fidel Castro’s revolution in 1959 (Kaplowitz, 1995). A detailed evaluation of all the risks Sherritt would face is included further below in the case study analysis.
TO WHAT CONDITIONS DID SHERRITT AND THE CUBAN GOVERNMENT AGREE?
An equally split joint venture between Sherritt and the Cuban government implied not only shared profits and benefits to both partners, but also bound them to mutual responsibility for the venture. The Cuban state was accountable for providing physical infrastructure, workforce and capital equipment, while Sherritt contributed with technological capabilities, and managerial skills and knowledge. Cuba insisted that the part-foreign agency ACOREC, which was under full government control, would manage recruitment and salary rates. Such an agreement would benefit the state by appropriating 95% of the salaries, due to currency exchange rates and would allow it to oversee wages and the work force.
Shortly after Sherritt and General Nickel Co. committed to the new enterprise, the Cuban government enforced Law 77, granting protection to all foreign investors against expropriation. However, despite Sherritt’s precaution measures on this matter, it was left unclear whether future Cuban governments would respect the expropriation agreements signed by Castro. To protect itself from a breach of contract, Sherritt insisted on appointing the International Chamber of Commerce, Paris as an arbitration mechanism.
ANALYSIS OF THE RISKS FACED BY SHERRITT INTERNATIONAL
According to Doh and Ramamurti (2003) the most important role of the government in a joint venture is that of a ‘rule maker’ or ‘regulator’ – the power to shape the conditions under which investments are made and to initiate shifts in regulations. In case of forming a joint venture under an authoritarian regime, commonly characterised by variability and unpredictability, a change of the ruling government might pose potential threats to a MNC. Following from the case study, we could argue that even though Delaney benefits from Fidel Castro’s goodwill, a change in government would make Sherritt even more vulnerable to shifts in the contract agreement, outright or de facto expropriation, changes in taxation and regulation, shifts in the power of non-ruling political groups (Doh & Ramaruti, 2003). Such a drastic alterations could prove to be crucial for Sherritt, considering the ore extracted from Cuba is an essential element for the success of its business.
Characterised by ‘state ownership of the means of production’ and central planning (Wilczynsk, 1972), socialist systems are associated with equal distribution of wealth and limited salary levels, thus impeding Sherritt from using monetary rewards as employees’ motivation. Lack of an incentive to work might result in operational inefficiencies or difficulty in management, consequently hindering Sherritt’s competitive position in the market. In favour of increasing work incentives, Sherritt should aim to develop stronger health and safety policies and improve the working conditions of employees. Even though this must be incorporated in their long-term strategy, it is not directly associated with the government limits on payments and does not hinder the authority of the political system.
According to Vernon (1971) once a MNC commits to a FDI some of its bargaining power will decrease and shift to the host country government which will start acting in favour of its internal interests. Regarded as ‘obsolescing bargain’, this phenomenon is common in ventures where a core part of the investor’s business is dependent on the host country. The uniqueness of the natural resource needed, and the inability to deploy it elsewhere, is proportional to the decrease of bargaining power Sherritt owns. Thus, facilitating the government to seek a greater share of the profits, reopen the negotiations of the contract or alter regulation to the disadvantage of Sherritt.
It could be argued that over time the government would aim to be less dependent on Sherritt in terms of profits and would encourage nationalism policy by involving local firms into the process. To avoid the aforementioned, Sherritt should aim to leverage the bargaining power of the Cuban government by offering benefits that outweigh those of the ‘obsolesce bargaining’ such as an increase of employment rates, supply of equipment, the adoption of lucrative business strategies and support to the development of physical infrastructure.
A further obstacle is the heavy financial commitment associated with immobile investments which would make a potential market exit really difficult or even impossible. Under such circumstances Sherritt would be forced to consent to governmental decisions acting against its interest. The company would not be able to exit the market quickly in the case of change of government where the costs of continuing business would be presumably greater than those of exiting. In order to mitigate these location risks, Sherritt could strategically decide on being financially protected by a project finance loan which would be secured against the venture itself and any assets the company has acquired post entry. Hence, the company would be able to protect the assets it owned before undertaking the investment and avoid the possibility of going into administration.
Known as the ‘Sherritt process’, the technique of refining ore developed by the Canadian company, has evolved to be a major competitive advantage in the marketplace. The process resulted in better quality steel and decreased amounts of waste after the production process, thus reducing costs substantially. Once a joint venture is established, the company might become a victim of ‘knowledge spilling’ by trying to incorporate its practices among Cuban employees. Should they decide to leave the company and establish their own business, possible precaution might be patenting the process thus making it illegal for anyone else to replicate it.
ANALYSIS OF THE OPPORTUNITIES FACED BY SHERRITT INTERNATIONAL
Even though the risks associated with Sherritt’s post-entry stage are numerous and could potentially affect the company’s business to a great extent, the joint venture could also unveil new opportunities. Firstly, by commencing work in a foreign country, the Canadian company can acquire new knowledge and working practices. To work more effectively, Sherritt could carry out a process review assessing what the best practices from both parties are and create a leaner work process. In addition, having entered a socialist country could aid Sherritt towards reducing its labour and office costs due to the low salary limit imposed by the government and the low costs of renting or buying office space. This would give Sherritt the opportunity to invest elsewhere such as in new production technology, research and development or to enter a new industry.
If Sherritt engages in pursuing the latter it would have the opportunity to extend its business into other sectors of the Cuban market where it might prospectively be a first-mover due to the lack of concentrated market presence of international companies. As described in the case, agriculture, telecommunications and natural resources are possible options and are integral part of Cuban economy. Furthermore, the company would have already built a relationship with the government and adapted to their means of conducting business.
This would give Sherritt a competitive advantage to potential new entrants either local or multinational. Moreover, according to “Law 50: The Cuban Joint Venture Law’ implemented in 1982, any foreign investor could ‘import or export directly free from tariffs and duties’ (Kaplowitz, 1995). Although the aforementioned would not apply to the current joint venture since its assets could not be deployed anywhere else apart from Cuba, if Sherritt would enter a new market such as agriculture it could potentially develop export strategy with low cost of logistics.
ANALYSIS OF THE RELATIONSHIPS BETWEEN CUBA, US AND CANADA
A unique key factor – both positively and negatively related to Sherritt’s entry into Cuba – is the potential influence from the new US legislation movements – Helms and Burton Act of 1996. The aforementioned legislation not only prohibits any business relationships between the US and Cuba corporations but also implies the authority to the US government to impose such suspensions to foreign investors as well.
Thus, The Helms and Burton Act would be connected with negative connotations to Sherrit’s case due to its power to impose severe sanction to firms practising business in Cuba and implies discrimination to all companies and people connected to them. To cope with the influence of the Helm and Burton Act, Sherritt could refer to the contra legislation movement of the Canadian government – Foreign Extraterritorial Measures Act form 1997, which states that the US law would not be recognised in regards to Canadian corporations. Undoubtedly, this provided Sherritt with great security against the potential threats imposed by the Helms and Burton Act.
In spite of the negative perception of the new legislation development, foreign investors could potentially foresee its positive influence on their future business endeavour. When increasing costs and posing hurdles to would-be entrees into the Cuban market, such a threat will often deter MNCs from entering Cuba. Thus, it could be argued that the discussed US law would decrease the competitiveness of the Cuban market, consequently, resulting in favourable market conditions to potential investors such as Sherritt.
RECOMMENDATION REGARDING POSSIBLE STRATEGIES FOR MNC ENTERING AND EM
Even if we could unite all developing countries under the umbrella name of emerging markets, it is essential for MNCs to recognise the underlying characteristics to each specific nation (Arnold, 1998). MNCs often assume that emerging markets are in their early stages of development thus the entry to a foreign developing market is a game of catching-up and the evolution of the market will replicate the one that is present in a developed economy (Arnold, 1998). The reality is quite contrasting, however. MNCs have to examine the distinctive dynamics of each specific EM and reconsider their strategies in order to capture the underlying benefits from a FDI in an emerging market.
Despite the decades of history, there are no set coherent frameworks or methodologies for success to how firms should enter emerging markets (EMs) under authoritarian regimes (Johnson and Tellis, 2008). Thus, Sherritt faced and hedged a number of risks and opportunities, discussed in the previous section, with no certainty for success or failure. In this section of the case study analysis some conclusions and possible recommendations as to the kind of strategies multinational companies (MNCs) should adopt to operate effectively in emerging economies with authoritarian regimes will be outlined.
FIRST MOVER STRATEGY
The first strategic decision, which an MNC has to consider, is its entry timing. It could be argued that emerging markets have certain distinctive attributes that offer additional positional advantages to a first mover, as it is shown in the case of Sherritt International (Arnold, 1998). Delaney recognised the valuable opportunity to save Sherritt from a functional insolvency in the developing market of Cuba before any other company has. With this decision Sherritt would not only lock up access to core resources to its business but would also build tight connections to influential government bodies. The history shows that many EMs are either command economies or closed markets where government authorities are highly influential.
Thus the opportunity for a MNC to create favourable government relations will often ease the granting of certain licenses and permits, result in access to highly qualified joined venture partners or exploit governmental concessions and incentives – all points proven by the present case study (Pan and Chi, 1999). Another benefit of an early entrance is the possibility for consequent learning (Arnold, 1998) as MNCs are provided with the opportunity to observe and learn from various market attributes and functional operations. By leveraging useful ideas and experience across a number of successful subsidiaries MNCs can benefit from improved overall operation practices in their home country (Johnson and Tellis, 2008).
On the other hand, Golder and Tellis (1993) claim that first movers into an emerging market do not experience a long-term success. As the most often detected pitfall of an early entrance is considered the lack of specialised intermediaries to support the business model of a MNC. The underdeveloped infrastructure can often hinder the working process of the entrant through the absence of adequately developed distribution channels or research firms to support its operations.
Additionally, EMs do not praise with a high attractiveness ratio due to the numerous economic and political risks, discussed in the previous section. Therefore, the lack of predecessors to the would-be entrant implies the absence of sufficient information to what works best in the particular host country. This notion is supported by Sherritt’s case and their initiative to embrace the risks of investing in Cuba and trying to succeed in their own terms on a trial-error basis and by an “educated guess” (Watjatrakul, 2005).
ENTRY MODE STRATEGY
The entry mode decision “affects all future decisions and operations of the firm in that country market” (Kumar & Subramaniam, 1997, p. 54). Thus, in order to commit to a particular entry mode MNCs have to thoroughly consider the benefits and risks of each entry mode choice and resolve these differences by accepting certain trade-offs (Hill et. al., 1990). Additionally, the initial choice of a particular mode is difficult to change and can bring considerable loss of time and money to an MNC (Lin, 2000). The choice of entry mode, however, becomes even more complex when entering an EM, where companies face various barriers and environmental limitations. The most important dimensions across which the different entry modes differ are the required investment, the market risk, uncertainty levels and the flexibility or control levels (See appendix Nr. 1).
Therefore, MNCs must decide what their greatest priorities would be when entering a new market. On one hand, the contribution of country specific knowledge from the host country is especially critical in emerging markets characterised by underdeveloped institutional infrastructure and a lack of transparency (Meyer, 2008). On the other hand, the technology resources of the MNC and its brand image will boost the competitiveness of the joint venture. Consequently, it could be concluded that joint ventures as intermediate option between a wholly-owned subsidiarity and a licensing is most often associated with mitigating high investment risks by sharing the costs with a host partner, a strategy worth considering when aiming at a long-term commitment in an EM (Hill, 2012).
BUSINESS MODEL STRATEGY
Relying on previously built strategies for success would render insufficient when MNCs enter an emerging market. Entrants need to define a tailored business model reflecting both the firm’s corporate strategy and the distinctive characteristics of each market. As outlined, ‘when companies tailor strategies to each country’s context, they can capitalize on the strengths of particular location’ (Khanna et al, 2005). Nonetheless, while suitability between country attributes and business models will vary, some key considerations for a successful FDI business strategy can be defined.
Following from the case, it could be suggested an MNC could adapt its business operation model to the new market while keeping its core values. Despite the need to adopt some key operational traits to the institutional surrounding an MNC has the opportunity to still retain its key points of differentiation. Radical shifts in its core values will not only loosen the MNC’s position on a global scale but also might fail to gain a competitive advantage over its rivals in the new EM (Khanna et. al., 2005). In terms of the issues outlined in Sherritt’s case study, the Canadian company is presented with the challenge of working with the contrasting business model of Cuba, comprised of underdeveloped institutional voids and a widespread state influence, whilst keeping its key components of its operations such as the Sherritt process.
On the other hand, a would-be entrée in an EM might consider altering the context in which they will operate (Khanna et. al., 2005) as a MNC might prove powerful enough to influence a change in the operational conditions of the emerging market. The entry of a foreign firm might cause a positive transformation related to the improvement of distribution channels or boost up the quality of the production. When entering the Cuban market Sherritt will inevitably decrease the unemployment rate and help Cuba develop its potential.