International expansion can be a fast-track path to lower profits as many companies ignore the complexity of operating in foreign markets. A step-by-step approach — expanding to new markets with operational complexity similar to the company’s current markets before attacking markets that are significantly more complex — is more likely to be successful.
Furniture retailer IKEA successfully expanded from its home base in rural Sweden to 52 countries across the globe. In contrast, Wal-Mart, the capital-rich retail leader in the largest economy in the world, has stumbled repeatedly in its efforts to expand its reach. Its latest failures include Germany and Brazil. And it is not alone among large, successful companies tripped up when trying to expand into a foreign country.
Why is international expansion so difficult? The reason, according to a global study from consultancy Wilson Perumal, is that companies ignore the complexity of operating in new markets. Wilson Perumal research collected data on the complexity of doing business in 83 countries, looking specifically in the areas of:
From their data, Wilson Perumal researchers created a Global Markets Complexity Index that ranks countries into eight groups of increasing complexity — from the low-complexity Group 1 countries labelled ‘MVPs’ (e.g., U.S., Australia, the Nordic countries) to the highest-complexity ‘Only the Brave’ Group 8 countries (e.g., Pakistan and Nigeria).
The researchers then laid data collected on the expansion efforts of companies against the template of the scale. The result: companies who attempted to skip too far ahead from their groups on the scale are the most likely to fail.
For example, a company successfully operating in a group 5 country such as Morocco will have a greater chance of successfully expanding to another group 5 country such as Tunisia. In contrast, a company that has never operated outside of its Group 1 country is less like to be successful in attempting a venture in a Group 5 country — in essence hopping over three progressively more complex country groups.
This gap between a company’s experience and the challenge level of the new market explains the astounding international success of IKEA. A historical analysis shows that the Swedish retailer always expanded to countries nearest to its location on the complexity scale, moving slowly from Group 1 countries to Group 2 countries, and once established in Group 2 countries, expanding to Group 3 countries, and so forth.
To measure the impact of a company’s category-skipping to its financial results, the researchers created a footprint complexity score (FCS) that quantified how many GMCI categories separated the company’s current countries from the category of the countries in which it was attempting to expand. Comparing the FCS to corporate operating margins showed that the higher the FCS (in other words, the further a company was attempting to skip ahead on the complexity scale), the more the operating margin of the company was reduced. On average, a company’s margin decreased by 4.35% for every .25 increase in the FCS.
Data analysis of performance compared to FCS also showed the reverse: reducing the FCS would increase a company’s operating margin.
The lessons of the study are clear: when expanding to a foreign market, find countries where the complexity of launching and operating a business is similar to your home market or to markets where you have successfully expanded. Even the most powerful and well-heeled companies will fail when faced with unexpected and unfamiliar market, operational and regulatory complexity in a new market. Taking the time to 1) assessing the complexity of the markets in which you are successfully operating, then 2) assessing the complexity of the new markets in which you have an interest can help you avoid a very costly and somewhat embarrassing mistake.
The study also warns against red herrings that may make a market seem compatible, such as size and proximity. India may be one of the largest economies in the world, it is still a highly complex market in which to do business. And just because a market is next door does not mean that it is compatible in terms of complexity.
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