The vast expansion of international trade that has taken place since World War II has been dominated by large publicly traded corporations with the wherewithal and staying power to compete in distant markets. While these companies were developing strategies to maximize global revenues and profits for their shareholders, privately held and family owned businesses encountered formidable obstacles and constant frustration in trying to do business abroad.
How things have changed! Not only has the global playing field been leveled in recent decades, but in some key areas it has shifted in favor of family businesses.
Beginning in the 1980s and accelerating through the early 1990s, both developed and developing countries have weakened or ended onerous foreign investment laws that have kept all but the largest global companies out of the market. As part of the general movement toward market economies, governments have decentralized services and simplified processes for gaining approval of everything from creating companies to winning import licenses. Many have streamlined their tax codes and relaxed laws limiting payments for transfers of technology. Today foreign companies are given relatively free access to the economies of almost all nations and now receive fairer royalties for products and technologies licensed in these countries.
The liberalization of economies all over the world does not mean that small family businesses will not encounter significant risks in venturing abroad. Financial upheavals such as the devaluation in Mexico in 1995Ñthe so-called ÒTequilla crisisÓÑand the more recent flight of capital from some Asian countries cause major setbacks for companies, large and small, operating in these countries. While currency volatility remains endemic to some developing economies and has to be watched, however, long-term these markets still offer foreign companies some of their best opportunities for growth.
There are five specific trends, described below, that I believe are favorable to the globalization of family business in the decades ahead. Since every firm contemplating an expansion into foreign markets is different, I also suggest some of the initial steps a business should take in assessing whether it is ready to enter the global marketplace (see, ÒAssessing your companyÕs readiness,Ó below).
Trend 1: The leveling of the economic playing field has opened up many new opportunities for family business.
One advantage global companies have long enjoyed is their ability to source labor as well as components in low-cost countries. It is now substantially easier for companies of all types and sizes to do so. Local entrepreneurs have found excellent opportunities to provide resources for smaller companies getting started within their borders. An example of this is the Òshelter programÓ found within the Mexican Maquila industry, which provides services to foreign plants manufacturing in the country. A local company, usually family owned and run, will establish an industrial park and offer complete services to clients under contract. Typically, the Mexican company handles all operations on behalf of the foreign company except for product technical support. The Mexican company is responsible for all assembly-line workers, the building, payroll, customs documentation, utilities, permits, and plant maintenance. Many of these shelter programs have been operating for more than 20 years. Along with lower wage rates for employees, they offer the foreign company some assurance of quality control while limiting its corporate commitment to Mexico. Similar programs exist in other parts of Latin America and in certain Asian countries.
A second advantage enjoyed by global corporations was their ability to undertake global tax planning, which often allowed them to take their profits in lower tax jurisdictions. By taking a number of steps to level the playing field between themselves and the global corporations, governments in a number of developing countries have assisted smaller foreign firms. For example, tax treaties between nations have enabled companies doing business abroad to avoid double taxation; by providing writeoffs for taxes paid abroad, these treaties lower their taxes in their home country. These treaties thus establish the tax rate of the headquarters country as the effective tax rate. They encourage companies to look at other reasons besides taxes for determining their global strategy.
Another change in the playing field benefits local distributors who commonly handle trade between smaller companies. Led by the U.S. Internal Revenue Service, most governments have taken major steps to closely monitor inter-company pricing to ensure that global companies donÕt take their profits in lower tax jurisdictions overseas by selling too high (or too low) to their subsidiaries. Typically, this strategy worked as follows: A U.S. multinational charges its subsidiary in Germany 95 percent of the ultimate selling price for the product sold in that country. The German subsidiary breaks even or loses money and therefore is not subject to German corporate income tax (50 percent), while the U.S. parent makes more profits that are taxed at around 30 percent at home. To the extent that they have been successful, the governments have taken away this competitive advantage of a wholly owned subsidiary over a small company using local distributors.
Smaller family businesses now have easier access to low-cost international financing once available only to very large companies. The international monetary debt crisis of the 1980s weakened banks while savings institutions, insurance companies, and pension funds expanded. The result has been that banks are no longer the main intermediary between savers and borrowers. International financing is now available to any companyÑsmall or largeÑwith the credit rating and/or resources to afford it. In addition, governments have abandoned ex change controls and attempts to determine long-term interest rates. Interest rates are now set more by global supply and demand than by government policies, and have in recent years been generally lower for small and large business borrowers alike.
Until recently, some countries provided little or no protection of intellectual property within their borders. The only sure way for companies to bring in technology was to license it to a subsidiary. Since smaller companies do not have subsidiaries, they had to license proprietary technologies to third parties for royalties. Beginning in the late 1980s, many governments altered their intellectual property regimes in two significant ways from the point of view of the family firm: First, they strengthened legal protection to intellectual property by passing new laws and strengthening enforcement of existing laws. Second, they increased royalties for foreign technology transfer to local parties by allowing the parties to negotiate their own deals and by lowering the withholding tax rates on royalties (often through tax treaties). For example, prior to 1987 the maximum royalty that could be granted on software in Brazil was 5 percent of the sales price. The royalty is now up to whatever is commercially reasonable.
Trend 2: The days of the old craft-based manufacturing methods are returning.
The 20th century may be remembered as beginning with the rise of mass production in manufacturing and ending with its decline.
Mass production seems likely to continue for consumer and industrial durables. However, critical changes in technology have resulted in the retreat from mass production which began in the early 1980s and has continued with increasing speed into the 1990s. In his book ÒThe World in 2020,Ó British journalist Hamish McRae has described it as follows: Ò...inside the factories of the rich countries there have been enormous changes in the use of labour: instead of large numbers of workers performing repetitive tasks, a much smaller number are performing much more highly skilled jobs.Ó McRae suggests that the world we live in today and for the near future will require more production of individual made-to-order products, but at mass production prices. This will result in a shift back to craft-based manufacturing methods in part, and continued movement away from line workers to more people on specialist teams who organize and complete the increasingly complex tasks of manufacture and assembly.
Whether itÕs making hand-tooled Chrysler street roadsters or the specialized tortillas for the Breakfast Burrito, the movement back to craft-based methods should favor family owned and privately held business, and will be a factor in their global expansion. Such businesses tend to be more responsive to the niche markets and are able to move at a more rapid pace in spotting opportunities and converting them to successful businesses.
Emphasis on craft-based manufacturing is to a certain extent part of the general world trend toward services and toward what is now known as knowledge work. The knowledge worker, whether a technical specialist or financial analyst, is more likely to be at home in the family firm environment. Large corporations today, family or otherwise, are trying to have their employees act like owners. Organizations continue to reshape themselves in hopes of becoming more entrepreneurial. They are becoming flatter, with fewer layers, partly in order to get closer to customers who are becoming more and more demanding; the trend is to smaller-scale, decentralized business units that move quickly to meet customer needs and resolve customer problems.
These steps are a response not just to American trends but to global trends. Whether in New York or Nairobi, lean, mean sales and support teams have the advantage over slow-moving corporate bureaucracies. Individual genius and innovative entrepreneurial skills are far more likely to discover new products and profitable niches than large corporate R&D organizations. Finally, personal relationships are critical to doing business in many foreign cultures, and smaller family firms, whose leaders excel at cutting deals face to face, have an edge over more bureaucratic organizations in building such relationships.
Trend 3: The movement to market economies abroad has led to exponential growth of family businesses.
With the exception of North Korea, it is very difficult to find a true command economy left in the world today. The first step normally taken by governments that want to liberalize their economies is to allow the formation of small family businesses. Thus family businesses formed in the late 1970s and early 1980s in Hungary and the Czech Republic now compete with the privatized state industries in many key areas of the economy. In fact, many privatized state firms were acquired by family firms.
Nowhere is this trend more visible than in todayÕs Cuba. Only some of the entrepreneurial Cubans left the island in the 1960s. Limited reforms by the Castro regime have created a substantial small enterprise sector known as the cuentapropistas, or the self-employed. With the ability to trade in hard currency (U.S. dollars), Cuban families now rent rooms to tourists, drive taxis, have beauty shops in their living rooms; they have created some of the best restaurants on the island. They have also created problems for CastroÕs regime. They have drawn a number of the best minds away from government service; and they are difficult to tax because the government lacks experience in taxation and adequate resources for keeping track of their revenues.
Significant growth in family enterprises is occurring in the non-Communist world as well. Starting with Margaret ThatcherÕs United Kingdom in the early 1980s, most countries in Europe are moving to privatize major state-owned companies. The same trend is apparent in Latin America. In Mexico, for example, many of those companies were acquired (whether it was proper or not) by families with close contacts to the Salinas regime. Even in countries where the large public businesses have been sold to global companies or publicly traded local companies (ports, airlines, and utilities), these new companies need to be more responsive to the local businesses and are far more likely to source from the hundreds of thousands of family owned companies that have arisen to supply or service them.
Part of the developed world and most of the developing world long suffered from extreme centralization of political power. In Mexico, for example, nearly all major decisions (including administration of police, hospitals, and education) emanated from the capital of Mexico City. Providing goods and services to these government agencies was an onerous task accomplished only by powerful, well-connected companies and individuals.
In a recent article about Albert Andrade, the dynamic mayor of Lima, Peru, The Wall Street Journal described the meaningful decentralization of government services that has been taking place all over Latin America as well as elsewhere in the world. The article reported that moving services from the national to the municipal level in that country has brought government into the day-to-day life of the average citizen and helped to break down the alienation that kept people and their businesses in the so-called Ògray market,Ó which operates outside the law. People now working in city governments in these countries are younger, better trained and more dynamic than the bureaucrats in the central government. All this has contributed to the growth of family business in the city, and many of these new businesses are ready to handle the products of other family businesses.
Trend 4: The development and strengthening of global ÒtribesÓ will provide unique advantages for family firms.
I was recently retained by a U.S. company to assist them in taking their business abroad. Owned by two Jewish school friends, the firm was born in a garage and had grown substantially approaching $100 million in sales. The owners had selected a smaller but substantial Jewish-owned business in Mexico City to assist them in their expansion into other Latin American countries. Given the diversity of Latin America, I am always suspicious when a local firm in one country wants exclusive rights to distribution in other countries of the region. I raised the issue at our negotiations.
The Mexican company did not have offices outside Mexico. What it did have was relationships with a number of Jewish-owned companies throughout Latin America. Some of these relationships were with relatives; some were with similar types of distributors; others were merely personal contacts in their network. My clients found this series of relationships to be perfectly acceptable and agreed to give the Mexico City company rights to distribute through them in all of Latin America.
Joel Kotkin described these new cross-border business networks in his controversial book, ÒTribes: How Race, Religion and Identity Determine Success in the New Global EconomyÓ (Random House, 1993). Kotkin argued that two factors are critical for success in todayÕs global marketplaceÑgeographic dispersion and belief in scientific process. He identified five ÒtribesÓÑJews, the British, the Japanese, the Chinese, and IndiansÑthat are highly successful at doing business abroad because of a strong ethnic identity and a sense of mutual dependence. All five have a global network based on mutual trust as well as a passion for technical and other knowledge.
Kotkin suggested that six other groups are developing similar networks and may in the future qualify as global tribes under his definitionÑthe Armenians, Lebanese, Koreans, Vietnamese, Iranians, and the Mormons.
Finally, the importance of relationships in building a global business may also lead to the creation of networks based on other ties besides ethnic group, religious affiliation, or nationality. Business contacts often result from cultural and/or student exchanges, for example. People with common educational backgrounds or professional credentials retain close ties which open doors across borders that may otherwise be closed. Other groups sharing the same interests Ñ collectors, sports enthusiasts, hobbyists of all kindsÑmay form strong enough networks in the future for doing business abroad.
Trend 5: As laws are simplified and regulations relaxed, it is becoming easier to operate within the legal Òwhite market.Ó
Until very recently, many family firms from Brussels to Buenos Aires operated in a legal twilight zone; they sold legal goods while not conforming with many government regulations. The so-called Ògray marketÓ constituted upwards of 30 or 40 percent of businesses in some countries, often employing more people than the legal Òwhite market.Ó Many family businesses simply found it impossible to do business with full legal status because of high incorporation and notary fees, difficult documentation, burdensome employee-withholding requirements, and high corporate taxes. Governments tolerated the existence of the gray market because it was important to their economies and, in many cases, because they simply lacked the ability to enforce the laws.
Often these firms were of substantial size for their markets. One clear example was a Mexican company that during the 1980s had revenues of $5 million and was the technology leader in its market. This companyÕs payroll included 73 people, of whom 19 were family members; two of these family members were pre-teens and one was an elderly uncle who lived more than 1,000 miles away from the operation.
The reason for loading up the payroll with relatives was simple. If the CEO was paid $200,000 a year, his income would be taxed, after the first $15,000, at the rate of 45 percent. But if the company paid 19 family employees around $10,000 each, after a few deductions they would pay very little income tax. This strategy was a natural way to take care of needy family members in a society in which there is no welfare and the family is the safety net; where enforcement of laws is weak; and where the tax authorities can be dissuaded from audits by bribes and other Ògifts.Ó
Today, in 1998, this company is operating in a similar manner to family businesses in the United StatesÑthat is, legally. This is the result of major changes in law and policy such as those mentioned at the beginning of this articleÑdecentralization of government, reductions in taxes, simplification of bureaucratic rules and proceduresÑthat have brought the gray market into the white market. These companies are now more likely to trade and partner with foreign companies.
While going international is obviously not the right move for every company, global trends bode well at this time for the expansion of family owned and privately held businesses into foreign markets. Venturing into unfamiliar territory with different laws and customs is an exciting challenge, offer ing oppor tunities to meet new business partners, become ac quainted with different cultures, learn new languages. In some firms, the decision permits the younger generation to take over domestic operations while their elders travel abroad in connection with the expansion. In other companies, adventurous successors may see expansion overseas as an exciting way they can bring something new to the business. Either approach is an excellent way to build the business and revitalize cultures suffering from a status quo mentality.
Lawrence E. Koslow Lawrence E. Koslow is an international business advisor and attorney who specializes in international strategic planning and analysis for small and middle sized companies attempting to enter new markets, including the USA. His latest book is "Global Business: 308 Tips To Take Your Company Worldwide" (Cashman Dudley, 1999). He can be reached at lkoslow@black-hole.com.
Deciding to enter the global marketplace or to expand operations abroad is never easy. Some companies are pulled into the international marketplace by promises of larger revenues and profits. Others are pushed into it by the need to keep up with their competitors. One of the biggest reasons why companies fail in expanding abroad is that they enter these markets piecemeal, with no overall assessment of global possibilities. A preliminary global assessment might include the following steps:
1. Assess your domestic market. Is there still growth potential? Is my customer base diversified enough? Are profits more than adequate? If there is still growth potential at home, you may prefer to conquer St. Paul before you take on Sao Paulo. Consider that you can also Ògo internationalÓ by adding foreign products to your existing lines of business.
2. Look for clues in your industry. What is being discussed at industry meetings? Are your competitors entering world markets? Most importantly, are your customers going international? If your company is a supplier to a multinational corporation in your domestic market and the multinational expands into other territories, you may need to expand or take the risk that a competitor will become the supplier for the multinational.
3. Assess overseas markets. As someone who has been involved in international business for 25 years, I find it difficult to name a single product or service that cannot be sold across borders in one way or another. Yet it is clear that for some products such sales might fall into the Òtoo-hardÓ category. Some products and services just do not transfer well because they are over-engineered or geared strictly to local tastes (ant eggs in Mexico). If you have such a product, you are generally better off trying to increase your market share at home.
4. Assess whether your products or services are ready for global markets. Does the product need to be modified to function abroadÑfor example, because of different systems of measurement? Do you need to translate instructions and warranties? If you make the needed modifications, will your product still be competitive?
5. Assess your willingness to commit the resources to go global. What internal constraints must be considered? Are you willing to commit financial resources to learn how to do the business? Are human resources available? Are you concerned about a possible dispersion of your corporate focus?
6. Assess opportunities that may be unique to your company. If your products are seasonal, could you find markets abroad for them during your offseason? During winters, for example, could you sell your lawn mowers or ice cream to countries in the Southern Hemisphere? Would global markets allow you to ÒharvestÓ your productsÑexpand their life cycles by selling in markets that are not state-of-the-art? Can you try a new product abroad before bringing it to the home market (for instance, products requiring FDA approval)? The need to rebuild the infrastructure of Kuwait after the Gulf War in 1991 brought opportunities to many U.S. companies. WouldnÕt you like to be in the paint business when the U.S. embargo on Cuba is lifted?
7. Assess opportunities for family business growth. Would the global market provide new opportunities for family members or trusted employees? Could such opportunities be used to prepare and evaluate successors? Is there a branch of the family abroad that could benefit? Finally, can going international help develop a global family vision?
Ñ L.E.K.