Legal Business Blogs

Comment: ‘Geography seduced everyone’ – is emerging market bias blind-siding your firm?

There is a notion in business that is often useful, but rarely observed – the idea of signal and noise, or rather being able to distinguish between the two. The not-remotely-new point I’m making – well illustrated in Nassim Nicholas Taleb‘s not-remotely-new book, Fooled by Randomness – is that in making informed decisions, leaders should endeavour to shut out the ‘noise’ of short-term, rapidly changing information, which is typically near worthless.

Instead they should focus on the longer-term, underlying trend, which can be worth a great deal if you can find it.

Such thoughts occurred while reading a recent piece in The Economist that tackles one of the dominant concepts in business over the last two decades – arguably the dominant idea – that western businesses must focus their growth and investment in key emerging economies. As the article ‘Emerge, splurge, purge’ notes, so prevalent has become this orthodoxy that it has escaped any real debate: ‘Corporate strategy is usually a contentious subject: there are fierce debates about how big, diversified or leveraged firms should be. But geography has seduced everyone.’

The thrust of the piece is inarguable: in many sectors, returns on equity in emerging economies are now failing to live up to expectations, with the low-hanging fruit in such markets having been long since picked thanks to an investment glut lasting a decade. An index by data firm STOXX of western companies with heavy emerging market exposure has lagged the S&P 500 index by around 40% for three years now.

The article further notes that a string of multinationals have disappointed shareholders with mark-downs on emerging economy growth, among them Vodafone, Cisco, Fiat Chrysler, Anglo American, Volkswagen and ThyssenKrupp. One figure stands out: the valuation of western acquisitions in emerging markets in 2007 averaged 17 times operating profits, roughly double the average valuation during equivalent 2000-03 deals.

While there are obviously huge variations in this picture, evidence is piling up that the idea of emerging market investment as a panacea for growth – however ingrained – is in some cases out of date and in others damagingly misleading.

You hardly need to spell out for law firm leaders the implication of that finding, given that the profession has been involved in an investment glut in Asia for five years now with relatively meagre returns. Dogged by soaring prices for local talent, persistent fee pressure and protectionist Bar rules, it may be necessary as a long-term strategic move, but it doesn’t represent the prize it once promised and it doesn’t have to be for every firm.

Glancing at this month’s Global London special, you can’t help but think that London’s top law firms have become overly focused on Asia and the emerging markets at the cost of giving up too much ground in Europe to US rivals, while failing to make much progress in the vast US market for another five years.

Oh, there goes my inbox. Someone else has opened in Seoul…