RussiaMexico

–AND–

A COUNTRY AND INDUSTRY ANALYSISZSHELYZ LEE / MAY 30, 2014

INTERNATIONAL POLITICAL ECONOMY CLASSFINAL ASSIGNMENT

The ScenarioA hypothetical multinational FMCG food company headquartered in the Philippines is exploring market expansion into either Russia or Mexico. The company plans to set up a plant and a distribution center for different types of packaged biscuits, noodles or both, with an initial investment of US$200M.

To decide between the two countries and secure board approval for the project, management developed a model that assesses the new enterprise's profit potential with three key levers: revenue, cost and risk. Revenue factors in the purchase capacity for the company's products, like consumption indicators and industry growth prospects; whereas considerations for cost include raw materials (wheat as the key ingredient in both products), local infrastructure, legal and regulatory framework for corporations, cost of financing and attractiveness of the country for headquarter managers to immigrate to, among others. Moreover, risk examines the macroeconomic, political and social situation in terms of stability and security.

The Model

(Revenue – Cost) X Risk

35

1

High Potential

Medium Potential

Low Potential

31

5

Low Cost

Medium Cost

High Cost

35

1

Low Risk

Medium Risk

High Risk

( 100 – 90 ) X 100%

As a first step, input scores (scale of 1-5) for each country and industry metric by benchmarking Russia and Mexico against the Philippines. Next, convert scores to the index provided below (3=100 for revenue, 3=90 for costs and 3=100% for risk). Last, do the formula to get overall score.

The Model

(Revenue – Cost) X Risk

As a first step, input scores (scale of 1-5) for each country and industry metric by benchmarking Russia and Mexico against the Philippines. Next, convert scores to the index provided below (3=100 for revenue, 3=90 for costs and 3=100% for risk). Last, do the formula to get overall score.

DEMOGRAPHICSPopulation

Population GrowthDisposable Income

Disposable Income GrowthConsumer Confidence

InequalityPer Capita Food Consumption

MARKETBiscuits Market Size

Biscuits Market GrowthBiscuits Market Leader's Dominance

Noodles Market SizeNoodles Market Growth

Noodles Market Leader's Dominance

OPERATIONSDIRECT

Raw MaterialsLabor

UtilitiesINDIRECT

Logistics & DistributionMarketing

DOING BUSINESSFinance

Legal & RegulatoryTax

Starting a businessIncentive for HQ Managers

POLITICAL & SOCIAL

ECONOMIC

analysis

Russia

Mexico

revenues l DemographicsPOPULATION & GROWTH

143M-1%

DISPOSABLE INCOME & GROWTH

($ '000 annual per capita)

8.7+7%

CONSUMER CONFIDENCE

-11

INEQUALITY (Gini 2013)

42.1'08 '09 '10 '11 '12 '13

POPULATION & GROWTH

117M+18%

'08 '09 '10 '11 '12 '13

15

54

PER CAPITA FOOD CONSUMPTION

(Value CAGR)

+8.6%

CONSUMER CONFIDENCE

+90

INEQUALITY (Gini 2013)

50.2

PER CAPITA FOOD CONSUMPTION

(Value CAGR)

+17.2%

3

5

'08 '09 '10 '11 '12 '13

35DISPOSABLE INCOME &

GROWTH($ '000 annual per capita)

8.2+1%

25'08 '09 '10 '11 '12 '13

2

1

4

5

3.3

3.9

SCORE

SCORE

revenues l MarketBISCUITS MARKET

$3.8B +7% SIZE & GROWTH

DOMINANCE BY

MARKET LEADER

7%45 3.8

2.5

2008 2009 2010 2011 2012 2013

5

NOODLES MARKET

$0.8B +5% SIZE & GROWTH

DOMINANCE BY

MARKET LEADER

37%42

32008 2009 2010 2011 2012 2013

BISCUITS MARKET

$3.2B +5% SIZE & GROWTH

DOMINANCE BY

MARKET LEADER

38%35

2

NOODLES MARKET

$0.4B +2% SIZE & GROWTH

DOMINANCE BY

MARKET LEADER

71%31

12008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013

SCORE

SCORE

costs l OperationsDIRECT

Raw Materials -Wheat Producer Price $/kg-Locally Produced? YES

Labor

Utilities

1

2.6

3.0

SCORE

SCORE

174

3

1

INDIRECTLogistics & Distribution

Marketing

DIRECTRaw Materials -Wheat Producer Price $/kg-Locally Produced? YES

Labor

Utilities

2290

4

2

INDIRECTLogistics & Distribution

Marketing

3

5

3

4

PHI RUS ScoreCompensation Levels ($/hr) 0.94 6.21 5Labor productivity (PPP, $/hr) 5 26 1Skilled labor is readily available (1-10) 7.37 6.38 4Industrial disputes (lost days/1000/year) 0.14 0.12 3Labor relations is very good (1-10) 6.53 6.25 3

PHI MEX ScoreCompensation Levels ($/hr) 0.94 5.03 5Labor productivity (PPP, $/hr) 5 17 2Skilled labor is readily available (1-10) 7.37 5.19 5Industrial disputes (lost days/1000/year) 0.14 4.07 5Labor relations is very good (1-10) 6.53 6.52 3

PHI RUS ScoreUrbanization (Urban/Rural) 1.0 3.1 1Modern Trade (% of Biscuits Market) 25 47 1Retailer Dominance (#1 Player/#2 Player) 2.4 1.0 1Distribution Infrastructure (Survey: The distribution infrastructure of goods and services is generally efficient, 1-10)

4.73 5.61 3

Management of cities supports business development (Survey, 1-10)

5.32 5.36 3

Logistics management supports business development (Survey, 1-10)

5.78 5.41 3

Communications technology (voice and data) meets business requirements (Survey, 1-10)

6.51 7.27 3

Office Rent ($/sqm/yr) 387 1777 5

PHI MEX ScoreUrbanization (Urban/Rural Households) 1.0 3.7 1Modern Trade (% of Biscuits Market) 25 39 2Retailer Dominance (#1 Player/#2 Player) 2.4 2.9 3Distribution Infrastructure (Survey: The distribution infrastructure of goods and services is generally efficient, 1-10)

4.73 5.46 3

Management of cities supports business development (Survey, 1-10)

5.32 5.25 3

Logistics management supports business development (Survey, 1-10)

5.78 6.29 3

Communications technology (voice and data) meets business requirements (Survey, 1-10)

6.51 5.21 2

Office Rent ($/sqm/yr) 387 490 4

PHI RUSAccess to commodities (basic resources, food,

etc.) is adequately addressed (Survey, 1-10)6.44 7.43

PHI MEXAccess to commodities (basic resources, food,

etc.) is adequately addressed (Survey, 1-10)6.44 6.39

PHI RUS ScoreElectricity costs, industrial clients ($/kwh) 0.18 0.05 1Energy infrastructure is adequate and efficient (Survey, 1-10)

3.52 5.63 1

PHI MEX ScoreElectricity costs, industrial clients ($/kwh) 0.18 0.12 2Energy infrastructure is adequate and efficient (Survey, 1-10)

3.52 4.82 2

PHI RUS ScoreAd Spend/capita ($/yr) 19 56 5

PHI MEX ScoreAd Spend/capita ($/yr) 19 47 4

HQ

M

AN

AG

ER

SS

TAR

TIN

G A

B

US

INE

SS

TAX 3

FIN

AN

CE

LE

GA

L &

R

EG

UL

AT

OR

Y

3

4 2

3

HQ

M

AN

AG

ER

SS

TAR

TIN

G A

B

US

INE

SS

TAX 2

FIN

AN

CE

LE

GA

L &

R

EG

UL

AT

OR

Y

3

4

costs l Doing Business

2.8

3.0

SCORE

SCORE

2

3

PHI RUS ScoreCost of capital encourages business development (Survey, 1-10)

5.13 3.51 4

Interest rate spread (lending rate -- deposit rate) 4.11 3.88 3Credit is easily available for business (Survey, 1-10) 5.75 4.34 4Corporate debt does not restrain the ability of enterprises to compete (Survey, 1-10)

5.67 4.76 3

Banking and financial services do support business activities efficiently (Survey, 1-10)

6.30 4.54 4

PHI MEX ScoreCost of capital encourages business development (Survey, 1-10)

5.13 3.76 4

Interest rate spread (lending rate -- deposit rate) 4.11 2.92 4Credit is easily available for business (Survey, 1-10) 5.75 4.29 4Corporate debt does not restrain the ability of enterprises to compete (Survey, 1-10)

5.67 5.18 3

Banking and financial services do support business activities efficiently (Survey, 1-10)

6.30 4.68 4

PHI RUS ScoreCorporate tax rate on profit 30 20 1Real corporate taxes do not discourage

entrepreneurial activity (Survey, 1-10)4.69 4.29 3

PHI MEX ScoreCorporate tax rate on profit 30 30 3Real corporate taxes do not discourage

entrepreneurial activity (Survey, 1-10)4.69 3.97 3

PHI RUS ScoreLegal & Regulatory framework encourages the competitiveness of enterprises (Survey, 1-10)

4.04 3.32 3

Competition legislation is efficient in preventing unfair competition (Survey, 1-10)

3.81 3.46 3

Transparency of government policy is satisfactory (Survey, 1-10)

4.15 3.91 3

Bureaucracy doesn't hinder business activity (Survey, 1-10)

2.67 1.97 3

Bribing & corruption don't exist (Survey, 1-10) 1.45 1.68 3

PHI MEX ScoreLegal & Regulatory framework encourages the competitiveness of enterprises (Survey, 1-10)

4.04 4.70 3

Competition legislation is efficient in preventing unfair competition (Survey, 1-10)

3.81 3.90 3

Transparency of government policy is satisfactory (Survey, 1-10)

4.15 2.78 4

Bureaucracy doesn't hinder business activity (Survey, 1-10)

2.67 2.05 3

Bribing & corruption don't exist (Survey, 1-10) 1.45 1.64 3

PHI RUS ScoreCreation of firms is supported by legislation (Survey, 1-10)

4.73 5.35 3

Start-up days 35 15 2Start-up procedures (# of procedures) 15 7 2Investment incentives are attractive to foreign investors (Survey, 1-10)

5.33 4.39 3

Foreign investors are free to acquire control in domestic companies (Survey, 1-10)

3.89 5.59 2

PHI MEX ScoreCreation of firms is supported by legislation (Survey, 1-10)

4.73 4.54 3

Start-up days 35 6 1Start-up procedures (# of procedures) 15 6 2Investment incentives are attractive to foreign investors (Survey, 1-10)

5.33 5.82 3

Foreign investors are free to acquire control in domestic companies (Survey, 1-10)

3.89 6.26 1

PHI RUS ScoreImmigration laws do not prevent your company from employing foreign labor (Survey, 1-10)

6.11 5.16 3

Foreign labor force (% of total labor force) 0.05 1.52 1Foreign high-skilled people are attracted to your country's business environment (Survey, 1-10)

4.87 4.65 3

Quality of life is high (Survey, 1-10) 4.95 4.37 3Tourism Receipts (% of GDP) 1.60 0.55 5

PHI MEX ScoreImmigration laws do not prevent your company from employing foreign labor (Survey, 1-10)

6.11 6.69 3

Foreign labor force (% of total labor force) 0.05 0.18 2Foreign high-skilled people are attracted to your country's business environment (Survey, 1-10)

4.87 5.23 3

Quality of life is high (Survey, 1-10) 4.95 5.03 3Tourism Receipts (% of GDP) 1.60 1.08 4

risksPOLITICAL & SOCIAL

2.5

3.0

SCORE

SCORE

ECONOMIC

23

POLITICAL & SOCIAL ECONOMIC

33

PHI RUS ScoreRisk of political instability is very low (Survey, 1-10)

6.11 5.49 3

Youth Unemployment (% of youth labor force under 25yo)

16 13 4

Personal security and private property rights are adequately protected (Survey, 1-10)

4.55 4.17 3

Intellectual property rights are adequately enforced (Survey, 1-10)

3.82 4.96 4

Cyber security is being adequately addressed by corporations (Survey, 1-10)

4.40 4.67 3

Investor Protection (BMI Score, 1-100) 36.3 37.7 3Rule of Law (BMI Score, 1-100) 36.8 18.1 1Contract Enforceability (BMI Score, 1-100) 60.1 92.7 5

PHI MEX ScoreRisk of political instability is very low (Survey, 1-10)

6.11 6.05 3

Youth Unemployment (% of youth labor force under 25yo)

16 10 5

Personal security and private property rights are adequately protected (Survey, 1-10)

4.55 3.05 2

Intellectual property rights are adequately enforced (Survey, 1-10)

3.82 4.44 3

Cyber security is being adequately addressed by corporations (Survey, 1-10)

4.40 4.11 3

Investor Protection (BMI Score, 1-100) 36.3 47.0 4Rule of Law (BMI Score, 1-100) 36.8 47.0 4Contract Enforceability (BMI Score, 1-100) 60.1 54.0 3

PHI RUS ScoreResilience of the economy to economic cycles is strong (Survey, 1-10)

6.69 4.14 1

Financial risk factor is adequately addressed (Survey, 1-10)

6.36 4.79 2

Investment risk (Euromoney country risk, 0-100) 49.85 52.09 3Consumer Price Inflation (/yr) 2.93 6.76 1Exchange rate stability (Parity change from national currency to SDR, 2013 / 2011)

0.06 0.04 3

Country credit rating (Institutional Investor Magazine, 0-100)

57.2 68.0 4

PHI MEX ScoreResilience of the economy to economic cycles is strong (Survey, 1-10)

6.69 5.54 1

Financial risk factor is adequately addressed (Survey, 1-10)

6.36 5.17 2

Investment risk (Euromoney country risk, 0-100) 49.85 61.46 2Consumer Price Inflation (/yr) 2.93 3.80 2Exchange rate stability (Parity change from national currency to SDR, 2013 / 2011)

0.06 0.01 4

Country credit rating (Institutional Investor Magazine, 0-100)

57.2 69.3 4

analysis (Revenue – Cost) X RiskDemographics 3.3

Market 3.8

3.5

Operations 2.6

Doing Business 2.8

2.7 2.5

118 81 83%

31

(Revenue – Cost) X RiskDemographics 3.9

Market 2.5

3.2

Operations 3.0

Doing Business 3.0

3.0 3.0

107 90 100%

17

the recommendation

Invest in RussiaWith a large and highly urban population enjoying a high disposable income, Russia supports an extremely large and fast-growing biscuits market with no dominant player. Wheat and electricity also have very low prices as both are locally produced, and cost for sales distribution are likely to be low as biscuits are primarily sold through modern trade (also with no dominant retailer). Corporate tax is moreover only 20% of profits (although the abundance of tax disputes must also be considered: 84% of 58 international and Russian companies reported ongoing disputes).

Several other caveats come into play, however. On one hand, first, the economy is not resilient in general; the Crimean crisis led to significant capital flight (US$50B in one quarter) in the credit market. Consumer confidence is particularly low in view of an elevated consumer price growth (a year-high of 7.3% last April 2014), mostly due to the rouble's record low exchange rate versus the dollar last March 2014. On the other hand, the economy bounces back pretty quickly with immediate government response, like the plans to freeze utility prices until 2015 and the central bank's heavy intervention in foreign exchange markets.

Yet despite these risks, Russia is still an attractive market for the FMCG food manufacturer, especially vis-à-vis Mexico. This is mostly clearly demonstrated by Mondelez's announcement last April 2014 of its investment in a new US$110 plant in Novosibirsk.

Second, governance remains an issue with no recourse in sight, as highlighted by rampant corruption, rising state protectionism, limited impartial judicial oversight and massive infrastructure deficit. The Philippines experiences this currently in the same degree, however, along with security concerns. Still, it should be noted that rule of law is grossly lacking in Russia with street crime continuing to be prevalent.

Sources

• Passport• Demographics• Industry data• Advertising Spend

• IMD World Competitiveness Report 2014• Cost metrics for operations and doing business• Political, social and economic risk metrics

• Business Monitor• BMI Score • Economic Outlook• Business Environment Outlook• Food & Drink industry overview

• Index Mundi• Consumer Confidence

• FAOSTAT• Wheat Producer Price

Several online databases were used in building the model and in crafting the overall assessment.