risk mgmt s africa

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Long Range Planning 37 (2004) 259276

LRPlong range planningwww.lrpjournal.com

Risk management and thebusiness environmentin South Africa

Jay van Wyk, William Dahmer and Mary C. Custy

Risk management involves tracking market and non-market long-range risks, understandingtheir adverse impact on the business environment, and managerial responses to reduce riskexposure. As an emerging market, South Africa poses a challenging array of long-termpolitical, economic, financial and operational risks to investors. Risks such as concerns aboutincreased costs, lack of transparency, limited capacity to enforce the rule of law, governmentintervention, a volatile currency, regional contagion and the HIV/Aids pandemic heightenuncertainty about the business environment. Managerial responses to anticipate and mitigaterisks include matching mode of entry with risk tolerance, superior intelligence and lobbying,maintaining low tolerance for corruption, selecting appropriate financial instruments andbalancing shareholder and stakeholder interests.

The risk management framework presented, consisting of three elements: type of risk, impact

of risks and managerial response to counter adverse risk impacts, may be refined andexpanded for potential application to other emerging markets.Q 2004 Elsevier Ltd. All rights reserved.

IntroductionSouth Africa (SA) is known as the engine of growth for the African continent, generating 45percent of the continents GDP from only 10 percent of its population. The countrys econ-omic output ranks 29th in the world, making it one of the 10 leading emerging markets. SAoffers a sophisticated business environment in terms of infrastructure, legal system, natural and

human resources, telecommunication network and financial services.Since 1994, SA has undergone sweeping political and economic transformation, but, as with

all emerging markets, transformation is a work-in-progress. Since the end of Apartheid, thedemocratically elected ANC government has embarked on an extensive program of economicliberalization. The positive results have included an increase in competitiveness, internationaltrade and inward bound investments. However, a variety of risks are still present in the business

0024-6301/$ - see front matter# 2004 Elsevier Ltd. All rights reserved.

doi:10.1016/j.lrp.2004.03.001


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environment. After a decade of dramatic changes, it is prudent to assess the risk profile of SAand to raise awareness of the long-term risk management policies for present and potentialinvestors. It is our intent to outline a risk management framework consisting of three inter-related elements: first, to identify the manifestations of various market and non-market risktypes in SA; second, to illustrate how these risks may impact on business operations; thirdtheprimary thrust of our frameworkto analyze the various policy options that managers andfirms may adopt to preempt or mitigate the adverse impact of risk.

We have organized our paper into three parts: (1) a theoretical analysis of risk management;(2) a study of risk management in South Africa that addresses the three elements of risk identi-fication, risk impact and managerial policy options; and (3) conclusion and suggestions forfurther inquiry.

Framework for risk management analysisStrategic management theory has accumulated into a large body of knowledge, and under-

standing about managerial decision-making has been well advanced in terms offirmssustain-able competitive advantage over their competitors. However, risk management, as an integralpart of strategic management, remains underdeveloped. Too often, strategic risk managementis narrowly perceived as the impact of market, industry and financial factors upon the per-formance or return of firms. Managers, fixated on the risk-return paradigm and financialmetrics based on accounting data, often under-emphasize non-market forces as a source ofrisk.1

Managers often under-emphasize non-market forces as a source of risk

Even respected models, like Porters Five Forces and the Resource-Based View, pay littleattention to non-market risk factors.2 The PESTEL approach to strategy is also problematicsince its broad analysis of external influences on decision-making is not cost effective and cre-ates information over-load for risk management. It is good to identify long-term externaltrends outside industry but, as Narayanan and Fahey have noted, it is less effective in distin-guishing between vital and merely important developments.3 Noy considers risk as a majorcomponent of strategy, particularly the risk attitude of managers. Eisenhardt and Sull regardrisk as one of the seven strategic logics of a simple rules-approach to strategy. 4

Three general assumptions underpin risk as a concept. Risk is viewed as a (1) unit of analysisor level of analysis which must be determined; (2) broad rather than a narrow concept that is

not necessarily mutually excluded from related concepts; and (3) multi-dimensional concept.5

Specifically, risk may be analyzed on three subordinate levels: (1) general environmental uncer-tainty, i.e. systematic countrywide risks cutting across all industries or individual firms; (2)industry risks, i.e. differences in industrial or product specific variables; and (3) firm specificrisks, i.e. operating uncertainties.

The subject unit of analysis has influenced the definitions of risk. Studies linking risk andperformance or variance of return are more concerned with firm specific risks. Risk in thisregard refers to financial risk, anex post accounting measure of stock returns, financial ratiosand income stream uncertainties.6 While crucial, the tendency to term this concept strategicrisk is unsatisfactory because it does not reflect the full range of market and non-market risks

facing thefirm.The ordinal ranking approach to risk that is applicable to all three subordinate levels of

analysis defines the concept as the probability for any reference set (firm, industry, market for aproduct, country) losing rank position vis-a-vis other competitors. Risk is viewed as the chanceof loss, the degree of probability of loss and the amount of probable loss.7 In our view ordinalrankings, like country risk, are too broad and diffused. As managerial guides they fall short

260 Risk management and the business environment in South Africa


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since countries are lumped together with similar aggregate scores, but different profiles for spe-

cific risks (political,financial, operational).In this analysis the definition of risk is broad-based and captures both market and non-

market uncertainties. Our definition includes uncertainty associated with exposure to loss

caused by unpredictable events and variability in the possible outcomes of an event based upon

chance. The degree of risk depends on how accurately the results of a chance event may be pre-dicted. The more accurate the prediction, the lower the degree of risk. It is questionable to

regard risk as a situation where each action leads to a few known outcomes, each of which

occurs with a specific probability. Studies of risk-return utilizing sophisticated mathematical

models have mixed results with regard to outcome predictions.8 Resources (business intelli-

gence, market or country experience, access to political power) will enhance the certainty of

outcomes. The outcome of actions related to risk may be uncertain. Each action may lead to a

set of consequences, yet the probability of these outcomes is unknown. A risky situation is one

in which the decision-maker is unsure which outcome will occur. Such uncertainty may lead to

erroneous choices and, consequently, may increase costs or the chance of loss.To understand uncertainty, Milliken suggests risk should be viewed as a phenomenon

shaped by three related variables: state, effect and response.9 We have added type of risk to

emphasize the sources of risk and the time dimension (short, medium, long) to create a com-

prehensive risk management framework. Our framework for analyzing risk management in SA

is outlined inFigure 1.

Figure 1. Risk management framework

Long Range Planning, vol 37 2004 261


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Four types of risks

Several authors have suggested classification of risk types, butour classification will distinguishbetween political, economic,financial and operational risks:10

. Political risksrefer to government policies and societal instabilities that adversely affect thegeneral business environment;

. Economic risksrefer to the general condition and structure of a countrys macro-economy;

. Financial risksrefer to interest and foreign exchange risks and the confidencefinancial mar-kets have in a countrys government and central bank. It is determined by (and is reflectedin) the volatility of a currency in its exchange rate with major currencies;

. Operational riskssuch as employee issues or credit uncertainties, are similar to firm specificrisks as outlined above.

State of the risk environment

State of the risk environment refers to uncertainty about the current actions of key players andstakeholders in the business environment, i.e. the government, labor unions, competitors, sup-

pliers, shareholders and customers. General changes in this environment such as socio-culturaltrends, demographic shifts and instability during the transformation of economic and politicallife in a country can also produce uncertainty. Uncertainty about the future behavior of stake-holders such as government intervention in or withdrawal from the economy, regime changes,and nation-wide labor strikes has a bearing on the state of risk in a country. As Cummings andDoh find, players or stakeholders behavior toward the processes of change in the businessenvironment can also influence the state of risk.11 In general, business managers perceptionsof risk and uncertainty will be increased in a business environment characterized by volatility,complexity and deep societal cleavages.

perceptions of risk will be increased .. . .

by volatility, complexity and

deep societal cleavages

Impact of risk

The impact of risk on the business environment deals with the level of understanding of cause-effect relationships. The impact of a given state of events may cause uncertainty for a firm,industry or the general business environment. For example, a labor strike may increase the cost

of goods sold and adversely affect the supply chain: these will, in turn, influence customersatisfaction and profitability.

Time dimension

Risks are dynamic rather than static in nature and may increase or dissipate over time, andEisenhadt notes that a temporal dimension is crucial for effective risk management.12 Short-term risks have an immediate impact requiring priority and remedial action. Medium termrisks require monitoring since an early warning system is essential in business strategy. Long-term risk assessment (510 years) is vital for firms that have committed large sunk costs inforeign countries for operations that will only come online in the future. Future risk projec-

tions are essential to protect investments and to anticipate changes that may impact on com-petitive advantage.

Managerial response

Managerial response refers to managements ability to predict the likely impact of risks on thefirm as well as to adopt alternative policies that protect or enhance profitability. These policies



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include choices about mode of entry, lobbying political decision makers, intelligence aboutunfolding events, low tolerance for corruption, financial instruments, balancing shareholderand stakeholder interests.

Risk management and the business environment in South AfricaThe study ofshort-term risks in the SA business environment is covered in periodic countryrisk analyses.13 The focus of this analysis is the longer-term nature of various risks and theirimpact on the business environment. Firms may implement appropriate policies to anticipateor to respond to existing risks, thereby, reducing their exposure to risk. In Table 1, the types ofrisk, their manifestations and their impact on the SA business environment are outlined. Across section of examples is provided to illustrate firmsexposure to risks.

Political risks

The African National Congress (ANC) is positioned to win the 2004 elections since opposition

parties will remain weak. The government will continue to co-opt opposition parties andsocietal interest groups. It will also continue as a powerful stakeholder in the economy and willcontinue to embrace a neo-liberal macroeconomic policy (Botswana Model) rather than bla-tant redistribution of wealth (Zimbabwe Model). The governments hegemony will not allevi-ate business concerns about an over-regulated economy and insufficient transparency ofgovernment policy. The tenets of democracy will also be challenged by the controlled ratherthan open debate associated with co-optation.

Corruption will continue as a long-term issue for firms. Despite stepped-up law enforce-ment, the root causes of corruption will remain, i.e. cronyism and self-enrichment due to con-flicts of interest in government procurement contracts and insufficient capacity to enforce

ethical governance. According to Transparency International, the respected corruption watch-dog, countries with a Corruption Perceptions Index (CPI) score of below 5 out of 10 have aserious corruption problem. The seriousness of corruption in SA is evident in its CPI scores of4.8/10 in 2001 and 2002, and which have worsened to 4.4/10 in 2003. Transparency Inter-national also warns that the politicization of offices such as those of Public Prosecutor andAuditor General, which are designed to support constitutional democracy by preventing cor-ruption and the violation of human rights, is likely to limit their independence and effective-ness.14

SA has laws in place tofight crime and corruption, and to protect contracts and intellectualproperty, but it lacks the capacity and resources to enforce the law at consistent and acceptable

levels. The integrity of the police and the courts is in question due to low crime convictionrates and persistent irregularities. This creates uncertainty and diminishes the confidence ofinvestors who seek transparency and a predictable business environment based uponunequivocal applications of the law. A lax enforcement environment is a magnet for inter-national crime syndicates and has increased the cost of legitimate business due to money laun-dering, fraud, extortion and smuggling.15

A lax enforcement environment is a magnet for crime and increases

the cost of legitimate business

The implosion of the Zimbabwean economy has exposed the weakness of SA as a regionalleader and protector of private property rights and democracy. SAs failed foreign policy hasrevealed the volatility of its currency (Rand) and the vulnerability of the economy to regionalcontagion, with DFI and job growth adversely affected. Demands are on the rise in SA andneighboring Namibia for the expropriation of commercial farms: in the next decade, the ANC



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Table 1. Risks in South Africa (SA)

Type of risk State of risk Impact on business environment Firm examplesi

Political One Party dominates

politics

Insufficient transparency State as

Stakeholder

1. European Aeronautic Defense & Space

(EADS)uses bribes to secure defense

contract. CEO not prosecuted in SA, butunder investigation in Germany.Airbus(80%

EADS stake) also secured $3.5bn deal w/SA

Airways.

2. Zimbabwean contagion cost SA economy

$1.9bn & > 30,000 new jobs in 3 years,

according to think tank, Zimbabwe Research

Initiative.

Regional Instability Undermines investor confidence

Weak Capacity to

enforce law

Concerns about property, patents,

piracy, safety

Corruption due to Con-

flicts of Interest

Liability & reputation, uncertainty

in procurement practices

Economic Slow economic growth In GEAR scenario; weaker competi-

tive advantage

1. SAfirm,Freeplay Energy Grp,relocates to far

East, citing desire for economies of scale,

elimination of middlemen, & bigger intl mar-

kets

2. Leak of government BEE plan scares away

$1.5bn investment in mining industry.BHP

Billiton, Rio Tinto & Anglo Americansuffer

large sell-off.

3. ChemicalfirmOmniaincreased imports by

40%. Transport system could not cope caus-

ing late deliveries to

customers

Critical unemployment

levels

Strengthen populism, weaker free

market

Inadequate liberalization Over regulated sectors

Black Economic Empow-

erment

Uncertainty re current & future

government intervention & regula-

tions

Infrastructure Supply chain concerns

Operational Labor market rigidity Increased cost, lower productivity

Over-regulation

1. 74% of 325 large manufacturingfirms & 800

SMEs surveyed in Johannesburg cited labor

legislation as major impediment to business2. Mining Co.Anglo Americanspends $3m extra

on 3000 Aids infected workers pa. Cost will

escalate as disease progresses. Company esti-

mates 1/4 of 90,000 workers infected.

3. In one yearJD Grp.suffered 355 burglaries, 81

high-jackings, 11 armed robberies, 3 guards

killed. Cost > R20m pa.

4. Food retailer,Pic n Pay,spends R2m pa on

trauma counseling of employees & insurance

deductible of R50,000 per robbery.

HIV/AIDS pandemic Increase cost, HR concerns, liability

exposure, societal instability

Dangerously high crime

level

Increased cost, compromise safety

of personnel

Financial Volatile Forex market Variance in future earnings 1. Wine & spirit groupDistellsuffers R66.8mforex loss (June 02June 03). Net profit loss

despite increase in earnings and sales.

2. Nail & Rail5% BEE interest and all

voting power. Loan repayment hedged

on future earnings & share price rise. Non-

performance risk: BEE partners walk-

away, bank ends up w/ undesired

shares.

High inflation, high

interest rates

Operational cost, cost

of capital

Vulnerability to systemic

crises

Unanticipated losses, undermines

investor confidence

Settlement & Counter-

part

Financial distress, credit

worthiness, risks of SMEs

& BEEs,

i Current examples but with long-term relevance.



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governments commitment toproperty rights and the rule of law will be tested in the face ofradicalized political expedience.16

Economic risks

In the long-term, Boyd, Spicer and Keeton envisioned three possible scenarios for South

Africa.

17

A top-gear scenario is characterized by GDP growth of 56 percent pa, unemploy-ment halved within a decade, and per capita income doubling over 25 years. An in-gear scen-ario outcome includes modest improvement in governance, GDP growth of 34 percent pa,but increased unemployment. Areverse-gear scenariooutcome entails negative growth, polit-ical instability and large-scale state intervention in the market place to meet populist demands.The in-gear scenario appears to be the most likely for the next decade. SA averaged annualGDP growth of 2 percent over the past decade, and a 34 percent growth rate is projected forthe next five years. SA has made tremendous advances in economic liberalization and in theimprovement of market competitiveness. This transformation has reached a plateau, and it isthe opinion of these authors that it is vital for the SA government to continue with deregula-

tion, privatization of SOEs, appropriate education and skills transfer, and the promotion ofsmall business entrepreneurship in order to meet long-term challenges. The high unemploy-ment rate and poverty levels are long-term threats to political stability and neo-liberal econ-omic policies, and only a move towards the top-gear scenario can mitigate these risks.18

High unemployment rate and poverty levels are long-term threats to

political stability and neo-liberal economic policies

The SA government has adopted a broad-based Black Economic Empowerment (BEE)pol-icy with the aim to increase Blacks share in business ownership and economic wealth.19 Thegovernment has set up charters for various industries that set targets (quotas) and timetablesfor black empowerment infirms and government agencies. BEE is an intrusive policy that willprescribe many aspects of business operations including equity ownership, executive control,employment, affirmative procurement and supply, the transfer of skills, corporate social invest-ment in disadvantaged communities, and the development of entrepreneurship for SMEs andmicro-enterprises.

From a business risk perspective, BEE should be evaluated on principle and method. Theprinciple or intent of BEE is sound. The transformation of business and economic life in SA is

crucial to empower the black majority to gain a larger stake in business ownership, managerialpositions and jobs, wealth sharing and training. Whether BEE is the best method to empowerBlacks economically without harming business opportunity and economic growth has causedserious dispute between the government and business community. The dispute was ignitedwhen SASOL, SAs leading petrochemical company listed on the New York Stock Exchange,filed a 20-F disclosure to the United States Securities and Exchange Commission. This reporthighlighted BEE as one of thirty risk factors the company faced in SA. According to SASOL,there could be risk to shareholders that value may not be achieved in the case of BEE equitytransactions. SASOL could not guarantee that BEE transactions would take place at fair marketprice. The BEE charter for the liquid fuel industry prescribed equity sales to BEE firms at dis-

counted prices. SASOL warned that its shareholders might have to pledge the sale of a portionof the companys assets (up to R15bn) to finance BEE partners in their acquisition of a 25 per-cent stake in the company. President Thabo Mbeki attacked SASOLs risk assessment of BEE.He called it abigotedcompany bad-mouthing South Africas attempts to address the legacyof racism. Other SA companies listed on the NYSE also disclosed BEE as a risk for investors,including SAPPI, Harmony Gold, AngloGold and Telkom, a utility company in which the



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government has a majority stake. SAs largest business association, SACOB, has supportedfirms that cited BEE as a risk factor.

Affirmative procurement under BEE guidelines, which has not been fully defined, has raisednew uncertainties about access of foreign firms to government contracts. Foreign firms thatseek government contracts face the risk of restrictions on the repatriation of earned income. Acontract with an import content of US$10m or more will require the seller to invest at least 30percent of the value in a local black owned business. In the case of defense bidding, the figureincreases to 50 percent.

BEE will subject businesses to more governmental regulations. Firms will have to meetextensive balanced score card evaluations of their BEE progress. Long-term uncertainties havealso emerged in the business community regarding the likelihood that the government mayincrease BEE targets and quotas in the future or penalize firms that fail to comply voluntarilywith BEE targets and timelines. In sum, BEE is likely to harm the complementor relationshipbetween business and government that has been built over the last decade.

BEE is likely to harm complementor relationship between business and

government built over the last decade

Achieving the goals set out in the BEE charters will be costly for firms, but will contributesubstantially to economic transformation and Black empowerment. Equity transfer is theexception, however, since it has the appearance of an involuntary redistribution of wealth. Theauthors argue that continued economic liberalization in terms of the top-gear strategy as pre-viously described would be a more suitable route to the goal of Black economic empowerment.Higher levels of economic growth will attract foreign investment, create jobs and alleviate pov-erty. The net result would likely benefit a much larger portion of the population in a more sus-tainable manner.

Another long-term economic risk stems from the weak infrastructure and the necessaryupgrades required to cope with economic growth and logistic demands.20 Most container ship-ping lines classify Durban, the largest entry point for goods in Southern Africa, as a congestedport and charge additional fees. The antiquated rail infrastructure suffers from logistical pro-blems and late deliveries to inland destinations. The privatization of Transnet, the SOE thatoperates the harbor and rail systems, will likely reduce long-term supply chain risks. The con-struction of the N4 toll road, which was successfully completed by a consortium of private

constructionfirms, may stand as a model for future capacity upgrading.

Operational risks

Three issues present persistent operational risk to firms. First, the labor market has restrictiveregulations regarding minimum wages, inflexible hiring andfiring policies and a collective bar-gaining system that favors trade unions. The Employment Equity Act and BEE require firms toadhere to affirmative action hiring of personnel and executives. The Skills Development Actplaces a tax levy to fund training. The Labor Relations Amendment Act allows trade unions toblock or to reverse retrenchments and to limit the outsourcing of contracts. This legislationcreates risks for firms planning to acquire SOEs by constraining the ability to cut cost and

increase profitability by laying-off workers. SAs labor costs, at face value, appear to be low.However, once the effective tax rate, interest rate, investors earning expectations and thecountry risk premium have been taken into consideration, labor costs are not particularlycompetitive in comparison with other emerging markets.21

Second, according to the Metals Economics Group, high levels of violent crime andemployee security issues will remain a long-term risk for firms. The safety of personnel and the



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security of assets and inventory are time consuming and costly for firms. Thelack of capacityand credibility within the criminal justice system compounds this risk exposure.22

Third, the HIV/AIDS pandemic has added a new facet to the long-term risk landscape. SAhas the highest infection rate in the world with 5 million out of a population of 43 million HIVpositive. SA is facing the death phase (deaths > infection rate) of the disease over the nextdecade. The depletion of human capital, i.e. the stock of experience, skills and education, willadversely impact on the economy in the long range. Poverty and government intransigencehave resulted in poor access to anti-retroviral drugs and a low priority for preventativeeducation. In the long-term, labor productivity will suffer. In work places, there will be highabsenteeism, high staff turnovers due to deaths, diminishing transfer of skills and a generallysickly workforce. Lowly skilled workers and young managers face the highest risk of infection.In turn, low productivity will result in lower profitability and higher costs for firms, loweconomic growth and a reduction in market attractiveness to both existing and potentialinvestors.23

The depletion of human capital, the stock of experience, skills andeducation, will adversely impact on the economy in the long range

Financial risks

Investment in SA faces a number offinancial risks to firms including foreign exchange vola-tility, high interest and inflation rates, counterpart and settlement concerns, and vulnerabilityto regional and systemic crises. SA has the institutions, legal structures and regulations fordealing actively withfinancial risks. The Rand, although not fully convertible, is not subject to

artificially high official exchange rates as far as commercial transactions are concerned. Sellingthe Rand short in the spot or forward market requires underlying transactions in stocks,bonds or physical import of goods. Commercial banks in SA or offshore are free to transact onbehalf of their customers. The market, while volatile, is relatively liquid with reasonable bidoffer spreads. Historically, the Rand has been very volatile even in comparison with otheremerging market currencies, losing 75 percent of its value against the dollar in the period19942001, but gaining 40 percent in 2002.24 A weak Rand makes SA exports very competitivewhile making imports of capital, oil and consumer goods more expensive. This complicatesbusiness planning. During extreme volatility, the market tends to be very illiquid with prohibi-tively wide bid offer spreads. During crises, hedging instruments, such as forward outrights

and options, become expensive. SA, unlike other peers such as Russia, Turkey and Brazil, hasan active forward and options market. Investors have a wide range of risk management tools attheir disposal with an ease-of-use not available to investors in other comparable markets.

SA suffers from high and volatile inflation rates, but succeeded in 2003 in achieving its owntargeted inflation rate of 36 percent. Structural problems bedevil sound monetary policyincluding dependency on imported oil, high food prices, the boom-bust cycle of domestic bor-rowing and demands for higher wages. Pressure on the Rand and surging imported in flationinevitably leads to interest rate hikes. As a result, SAs risk premium is heightened by both thedifference between SA interest rates and that of majortrading partners and the poor purchas-ing parity of the Rand which makes imports expensive.25

Settlement risk occurs when a firm settles its accounts payable, but does not get paid foraccounts receivable; or afirm pays, but does not receive bonds or stocks that is due. Banks andfinancialfirms are more affected than manufacturers and service companies. Counterpart risk(or credit worthiness) is more applicable to SA due to the large number of SMEs, which areseldom rated by rating agencies due to having a credit history that is shorter and known onlylocally and to fewer creditors. Ratings have helped foreign investors and suppliers to assess



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credit worthiness and to manage counterpart limits to control risk. International and localcredit rating agencies such as Duff & Phelps Credit Rating Agency of SA currently ratesapproximately 200 of the largest companies in SA. For larger counterparts, securitization ofreceivables and credit derivatives may be used. For SME counterparts, prepayment, cashagainst delivery and letters of credit may be used to mitigate risk. BEE has spawned manyfirmsand consortiums with uncertain credit worthiness, and firms setting up supplier contracts or

joint ventures with such firms can face a daunting task to limit exposure to counterpart andsettlement risks ranging fromfinancial distress to operational uncertainties and bad debts.

SA presents interesting event risk and contagion risk perspectives for management. Since it ismore politically stable than its neighbors, a firm may use SA as a launching pad for distri-bution into Sub-Saharan Africa. However, if investments involve large upfront sunk costs andlong pay back periods, then SA represents more risk than developed markets. With a globalcredit crunch or jitters in other emerging markets, SA tends to get punished byfinancial mar-kets along with other debtors in this category: political instability in Zimbabwe and debtdefaults in Argentina have both unnerved international investors in SA.

Managerial responseTo conduct business in SA, management must reduce, mitigate and transfer risk exposure. Fiveboard policies have relevance for anticipating and reducing risk: mode of entry, lobbying andintelligence, low tolerance for corruption, financial instruments, and balancing shareholderand stakeholder interests. Policies are not necessarily risk type specificrather they may beused to counter the full array of risks.

To conduct business in SA, management must reduce, mitigate and

transfer risk exposure

Mode of entry

Management of economic and operational risks has a strong bearing on the choice of mode ofentry into the SA market. Three types of entry modes may be distinguished:

1. non-equity or export mode, preferred byfirms perceiving high risk since it shifts most of therisk to anotherfirm;

2. joint venture mode (JV), whether with a majority, minority or 5050 percent share, suitablewhere risk is perceived as moderate and

3. wholly owned subsidiary,established or acquired, when the perceived risks are low.26

Given SAs risk profile, the exporting and joint venture modes offer the best risk manage-ment options.

The desire of foreign investors to reduce risk exposure as well as the government policy topromote BEE have made Joint Venturesthe most common mode of entry. JVs may take manyorganizational forms. A foreign firm and a SA firm may establish a JV. Renault, the Frenchautomaker, formed a JV with Imperial Holdings Ltd., SAs largest transport firm, to sell auto-

mobiles. Renault acquired 51 percent of the JV at a cost of $9.8 million. The JV operates 47auto dealershipsin SA and has targeted an increase in market share from 4 percent to 7 percentin three years.27 A second form is a JV between a foreignfirm and a South African BEE. Theworlds largest marine salvage operator, Tsavliris Salvage Group of Greece, formed a JV withCape Diving & Salvage of South Africa that has a 66 percent black equity stake. This JV is wellpositioned to negotiate a government salvage and rescue contract and to secure competitive



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advantage in salvage operations to the oil exploration industry off the southwest coast ofAfrica. Services includefirefighting, medical evacuation and pollution control.28

SA subsidiaries of foreignfirms have also formed JVs with other SA firms. Ranbaxy SA Pty, awholly owned subsidiary of Ranbaxy Laboratories Ltd. of India, formed a JV with SAs AdcockIngram, the health care division of Tiger Brands. This 5050 percent JV competes in the anti-retroviral market in SA. Adcock Ingram leverages its strong distribution and supply network andleadership position in the pharmaceutical private market and hospital sector. Ranbaxy manu-factures and markets branded generic pharmaceuticals in over 100 countries. Ranbaxy has astrong R&D capability with proprietary platform technologies. Although a low marginbusiness,this JV will rely on cost effectiveness and economies of scale for long-term profitability.29

Eurasia Mining PLC joining with Randgold & Exploration Company is an example of a JVbetween a foreignfirm and a SAfirm where the foreignfirm has the option to acquire a majorityshare. The JV was established to explore for platinum in the Bushveld Complex. Eurasias initialacquisition of a 25 percent share, may be increased up to 75 percent within 12 to 15 months.Merger and acquisition is another approach. The SA subsidiary, PricewaterhouseCoopers,merged with MSGM Masuku Jeena, Inc., SAs largest black owned accountingfirm.The mergermet the BEE targets of equity ownership, operational control and employment equity.30

The non-equity export entry mode into the SA market has grown exponentially since 1995.These exports constituted one-fifth of the total local market in 2002. Major exports to SAinclude capital equipment and intermediary goods such as machinery (30.9 percent), primarygoods suchasmineral products (12.8 percent), chemicals (11.8 percent) and consumer goods(7 percent).31

Due to non-viable domestic economies of scale, the expansion of SA manufacturing sectorhas added to the volume and value of imports of investment goods and capital equipment.Exporters to SA often enjoy a competitive advantage since their products are often less expens-ive and perceived as superior in quality when compared to local products. For example, SA gas

container manufacturer Cadac has lost about 25 percent of its share in the local market to lessexpensive imported products from Thailand and Portugal. Cadac blames its loses on the highcost of imported valves and inflated prices paid for steel produced by ISCOR. ISCOR employsimport paritypricing which results in domestic buyers paying more than foreign buyers forISCORs steel.32

Exporters. . .products are often less expensive and perceived as

superior in quality when compared to local products

Many consumer durables manufactured in SA are indeed inferior to imported products,notably white goods and electronics.33 Despite the quality of their products, US firms export-ing goods and services to SA still face numerous trade barriers. These include trade permits;increases and reclassification of tariffs due to the lobbying of SA competitors and labor unions;questionable anti-dumping action against foreign firms; rebates that restrict exports to SA,notably textiles and automobile parts; customs duties; bureaucratic delays for products thatmust meet regulatory standards; government export subsidies to SA competitors; poorprotection of patent rights; and unfair competition from state monopolies in various indus-tries.34 The anticipated free trade agreement (FTA) between the USA and the Southern African

Customs Union (SACU) will remove most of these barriers, if enforced, and will facilitate theexport mode of entry.

Lobbying and intelligence

The reduction of political risk is a long-term, incremental process in which lobbying is used toachieve goals such as the strengthening of good governance and transparency, and the lessening



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of regulations. Intelligence monitoring is essential to track the progress of these goals, and

access to political decision-makers in SA and in the firms home country is an advantage.

Obviously, large multinationals have an advantage over SMEs as lobbyists and campaign

finance contributorsnonetheless, all firms, regardless of size, should endeavor to influence

economic decision-making. Interest aggregation is the most effective form of lobbying, and

trade associationsindustry based or countrywidewill be more effective lobbyist than indi-vidualfirms. Government consultations with interested parties offer opportunities during the

legislative process to influence bills dealing with labor relations, free trade negotiations and

BEE. Presentations during the committee stage of a bill provide trade associations with a public

venue to shape legislation and regulatory outcomes. Political power in SA is concentrated in

the Executive rather than the Parliament, and thus the most effective lobbying efforts are those

directed primarily at the political executive (president and cabinet ministers) and the bureau-

cratic executive (managers of government departments and SOEs).Firms may utilize lobbying to renegotiate the terms of BEE industry charters. The mining

sector and its trade association, Chamber of Mines, have successfully lobbied the government

to reduce the 51 percent quota to 26 percent for equity ownership for BEE firms within ten

years. The governments prescribed ten-year term for mining companies to underwrite R100bn

to finance black equity ownership has been reduced through negotiations to five years. The

experience of the mining sector with other BEE targets shows that it will be difficult and costly

to effect change within a ten-year period. Negotiations or lobbying, rather than non-

compliance, will determine adjusted BEE timeframes and targets. The ten-year target of 26 per-

cent BEE equity ownership will be subject to the availability of debtfinance and the presence of

willing sellers-buyers. Foreign investors will be frightened if stocks are not sold at fair market

value and within the bounds of acceptable risk exposure. Firms may lobby the government for

tax incentives to offset additional costs and risks incurred with the implementation of BEEquotas.35

For the next few years, FTA negotiations between the USA and SACUof which SA is the

dominant memberwill be ongoing. The institutions, laws and practices that will shape free

trade between the USA and SACU will be established. Firms and trade associations have a

unique opportunity to lobby the USA and SA governments to further deregulation, to improve

good governance (transparency, capacity building and anti-corruption), and to establish fair

competition for government procurement contracts. SA concluded a FTA with the EU in 1999

and is currently pursuing FTAs with the US, China, India and Mercusor which will afford

similar opportunities to influence the long-term outcomes.36

To retain competitive advantage in an emerging market like SA, it is vital that firms main-

tain sound intelligence in anticipating risk-generating events and behavior of key stakeholders.

Domestic and international issues that create uncertainty and could potentially degenerate into

crises must be continuously monitored with a long-term perspective in mind. If SA moves

from an in-gear to a top-gear scenario, risks will dissipate and more business opportunities will

emerge. However, contraction of operations to limit losses might be necessary if the economy

slides from an in-gear to a reverse-gear scenario. Political, economic and business data are

freely available due to the global reach of the Internet and the IT connectedness and sophisti-

cation of the SA business and communication environment. Outsourcing risk management toSA or global consultingfirms is another sound option.

. . it is vital that firms maintain sound intelligence in anticipating risk-

generating events and behavior of key stakeholders



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Low tolerance for corruption

A commonly held perception is thatfirms must bribe to stay competitive in emerging markets.Facilitation such as small payments, gifts and favors will remain a necessary element to smoothbusiness in SA. Large-scale corruption was revealed in SA when the PAC opposition partyexposed bribes to politicians in a $5bn arms deal. A permissive culture requires managers toremain vigilant about corruption. Government procurement contracts will remain susceptibleto bribes and kickbacks in the long run. The latest BEE prescription for affirmative procure-ment will not eliminate briberys root causes, i.e. conflicts of interest, nepotism and the self-enrichment schemes of officials. Prosecution rates for corruption and white-collar fraud willremain at low levels due to lack of capacity. In dealing with government agencies,firms shouldnot assume that officials will necessarily follow laws and procurement rules. Dealing with prov-incial governments is especially difficult since political and bureaucratic oversight is poor.Many companies appoint well-connected black board members to guide them through theprocurement process, the uncertainties of BEE policies and the intricate relationship betweenthe ANC and new emerging companies and consortiums dominated by black shareholders.The anticipated US-SACU FTA will hopefully improve transparency in procurement and

licensing practices in SA.37

The Foreign Corruption Practices Act (FCPA) of 1977 outlaws the payment of bribes byAmerican firms to foreign officials and politicians anywhere in the world. The UK adoptedsimilar legislation in 2002. The OECD Convention on Bribery, signed by 35 countries in 1997,decrees that enterprises should not, directly or indirectly, offer, promise, give, or demand abribe or other undue advantages to obtain or retain business. The pace of prosecution hasincreased and has been expanded to include the prosecution of subsidiaries of parent compa-nies in emerging or foreign markets and non-resident foreign nationals.

Firms operating in SA may take practical, nuanced steps to establish a low tolerance policyfor corruption. First, they should provide employees with clear advice on the steps to be fol-

lowed when they suspect that bribes are being offered or demanded. Employees need telephonenumbers and emails to report suspicious incidents. A wise firm will not only protect whistle-blowers but reward them for their ethical behavior. Second, training is essential. Although abribe occurs as part of a brief transaction, the process that leads up to it is often what makesthe bribe possible. Training may assist employees to recognize early warning signals. Third,carefully designed internal audit procedures may help flush-out bribes disguised as legitimatetransactions (e.g. agentscommissions). Fourth, due diligence is essential to avoid unintendedfuture liabilities arising from government procurement contracts. Fifth, benchmark the bestpractices offirms that have successfully executed low tolerance policies toward corruption, e.g.Friends Ivory & Sime, a large UK fund manager; United Technologies, the US conglomerate;

and the multinational Proctor & Gamble. Their experience demonstrates that the eliminationof bribery had no adverse impact on profitability.

Financial instruments

A full range of products exists in SA for hedging foreign exchange and interest risks, rangingfrom overnight money market rates through the 25-year benchmark government bond to crosscurrency and interest rate swaps and a repo market. Firms can hedge their interest rate risk andlower their cost of capital while putting surplus capital to work efficiently. A steady externaldebt rating of Baa2/BBB-/BBB3 and a local currency rating of A2/A- means that SA may effec-tively access both domestic and international markets to raise debt more cheaply. The continu-

ous benchmark government yield curve has also helped SA issuers such as Eskom and theDevelopment Bank of South Africa to issue domestic bonds. International corporations andsupra-nationals may issue Rand bonds with a variety of maturities and issuers, thereby facil-itating transparency and efficient allocation of capital.38

Equity transfers, the typical BEE deal, must be done in a sustainable manner. Risk involvesthe transfer of equity from those who have money to those who do not. The pressure for quick



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equity transfers to hastily-created consortiums comes at the risk of insufficient attention to duediligence andfinancial scrutiny. Commercial loans, instead offinancial engineering and special-purpose vehicles, should be used to protect a firms competitive advantage and shareholdergains, and to limit financial distress among BEE firms. In any deal, the gearing risk of BEEfirms (debt or cover ratio) should be determined before a sale. Firms may exploit BEE by sell-ing under performing business units to BEE firms.39

. . .quick equity transfers to hastily-created consortiums come at the

risk of insufficient attention to due diligence and financial scrutiny

Risk insurance, albeit costly, is a prudent way to share the risk burden since emerging mar-kets are susceptible to sudden and dramatic shocks. Government sponsored, multilateral andprivate insurances are available for foreign investors. For example, the World Banks MultilateralInvestment Guarantee Agency charges investors between 1.2 percent and 6 percent of their

investmentsvalue to protect against all political risks. The UK government provides insurance(amber zone budget of the ECGD) for capital goods exporters doing business in emergingmarkets such as SA.40 The USAs Overseas Private Investment Corporation also provides simi-lar risk insurance.

Shareholder versus stakeholder interests

With the introduction of BEE, firms are pushed away from shareholder wealth maximization(SWM) towards a model ofcorporate wealth maximization(CWM). In the SWM model,firmsassume responsibility for operational and market risks, but the individual investor is respon-sible for personal investment decisions. For SWM, the dominant goal offirms is to achieve sat-isfactory returns for shareholders. Company governance is based on one-share-one-vote,although abuses of the agent-principle practice have somewhat undermined the SWM model.The model emerging in SA is closely related to CWM. Firms should not only pursue profits,but also advance the governments policy for the economic empowerment of the disadvantagedblack majority. The government considers business enterprises as social institutions thatshould treat other corporate interest groups or stakeholders on par with shareholders. Thesestakeholders include government, management and employees, trade unions, disadvantagedcommunities, suppliers and even NGOs. BEE policy will increase the stakeholder role ofgovernment in the business environment. The government aim is to co-opt firms withoutcoercion as partners in the provision of public goods to society while at the same time allowingfirms to pursue profits, albeit at a lower return rate.

Even iffirms embrace the SWM model, a reduction of operational risk will require a mana-gerial strategy that addresses the welfare and safety of employees. The pursuit of profitabilityand market share must have a human face.

The pursuit of profitability and market share must have a human face

Somefirms, such as Anglo American and Old Mutual, have adopted comprehensive healthcare programs, including provision of free anti-retroviral therapy. These programs have

reduced long-term costs by 3240 percent. SMEs, with fewer resources, will still benefit by pro-viding prevention information to employees. By spending $1015 per worker, the infectionrate may be reduced by as much as 50 percent. It is essential for firms to calculate fully the costof HIV/Aids. This includes individual costs, direct (medical care) and indirect (productivitylosses); and organizational costs, direct (insurance premiums) and indirect (managerial timeand depressed morale). The cost of Aids accumulates over time as the health of a worker dete-



15/18

riorates. The SA Institute of Chartered Accountants favors the inclusion of Aids costs as a bal-ance sheet item.The cost of prevention may range from 0.4 percent to 5.9 percent of a firmsannual wage bill.41 However,firms are not solely responsible for fighting HIV/Aids, but shoulddevelop a coordinated strategy with other stakeholders such as medical scheme providers,government agencies, NGOs like the Global Fund, labor unions such as COSATU and tradeassociations.

Firms will also incur additional crime prevention costs including (1) employee training andcounseling for personal safety issues such as kidnapping, rape and carjacking; (2) surveillanceof workplace, plant and warehouse, and supply chain; and (3) associated insurance coveragefor loss and liability.

Firms operating in SA already add value to many stakeholders via direct and indirect taxes;interest to lenders; rent to landlords; and wages, salaries and benefits to employees. The BEEpolicy will, at least in the short-term, add additional value to many stakeholders that will comeat the cost of shareholder dividends and returns unless high economic growth rates increasesales to consumers. BEE requirements that suppliers (B2B, B2C) should be at least 51 percentblack owned may have a disruptive impact on supply chains that have been built over time.Three coping strategies have emerged:

1. frontingthe practice offirms to use businesses controlled by Blacks or women to acquireprocurement contracts;

2. first-to-marketthe oil firm, Engen, moved first to award a tender for freight and cleaningto Emtateni Freight Plus, a BEE supplier with a solid reputation; and

3. non-complianceSMEs, often family owned, lack the resources to meet BEE requirements.

The BEE policy will also increase demands for corporate social investment (CSI). Althoughthe demand is still at the low rate, firms will be expected in the long range to provide morepublic goods such as education, crime prevention and health care to disadvantaged communi-ties. Firms may benchmark the CSI of SAs National Business Initiative or banks such asCitibank, Westpac (Australia) and Standard Bank (SA).42

ConclusionRisk management in SA requires the identification of specific risks and their adverse impact onbusiness. A number of response strategies are suggested to reduce exposure to long-term risks.As part of strategy, these policies offer a more focused approach to deal with risk, something lostin the aggregated rankings in country analysis. The utility of our framework requires furtherapplication in SA. The uncertainties in many sectors in SA challenge managers to understandand control industry or firm specific risks more effectively. For management researchers facedwith multidisciplinary demands to understand risk management in foreign markets, continuedexploration is essential to comprehend the impact of politics and other non-market forces onbusiness decision-making. The future role of the SA government as an owner and co-opter orconsumer and business-friendly rule-maker will determine market attractiveness in SA.

The (many) uncertainties in SA challenge managers to understand and

control industry or firm specific risks more effectively

Our intention was to develop a risk management framework and apply it to SA. Any gen-eralization based upon our analysis about risk management in other emerging markets ispremature. However, our framework and its three related elements (risk type, risk impact,managerial response) may be refined and expanded for possible application in case studies or



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comparative studies of emerging markets. This will be a positive step in identifying potentialcommon trends in risk management in societies in the process of political, economic andsocial transformation.

Acknowledgements

The authors would like to acknowledge the helpful comments of two anonymous reviewersand the editor as well as Philip Court, Pieter Haasbroek, Jorge Jara and Wilbert Baerwaldt.

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BiographiesJay van Wykis an international business consultant and the author of Contemporary Democracy, published by

Congressional Quarterly. He holds a Ph.D. in International Relations/Political Science from the University of Pre-

toria, a MBA from Purdue University and a MBA from Tilburg University, The Netherlands. Meerkat Associates, 6

Camino Norte Vista, Placitas, New Mexico 87043 USA Tel: 1-505-771-0463 Email: [email protected]

William Dahmeris a Managing Director at Reserve Invest Cyprus Limited. His experience is in banking, treasury

andfinance with a special focus on the emerging markets of EEMEA. He holds a MSM from Purdue University and

a MBA from Tilburg University in The Netherlands. He is a FSA Registered Person and an Affiliate Member of the

Securities Institute in the U.K. Reserve Invest Cyprus Ltd., Bld. 1, 47 Bolshaya Polyanka St., 119180 Moscow, Russia.

Tel: 7 095 929 9526 ext. 1247 Email: [email protected]

Mary C. Custyis an international business consultant focusing on legal and political issues in emerging markets.She holds a JD and MA in International Relations from the University of South Carolina and a MLIS from Catholic

University of America. She is the author of Jurisprudence of United States Constitutional Interpretation, published

by Fred B. Rothman Publications. Meerkat Associates, 6 Camino Norte Vista, Placitas, New Mexico 87043 USA.

Tel: 1-505-771-0463 Email: [email protected]


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