Annex Bulletin 2007-38                             October 29, 2007

Recent...

Globalization Pandemic Catches Fire -  Analysis of global investments based on 2007 UN report

Googling to Top of IT World (Analysis of Google's ascent to Top 20)

GLOBAL TRENDS

Q

Updated 10/29/07, 3:50PM PDT, adds Ginni Rometty remarks...

Analysis of Global Investments Based on 2007 Annual UN Report

Globalization "Pandemic" Spreading...

...Fueled by M&A's, Surging "Greenfield" Investments; Globalization Accelerates at IBM, Too; So Does Rhetoric

Increasing Distance from Customer: Making Old Mistakes in New Ways?

"The World is Not Flat" (warns Harvard Professor)

SCOTTSDALE, Oct 29 -  Globalization "pandemic" is spreading around the world like the galloping influenza of 1918 (see *NOTE).  This bankers' EFT-transmitted virus is fueled by soaring M&As (mergers & acquisitions), and an 86% surge in "greenfield" (direct) investments.  In 2006, multinational companies invested $1.3 trillion in foreign markets, up 38% from the year before, according to the just-released annual United Nations agency that monitors such activities (UNCTAD).  This is just a notch below the all-time peak reached in 2000 ($1.4 trillion), after which the dot-com collapse and 9/11 cut the globalization expansion at the knees (see the chart).

Our last year's analysis of global investments also noted that "Globalization Is Accelerating" (Dec 2006).  Foreign investments jumped 27% last year, after surging by 32% the year before.  Nor is this some sort of a spontaneous thirst for foreign products developed by global consumers or workers.  It is a top-down investment banker- and business executive-driven "trend" (the reason we are putting the word "trend" in quotes is that the 1980s bestseller "Megatrends" noted that real trends are bottom-up, "fads" are top-down).

Well, as far as fads go, this is some sort of a "megafad."  About $10.3 trillion, or 86% of the world's cumulative foreign investment stock ($12 trillion - see the chart), was created in the last 17 years since the end of the Cold War.  And two-thirds of that, or about $7 trillion, were the investment-banker driven M&As.  The remainder were the business-driven "greenfield" investments and reinvestments of earnings ("what earnings?" - you may wonder, but that's another story which suggests this may be one giant fad).

Rise of China, India, Followed by Russia...

China is unquestionably the Cold War winner, as we have also noted in our past reports on global investments (see "China: Real Cold War Winner," Mar 2002).  China investments account for about two-thirds of the total spend on world's developing economies (see the chart).  In fact, China has now reached a point where its economic might  is such that its companies are starting to invest their earnings in foreign markets (Huthison Whampoa, CITIC Group, Jardine Matheson and China Ocean Shipping Co., for example, are among the top dozen biggest multinationals from developing countries).  Total foreign investment outflows from the developing economies reached $193 billion in 2006, or 16% of world outflows.

As for India, the new Mecca of IT companies' globalization efforts that are rapidly turning that country into the "world's help desk," foreign investments unsurprisingly soared 153% last year to $16.9 billion.  IBM, HP, Microsoft, Accenture, Oracle... the list goes on and on, seem to be tripping over each other throwing money at India. 

But just to keep things in perspective, despite such a massive transfer of IT jobs and capital into India, this subcontinent still accounts for only a fraction of the foreign investments that China gets.  But India is gaining ground on China.  It's share of China investments more than doubled in just one year, from 6% in 2005 to 15% in 2006.

In 2006, China attracted $113 billion of foreign capital, up 6% from the year before.  Mainland China's share declined 4% to $70 billion, while Hong Kong's inflows surged 28% to $43 billion.  Only two other economies were more appealing to global investors.  The U.S., which staged a comeback thanks to its weak dollar, received $175 billion in foreign investments last year, and the U.K., which got $140 billion.

Overall, investment inflows to developed countries surged by 45% to $858 billion, while developing countries received 21% more foreign capital last year for a total of $380 billion (see the chart).  Most of the heavy trading has taken place between the "friendly" neighboring trading partners.  The U.S.-U.K., China-Hong Kong, U.S.-Japan, U.S.-Germany and U.S. Canada are the top five pairs, in that order. 

But it was the so-called "transition economies" that took the cake last year, soaring by 68% to $69 billion.  The foremost among those was Russia, which received $29 billion in 2006, a 125% jump from the year earlier.  The increase is driven mostly by M&As related to the soaring energy prices that have helped lift the value of the vast Russian resources almost beyond measure. 

Meanwhile, Russia has been for years treated by the western governments, especially by Washington, as if the Cold War is still going on.  Such foreign policy is increasingly at loggerheads with multinationals' business interests.  Considering that money talks and politician walks, we can probably expect a change of the Beltway rhetoric after the next election in both America and Russia.

The biggest increase in foreign investments in 2006, however, does not belong to any of the so-called BRIC countries (Brazil, Russia, India, China), the major emerging markets.  It was the tiny Israel that was the big winner in 2006.  Its capital inflows soared by 198% to $14.3 billion (see the chart).  The big jump was mostly driven by M&As, especially in the pharmaceutical field, such as the $7.4 billion-Teva Pharma deal.

Elsewhere in the world, capital inflows to Latin America were flat at $70 billion in 2006.   This is in sharp contrast to the soaring outflows, which jumped by 125% to $43 billion.  So it would appear at a first glance that the yesteryear's hunted have become the hunters.

Not so if you peel the Latin onion.  It turns out that in South America, most of the countries registered strong growth in foreign investments.  But that was offset by significant declines in Colombia and Venezuela.  Again, politics meddling in business.

Brazil and Mexico remained the leading recipients (with $19 billion each), followed by Chile, the British Virgin Island and Colombia.  Also, greenfield investments became more important than cross-border M&As, and reinvested earnings became an increasingly important component (the largest component in South America alone).  Which are all signs of maturing of developing markets.

As for Africa, despite all the well-meaning humanitarian rhetoric in Washington, New York, London and Hollywood, Africa remains the world's most depressed region when it comes to capital investments. At $36 billion in 2006, Africa’s share of global foreign investments fell to 2.7% in 2006, compared with 3.1% in 2005, much lower than that of other developing economies.  And it will remain in the cellar until such time that we start to invest in developing Africa's human capital rather than its resources (Egypt, for example, the largest recipient, got $10 billion; the oil-rich Nigeria is second at $5 billion).

IBM Forcing Importance of Globalization onto "CFO Agenda"

Even the biggest macro trends or fads are made up of millions of tiny little specks, events around the world that in the aggregate shape a constellation like globalization.  Last week, we attended one such event in New York, hosted by IBM GBS financial sector people (Global Business Services - IBM's consulting arm).  It was a splendiferous affair, full of glitz and glamour, beautifully stylized and staged at, what IBM called, the "crossroads of the world" - the NASDAQ stock exchange at Times Square.

The attendees were even treated to a fleeting moment of fame, appearing to hover even over the biggest billboards at Times Square, like this writer in the left photo.  The charts were beautiful as was the whitepaper IBM handed out (see its cover below).  Senior IBM dignitaries were on hand as were esteemed members of the academia (Wharton Business School).  We were told it was the first of 50 such events Big Blue was planning to run around the world.

The ostensible reason for the conference was to discuss the findings of a survey of some 1,200 CFOs from 79 countries that Big Blue ran this summer.  Its purpose was to try to determine what the "CFO Agenda" is.  We say "ostensible" because it didn't take us long to realize we were actually attending a demand-generation event intended to raise the importance of global integration on the CFOs' agendas, not just report on it, as the invitation to "The Future of Financial Management - IBM CFO Study" promised.

In other words, we got the impression that what IBM was trying to do is frame the "CFO Agenda" with its self-fulfilling prophesy about globalization.  We told the IBM presenters as much during the Q&A. 

Once - may be a survey report delivery event.  Two or three times - could be regional seminars.  Fifty... 50 times at bat - that is a global marketing program! 

Why would IBM go through all this money and trouble?  So that GBS and GTS could sell the CFOs more services.  The latter was never mentioned at the NASDAQ event, but became pretty obvious from the data. 

"The IFOs (Integrated Finance Organizations - a new term IBM minted for the occasion two months ago - see above report cover) are three times more likely to use outsourcing," noted Steve Rogers, an IBM GBS executive who ran the CFO Agenda" project and reported on its findings in New York on Oct 24 (see above chart

Bingo! 

There is no problem, of course, with demand generation events like this.  After all, growth is what has been lacking in, and everyone is demanding from, the IBM Global Services.  We only find the GBS tactics problematic.  The “CFO Agenda” survey seems to be used as bait in its “bait and switch” marketing.  We think that IBM should have simply said, “this is what we believe,” instead of making it seem as if it's merely responding to customers' demand.  "Bait and switch" tactics only cheapen the globalization argument which has a lot of merit on its own.

GBS's Rogers, for example, presented a chart (right) which clearly showed that risk management and global integration were the lowest among the CFO priorities.  Yet IBM is trying to make a case that they are crucial to a company's success.  That sounds like a famous trial lawyer's summation to the jury: "And those, ladies and gentlemen of the jury, are the conclusions upon which I based my facts."  :-)

Speaking of facts, we heard something else at the IBM conference that we found downright startling.  Urging companies to act rather than wait to get all their ducks in order, Rogers said, "even if a number is wrong, it is right until corrected."  He was apparently quoting an unnamed CFO from the survey.

Bet our nation's Chief Executive could relate to that method of decision-making.  He waged a "just war" in Iraq supposedly based on what turned out to be wrong facts (by the way, is anyone ever going to correct weapons of mass destruction myth so we can pull out and stop the slaughter?).  Tens of thousands of lost lives is the price mankind is paying for those wrong facts.

Globalization Not a Bed of Roses: "The World Is Not Flat"

Besides, globalization has some pitfalls even with all the correct facts on the table.  Prudent executives should carefully evaluate both pros and cons before committing their troops to a long and potentially dangerous journey.  Global integration is not a bed or roses as IBM would have us believe. 

Political Risks. Take the political risks of globalization, for example.  They are a part of the 87% of "non-financial risks" the CFOs told IBM surveyors they had to face.  You saw earlier the chart which showed how 9/11, for example, "cut the globalization expansion at the knees," as we put it above (see the chart).

Big Blue historians could also point out to the money IBM lost in the former Soviet Union when the company expanded there ahead of the Soviet invasion of Afghanistan in late 1979.  At the time, the former IBM CEO (Tom Watson, Jr.) was the American ambassador in Russia.  IBM was keen on trying to cash in on the Cold War thaw that followed the June 1979 Carter-Brezhnev meeting in Vienna to sign the SALT II agreement.  The move backfired as the post-Afghanistan freeze in Washington-Moscow relations put some IBM assets on permafrost, too.  Another example of political "risk management" gone awry.

And then there are more pervasive risks of globalization.  To IBM's credit, the company did bring in an esteemed economist to discuss them - to a meeting in St. Louis back in May, if not to New York in October.   Dr. Laura Tyson, who is a senior advisor at the McKinsey Global Institute, was introduced at IBM's Partnerworld as "one of the top 25 most influential women in the world."  Here's what she said about globalization:

"Globalization can lead to 'creative destruction'," she warned.  

She pointed out that during a part of the industrial revolution (1870-1914), the world experienced another period of intense globalization.  Just as this is now happening under the leadership and the strength of the American economy, back then the Britain and its Commonwealth were the catalysts and champions of that global trend.

"The world was about as integrated back then as it is now." Dr. Tyson noted.  "Cross border flows of people were even greater back then."  It was a world of rampant and practically unrestricted immigration that fed the insatiable need for labor that the industrial production created. 

But as is the case with all major economic changes and disruptions, there were winners and there were losers.  The losers fought back.  Worker revolutions, protective tariffs, and two world wars followed. 

"That round of globalization ended badly," Dr. Tyson noted. "It wasn't until the mid-1950s that the world began to (re) globalize slowly again."

(for more of Dr. Tyson, click on "Dangers of Globalization," May 2007)

Business Risks. Besides the political, there are also business risks inherent in global integration.  When challenged about them by a questioner from the audience in New York last week, IBM executives also admitted there is some downside to it.  Globalization can damage the brand (e.g., Mattel); and bring about higher currency risks, conceded Robert LeBlanc, general manager of IBM GBS consulting services.

Some esteemed academics also warn of other business risks of globalization.

"With apologies to Thomas Friedman (a New York Times columnist whose book the globalists seem to be quoting like some sort of a new New Testament), managers who believe the hype of a flat world do so at their own risk," writes Harvard Business School professor, Pankaj Ghemawat in his new book ("Businesses Beware: The World Is Not Flat"). "National borders still matter a lot for business strategists. While identifying similarities from one place to the next is essential, effective cross-border strategies will take careful stock."

Prof. Ghemawat should know.  He worked as a consultant with McKinsey & Co. in London in 1982 and 1983, and has taught at the Harvard Business School since.  In 1991, he was appointed the youngest full professor in the Business School's history.

Globalization Increases Distance between Customer and Vendor

Making Old Mistakes in New Ways?

But there are some other business risks nobody talked about that we find the most worrisome.  Globalization increases the distance between the customer and the vendor. As a result, it threatens to alienate the local customer.

Any American who has had to deal with Indian tech support people, for example, will understand what we mean by increasing the distance between the customer and the vendor.  It is not just the geographic distance.  In fact, that's the least of it given today's telecommunications technology.  We are talking about cultural and other differences, like that new "global handshake" image symbolizing the gap between the two. 

Most people are not "citizens of the world," as hard as that may be for the globalists to believe.  People like their local idiosyncrasies.  They make them feel comfortable, safe.  Successful companies make their customers feel good about doing business with them.

Customers like personal touch and local presence.  That's what we've been hearing on our trips around the world.  A corner service station is better than that one on the next block.  The next block is better than another suburb.  Another suburb is better than another city.  Another city is better than another state.  Another state is better than another country.  Another country is better than another continent…

By contrast, globalization puts business processes (bureaucracy) ahead of the customer.  The farther away the service center is from the customer, the more potential for customer alienation. And that can only be bad for business in the long run.

Globalization also diminishes local uniqueness and cultures; aiming to replace them with faceless uniformity.  That’s how machines work, not humans. What does a customer in Mobile, AL, for example, have in common with a service rep in Bangalore?  No two hands or sunsets are alike, as our chart (right) shows.

The last time IBM put  its financial interests ahead of that of its customers, it ended up badly.  In fact, it nearly ran the company into the ground.  It was back in the late 1970s-early 1980s when Big Blue decided to switch from a rental- to a purchase-based business.

Facing fierce price competition from the Japanese-backed PCMs (Plug Compatible Manufacturers), Frank Cary and John Opel, IBM leaders at the time, figured purchase-based pricing would give them more flexibility to fight back without devaluing their own rental inventory.  John Akers carried on the same strategy after 1985.

Results were disastrous.  IBM became so alienated from its customers that the situation compelled the then fairly new IBM CEO to declare 1987 as "the year of the customer."  Akers was promptly mocked by competition who claimed that, "at DEC, every year is the year of the customer." 

The late IBM CEO, Tom Watson, Jr., was also critical of this IBM strategy in his book "Father, Son & Co." (1990).  “I was alarmed when (IBM) rapidly phased out the rental system… rental contracts wedded us to our customers, gave us a powerful incentive to keep the service top-notch,” he said.

Is Globalization Really "Inevitable"

Today, the IBM CEO Sam Palmisano is saying, “globalization is inevitable.  It is here.  It is not going away” (at the IBM meeting for financial analysts in New York, May 2007).  It was an echo of similar remarks he has been making for at least a year now.

Is it inevitable?  Hm...  we are not sure, even if most of the big IT players seem to think so, and not just the IBM chairman (HP, Microsoft, Oracle, Accenture, Capgemini... etc. all have huge and growing operations in India, for example).  Safety in numbers?  Ask the lemmings.  Top-down "fads" should not be confused with real trends.

Harvard's Prof. Ghemawat seems to agree.  "Businesses Beware: The World Is Not Flat" warns the title of his new book (right chart).  He warned that businesses must respect national differences rather than try to seek global uniformity.

We also saw how quickly another top-down "trend" died on the vine in the 1990s.  Anybody still remember MAI?  No?  Our point exactly.  Inevitable?

MAI stood for "Multilateral Agreement on Investment."  The only problem people wouldn't agree.  It was a globalist elite's idea negotiated behind closed doors by members of the Organization for Economic Co-operation and Development (OECD) between 1995 and 1998.  Its purpose was to develop multilateral supra-governmental global rules that would ensure free investment flows between countries. When it was leaked to the public, the MAI never survived the public scrutiny.  People saw it for what it was - a globalist elite effort to undermine sovereign powers of their nations.  When France pulled out in Nov 1998, the MAI withered and died.  RIP.

We also saw, for example, how quickly the globalization "trend" abated after the World Trade towers came down on 9/11.  Real trends are bottom-up, like the PC or the Internet revolutions.  They are inevitable.  Because they are driven by billions of people around the world making similar individual decisions, not by a few hundred CEOs sending top-down messages to their troops and customers.

Another thing that Apple and Google have that seems to elude most industrial IT giants is creativity.  Real innovation, not that measures in thousands of patent applications that don't contribute much to customer experience with technology.  Creativity is the single most important differentiator that generates buzz, growth and high stock market valuations.

Leading a Company to Extinction: A Viable Risk Management Strategy

A discussion about the importance of creativity during a Q&A with a conference panel led to an interesting discourse with Prof. John Persival of Wharton, one of the top three graduate business schools in the country.  In his presentation that preceded the panel discussion, Prof. Persival talked about the companies having to choose nowadays between growth and (profit) margins (right chart).

"Commoditization is driving the growth and (leading to) lower margins," he said.

So we pointed out to Prof. Persival during the Q&A that growth and margins needn't be mutually exclusive.  Creative companies can have both, we suggested, citing Apple and Google as examples. 

"They are experiencing both high growth and high margins," this writer said.

The professor agreed.  "All these companies (industrial era relics) used to be Apples and Googles once," he replied.  "But they lost that edge.  And now they have to choose between growth and margins."

In a semi-private conversation over lunch, Prof. Persival expounded further on that point.  And what he said was quite surprising.  He said that managing a company to extinction was "a viable low risk management strategy." 

He pointed to Kodak as an opposite example; a case where the management in an effort to reinvent the company whose greatness lay in film technology was driving it into a new digital imaging field that other companies dominated. 

"They are blowing billions of dollars (of shareholders' money) on digital photography," he said.  He argued that shareholders of companies like that may be better served if the company were to be effectively dissolved.  "There are plenty of investors who will buy the assets of companies like that and sell them for spare parts elsewhere in the world," he added.

This conversation reminded us of our last "Holy Grail" search (Jan 2004), when we also talked about the choices the industrial dinosaurs were facing (see "Change of Perish" chart).  Everybody has always assumed that companies like that must change; try to reinvent themselves if they are to survive.  And here's now a respected academic voice saying basically that sometimes corporate euthanasia is better than slow and painful death (or a quick and painful end, such as in the case of Enron, WorldCom, Arthur Andersen etc.).

Why not?  At least that way shareholders would get to keep some of the money.  Is there a second career opportunity here for Dr. Kevorkian in corporate America?  :-)

Summary & Outlook

Healthy skepticism notwithstanding, we expect the globalization trend to continue in the foreseeable future.  Its momentum is such that it will take some tectonic "mega event" to derail it.  Global cross-border M&As, for example, the biggest financial gauge of globalization, surged $581 billion in the first half of 2007, a 54% increase over the corresponding period of 2006, according to the latest UNCTAD data.

As a result, the upward trend in foreign investments is expected to continue in 2007 and beyond – albeit at a somewhat slower rate than in 2006, UNCTAD predicted. This would be in line with global economic growth, which should remain above its longer term trend, although it might slow down moderately in the short term, especially in the U.S. market.

Such optimism is shared by UNCTAD’s World Investment Prospects Survey in which more than 63% of the responding multinational executives expressed optimism that capital inflows would increase over the period 2007-2009.  The most attractive destinations will continue to be countries like China and India, making the East and Southwest Asia the world's the most attractive region, according to the survey.

Of course, there is always a risk of being surrounded by lemmings.  Safety in numbers?  Not for this writer.  But feel free to feel that way.  Many do.  The world's an oyster.

In her closing remarks at the Oct 24 New York conference, Ginni Rometty, a very personable IBM executive who heads up the GBS unit, also talked about importance of the BRIC countries.  But she did it in the context of some of the largest non-financial risks she saw in the future. 

"The world's middle class will number 1.2 billion people by 2030," she said.  And one quarter of the university graduates will come from Brazil, India, China and Russia. So she saw a looming shortage of management skills as one of the global challenges we face.

And to help illuminate and solve that problem, Rometty saw the role of the CFO of the future also changing - "from providing taillights to headlights."  She was quoting IBM's CFO, Mark Loughridge, who said that in the Preface to the "CFO Agenda" whitepaper.

Let's just hope IBM doesn't catch a deer in its CFO headlights.  And that the confused creature is not the customer.

Happy bargain hunting!

Bob Djurdjevic

*NOTE: Galloping influenza of 1918 wiped out about 40 million people worldwide, afflicting one in four Americans in the process.

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