Capabilities do matter

One of the biggest questions in international business research is the relationship between multinationality and performance. It is still pretty unclear whether expanding internationally improves a firm’s profitability (or returns to shareholders), and whether the extent of expansion makes a difference. Recent stories on some of the world’s three largest fashion retailers paints an challenging picture.

First up, The Wall-Street Journal tells us that Spanish giant Zara (or rather their parent Inditex) is significantly outpacing US rival Gap with 10% sales growth over the past year versus Gap’s 23% decline.

These numbers are pretty convincing. One noticeable difference between the two firms is their level of internationalisation. Zara operates in 73 countries. Gap is in 6. Could that be the explanation for the divergence in performance?

Well, the news on Swedish competitor H&M muddies the water considerably. They have also announced a 12% profit drop (although sales did grow). These guys operate in 29 countries. We are this left in a bit of a conundrum. Is it the number of countries driving the story?

It would seem there is a clearer story in the area of margins. Inditex’s gross margin is 56.8% versus Gap’s 37.5%. H&M is also at 56.8% (but it is dropping, while Zara stays stable). These figures tell us that it is firm capabilities that are probably making all the difference.

Inditex and H&M run very tight ships, with super lean supply chains. This allows them considerable leeway in terms of lower pricing. Gap is less efficient, and also more exposed to the damaged and increasingly thrifty US consumer market. It cannot absorb lower prices at the consumer end quite as well. Put simply, it also just doesn’t deliver as exciting or new a product as its two European rivals.

Turning quickly to H&M it is notable that they are bearing the brunt of rising costs from Asia more than Inditex. Inditex owns a great deal more of its production facilities and thus is less prone to suppliers leaning on them in tough times (and/or passing on costs). This also means Inditex must continue growing so as to make production investments worth it.

What’s the upshot of all this? Trying to find a general multinationality-performance relationship seems rather futile once we note the huge variations in other equally substantial strategy choices and the execution thereof.

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As simple as ABC?

Running a business with booming demand (much of it funded through the public purse), and a big lead in market share and accessibility to consumers should be a license to print money.

That was certainly the logic behind the strong growth of stock market darling ABC Learning over the past few years down here in Australia. This firm modernised, aggregated and expanded a previously mum-and-dad (excuse the pun) business – childcare. They eventually ran more than 1200 childcare centres in Australia (upwards of 20% of the market), and another 800 or so in New Zealand, the US and the UK. Alas, it is has all gone very badly in the past 6 months or so for the firm and its founder. As of yesterday (November 6, 2008), they have gone into receivership (comparable to US-style Chapter 11).

So what went right and wrong?

In terms of the external environment in which this firm (let’s use Porter’s Five Forces) operated it looked like a great scenario:

– desperate buyers in the form of working parents often starved of local alternatives and increasingly subsidised by a complicit government

– low-paid employees with limited bargaining power

– a substantial first-mover advantage from securing properties in prime locations (creating a barrier to entry at the local level) and developing arrangements to supply services to corporate clients

– few relevant substitutes (stay-at-home parenting, nannies or grandparents)

– limited industry rivalry due to considerable market share advantage and the localised nature of competition.

So what wrong?

Here we see the issue of inadequate internal resources and capabilities. The systems and routines don’t appear to have been in place to adequately assess the merits of new properties and business lines (the firm had diversified into early primary education and also toys). General mangerial nous seems to have been scarce (it is a much bigger task running 1200 centres and 16000 employees than the 40 centres when the firm first went public). The financial management now looks incompetent (if not downright fraudulent). The international expansion was bold, but here also it may be that the firm underestimated the complexity of engaging in very different institutional environments, and mismanaged the huge financial risks of high borrowing in multiple currencies.

All in all, it turns out babysitting ain’t as easy it looks.