Theories behind overseas ventures

The logic behind Indian FMCG companies acquiring foreign companies is based on many economic theories. The following article touches upon a few important ones.

Globalisation

One of the fundamental concepts behind firms expanding their market outside of their domicile country is to take advantage of the encouraging demand and supply conditions abroad.

These favourable supply-demand market situations could be with respect to goods, services, knowledge, resources, goodwill or information, or a combination of them.

Knowledge sharing is perhaps the key characteristic of globalisation. For instance, by acquiring Hobi in Turkey, Dabur has taken advantage of the Turkish company's knowledge on the domestic market.

To explain, Dabur has eliminated the cost of acquiring information on legal aspects, resource availability, and domestic demand and supply conditions associated with starting the production of hair care products in Turkey.

So, instead of venturing out to set up a plant from scratch and begin production, Dabur has bought a company which already has a “sheltered” market. In the process, the Indian company has eliminated the cost of time and resources involved in generating a stable revenue stream.

Sometimes, it is more profitable to sell products directly in foreign markets than acquire local companies with existing customer base. Two of the important reasons for this is the cost of acquisition, and uncertainty in returns. An example in this regard is Marico, which sells variants of its “Parachute” brand directly in West Asia, Bangladesh and Nepal. Similarly, another important aspect of globalisation is the ease with which technological know-how can be transferred across companies in different geographies. Godrej's acquisition of Rapidol in South Africa is a fitting example.

If Godrej discovered that Rapidol was following a cost-effective process, it would then be able to apply the same methods in its domestic factories.

Risk Diversification

Basic consumer economics theory suggests that risk-aversion is an innate utility-based human behaviour. And reasons behind cross-country acquisitions of firms are not very different in that regard. Termed “defensive strategy” in managerial economics, similar sized companies merge in anticipation of changes in demand patterns, import composition and other production-related factors.

Demand distortions are likely to occur in the FMCG segment, mainly because of the nature of the goods. For instance, if the competitor of, say, Vatika hair oil, is able to decrease its cost of production and pass it on entirely to its customers, then users of Vatika are very likely to switch to the competing product. Also, product differentiation is not pronounced in such types of goods. To explain, olive-based body soap cannot be very different across brands, which makes substitutability that much easier compared to other goods.

Indian economIC CONDITION

The Indian economy is fraught with profound issues in recent times such as depreciating currency, stubborn inflation, and decelerating economic growth. These are some factors that affect both the demand and import patterns, which in turn influence mergers and acquisitions.

ramaprasad.r@thehindu.co.in

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