STRATEGIES TO MANAGE POLITICAL RISK

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Q5.) Discuss the various strategies to manage political risk.

Ans: Political Risk is generally defined as the risk to a firms' business interests arising from political instability or political change in a country in which the firm is doing business. Political risk includes risk derived from potentially adverse actions of Governments of the foreign countries in which one is doing business or whose laws and regulations one is subject to.

Having analyzed the political environment of a country and having assessed the risk to its operations, a firm should decide (a) whether to invest in that country, (b) if so, how to device coping strategies to minimize the risk. A few generalizations are possible here. as every firm, consistent with its field of activity, faces unique risk. 

1.) Pre-investment Planning: An MNC can follow each or all of the following policies-

a.) Avoidance.

b.) Insurance.

c.) Negotiating the environment.

d.) Structuring the investment.

a.) Avoidance: The simplest way to manage political risks is to avoid investing in a country ranked high on such risks. Where the investment has already been made, plants may be wound up or transferred to some other country which is considered to be relatively safe.

Many firms tackle political risk by avoiding investing in that country. The issue is what amount of risk, the company finds acceptable and is prepared to bear. If the firms avoid investing in a high-risk country, it also foregoes the high returns possibly available on their investment. Thus most multinationals use avoidance strategy only I-rarely and try to recognize and assess the risk, e.g..investing in dictatorial China, or economically volatile South Asian countries are risky. However, if the risk does not materialize, the returns are considerable.

b.) Insurance: Companies buy insurance against the potential effects of political risk. Some policies protect companies when host governments restrict the convertibility of their currency into parent country currency. Others insure against losses created by violent events, including war and terrorism.

Mostly high-risk multinationals will seek insurance. Hence adverse incentives are built-in by adjusting premiums in accordance with the perceived risks. Screening out certain high-risk applicants and by providing a reduced premium to the companies engaged in activities that are likely to reduce risk.

c.) Negotiating the Environment: There are two fundamental problems with relying on insurance as protection from political risk. First, there is an asymmetry involved. If an investment proves unprofitable, it is unlikely to be expropriated. Since business risk is not covered, any losses must be borne by the firm itself. On the other hand,  if the investment proves successful and is expropriated, the firm is compensated only for the value of its assets. Thus, although insurance can provide partial protection from political risk, it is not a comprehensive solution.

At times firms try to reach an understanding with the host government before undertaking an investment. This is called a "concession agreement" in which the rights and responsibilities of both parties are defined. These concession agreements are negotiated by multinational firms with developing countries. However, as the experience in developing countries shows, such concession agreements are difficult to implement, particularly in countries like Iraq, Iran, etc.

d.) Structuring the Investment: Multinational firms try to increase the cost of interference by the host country to minimize its exposure to political risk. This can be done by keeping the local affiliate dependent on sister companies for markets and supplies.

Another strategy is to establish a single global trademark that cannot be legally duplicated by a government. Control of transportation is used by some companies to prevent any adverse action on their projects by the lost government.

2.) Operating Policies: The operating policies relates to:

a.) Planned dis-investment.

b.) Short-term profit maximization.

c.) Changing the benefit/cost ratio of expropriation.

d.) Developing total stakeholders.

e.) Adaptation. 

Some authors have suggested that a multinational firm may phase out its ownership of foreign investment over a fixed time period by selling all or a majority of its equity interest to local investors. This may be difficult in practice. If the prices for buying out the MNC interest are settled in advance and if the project is less than successful, the host government or the strategic partner in the host government may be unwilling to buy. 

The multinational enterprise may try to recover the maximum amount of cash from the local operation. This can be done by deferring maintenance expenditures, producing lower quality merchandise, setting higher prices, and eliminating training programs, This way, while cash will be generated during the short run, the long-term effects of such policies will harm the project. Without considering the ethical aspects, one would have to consider such a short-sighted hit-and-run strategy only when faced with the danger of losing everything.

The better strategy for the foreign project would be to cultivate local individuals and groups in such a way, that any adverse action against the project would affect the influential local investors as well. If the consumers get dissatisfied with the quality of the product of the local entrepreneur who displaced the foreign owner, their protests will influence the government policies. During Janta Raj, the coca-cola withdrew from India, but customers not quite satisfied by the substitute product welcomed the company back when it finally came.