John Jullens, Per-Ola Karlsson, Rawia Abdel Samad
September 21, 2016
Following a period of growth, globally and locally, Gulf Cooperation Council (GCC)1 companies must now focus on capabilities if they want to maintain their growth and improve their positioning. Failure to adopt this new focus will put them at risk of falling into growth traps.
In their eagerness to grow, many companies in emerging markets focus primarily on top-line growth or country-specific comparative advantages, and neglect to build the foundations for future success. Typically, they initially benefit from being first movers in their home markets, but eventually they have to play catch-up with more experienced multinationals in global industries.
Multinationals are formidable competitors: They possess established brand names, advanced technologies, and access to efficient financial and labor markets. More importantly, these multinationals have a set of entrenched capabilities that they have developed over time. In this regard, their emerging market competitors are often decades behind. GCC companies, particularly those that are linked to their government, also have to deal with region-specific issues (such as poor corporate governance practices) that could weaken their competitiveness.
To circumvent these growth traps, GCC companies need to develop powerful capabilities through internal development, mergers and acquisitions, or partnerships. Each of these methods has advantages, drawbacks, and potential trade-offs. Companies from the GCC that have succeeded in this endeavor have followed a deliberate and stepwise plan for moving from basic capabilities to more sophisticated ones that can support world-class innovation, technology, and design.
With more than two-thirds of the top companies in the GCC linked to the state, governments also have a role to play in helping them become globally competitive. Government leaders should take measures to upgrade corporate governance practices within these companies and help them fulfill their potential. In turn, these companies would reap economic benefits from improved performance.2
GCC companies can catch up with more established competitors quickly and develop multiple capabilities simultaneously through M&A deals. Acquisitions based on capabilities fit and strengths can be divided into the following categories:
Capabilities-driven acquisitions include leverage and enhancement deals. These deals have a better chance of increasing total shareholder return (TSR). An assessment of the 75 biggest M&A deals in the GCC between 2009 and 2014 shows that capabilities-driven deals outperformed limited-fit deals by 23.3 percent in annualized two-year TSR and achieved returns that were 13.9 percent higher than the local market index. By contrast, limited-fit deals usually result in negative returns (9.4 percent lower than local market indexes).
Furthermore, intra-GCC deals performed better than deals in which GCC companies targeted companies outside the region (7.2 percent higher than local market return for intra-GCC deals compared to 2 percent for outside-GCC deals). Intra-GCC acquisitions typically involve complementary businesses in near geographies. This leads to strong synergies that are relatively easy to capture. Most of these deals are done on a friendly basis, which prevents unnecessarily high acquisition prices.
By contrast, limited-fit deals usually result in negative returns (compared with local market indexes), and this is the case across geographies and industries. There is also a fine line between a bad enhancement deal and a limited-fit deal. If an acquirer has miscalculated, some deals conceived of as adding important new capabilities to the acquirers’ existing systems turn out to be nothing but limited-fit deals.
Companies with a capabilities-driven approach to deal making don’t stick to one type of deal all the time. They may switch between leverage deals and enhancement deals, depending on how much growth they think they can achieve in their existing markets and with their current capabilities systems.
For GCC companies to avoid growth traps and become world-class, it is imperative that they build the necessary organizational capabilities and resources to compete head-to-head with world-class companies. They can either spend the time and effort required to do so in-house, or they may be able to pursue acquisition and partnership opportunities to accumulate new capabilities and resources more rapidly. However, their M&A strategy itself needs to be capabilities driven if they are to absorb their acquired capabilities seamlessly and leverage them effectively. They need to recognize that an organization’s capacity to absorb other firms through M&A is an important organizational capability in itself.
Emerging world-class companies from the GCC — both state-owned and private — are capable of accelerating their countries’ economic diversification and transformation efforts through job creation and investments in local communities. This can make them an important key to economic development in the region.
1 The GCC consists of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
2 John Jullens, “How Emerging Markets Can Finally Arrive,” strategy+business, May 2015; John Jullens, “How Emerging Markets Companies Can Avoid Growth Traps,” strategy+business, December 2015.