It is no secret that manufacturing has slowed in almost every market. February 2016 saw JPMorgan's Global Manufacturing Purchasing Managers' Index (PMI) fall to 50.0 – resting on the line that separates growth from contraction. As Reuters noted, the trend is “pushing factories to trim workforce, and dealing a blow to policymakers who are struggling to stimulate their economies.”
The slow-growth trajectory and overall global volatility have some companies seeking a new home for their facilities, especially as China loses its appeal. Every market, however, has its roadblocks, and difficult conditions may give some companies pause when it comes to establishing a new base. But the reality is that every marketplace at every point comes with scenarios of risk and reward. The trick is mitigating the former in order to forge a path to the latter.
Limiting risk requires a deep understanding of the nuances of the market, from culture to taxation to labor. Consider Ford’s famously disappointing European venture in the 1990s, when it bought into the region with the intent of applying broader scale manufacturing to boutique brands.
The automotive mammoth struggled with the luxury brands and in 2007 and 2008 sold them all off,” wrote HSBC. “In this case, it turned out the mainstream-oriented, large-scale style of Ford was a poor fit for the niche brands.”
Forethought, planning, and an understanding of the local environment can help improve the odds substantially. Whether opening a major production facility or a new, smaller distribution channel, manufacturers should consider three crucial elements as they look for international opportunities:
1. Labor Laws
Employing a U.S. citizen in another country carries a wide range of implications, and there are different guidelines in every market. In Turkey, for example, businesses must employ five local residents for every foreign worker. In Europe, different requirements are triggered by crossing certain employee count thresholds, and severance packages (redundancy costs) for local employees vary depending on their age and length of employment. When owners hire someone new, they should understand what it might cost to fire them.
In both Europe and Asia, the enforceability of non-compete agreements are also different: they apply in the UK, but rarely hold up in other markets. That means skilled labor comes with inherent risk; owners must be cautious about who has access to intellectual property (IP).
2. Corporate Structure and Tax Law
The most commonly applied options for structuring an overseas presence are a foreign subsidiary and a “branch.” Foreign subsidiaries are often the default, as branches are not an option in the U.S. but are frequently used in Europe and Asia. In essence, branches enable companies to treat overseas operations as a separate entity, even though they are technically tied to a home office.
Whichever structure houses the company, understanding local tax law is tremendously important. Just as in the U.S., owners must know how money flows into the foreign office and how much is required for taxes. This will inform them as to the best balance of offshore and onshore funding. In short, revenue generated in a specific market should likely stay in that market to support local operations, manufacturing, and distribution. On the other hand, if money is generated in one market but used for operations in another, more complicated international tax consequences will come into play.
3. IP Protection
Overall, controlling IP internationally is no small feat. While protection is strong in Europe, it is virtually nonexistent in much of Asia. China is an exciting place to manufacture product – but only if companies are willing to accept a certain amount of duplication and “grey goods.” Indeed, it is common practice for a facility producing high-end merchandise to simultaneously manufacture “knock-offs.”
Beyond the risk of IP loss, corruption is another pitfall. Petty graft and large graft (bribery) are illegal in both the U.S. and overseas, but are routinely encountered in other cultures. Business owners should hire legal counsel well versed in The Foreign Corrupt Practices Act of 1977 and local laws for legal compliance requirements.
The manufacturing sector is experiencing rapid change on a global level. Whether due to the steel glut out of China or the slow pace of orders from developed nations, challenges abound. When manufacturers move to a new region, they should be certain to eliminate the basic risks in order to focus on the strategic walls through which they must break.
Working with trustworthy, local law and accounting firms will yield key insights into navigating the cultural nuances of the region, while a U.S. firm bridges the gap between home and foreign markets. Mapping out the legal, business, and cultural landscape before extending into new locales will help business owners reduce risk and increase the odds of a rewarding, successful expansion.
Frederic Marx is a partner and former chair of the Business Law Group at at Hemenway & Barnes LLP.
