Tycoon Taking His Business Out of Israel? Not So Fast

Israeli businessmen don't have the scale, financial clout, managerial depth or connections to succeed overseas. And it's not just an Israeli problem.

Bloomberg

Whenever anybody talks about tightening the regulatory or tax regime against Israeli tycoons, the tycoons will tell him: “You just can’t do business in Israel.” Then come the threats to move their companies overseas.

They accompany these threats with descriptions of the wonderful conditions for businesspeople abroad, detailing the great harm their departure will cause Israel’s labor market and living standards. They’ll complain about “populism” and a hostile attitude toward the private sector, and of the media’s support for these attitudes. Those regulators and politicians simply get roped in, they'll say.

The tycoons will also unfurl the Israeli flag. They’ll talk about how they’re hounded here, but they want to stay here out of love for their country. And of course, if regulators proceed with their planned changes, these businesspeople will have no choice but to take their money away — not to mention the jobs it creates.

Ostensibly these are cogent arguments. There are global companies that go shopping abroad, looking for countries that will offer the greatest benefits. Intel is one such company; every once in a while Israel has to supply it with enough goodies so that it sets up operations here rather than in Ireland.

But for the vast majority of Israeli businessmen this argument is a specious one. The reason is simple: A company that grows and specializes in a local market — unless it holds patents or a clearly superior technology — will find it very hard to succeed away from home. There is now research to support this argument, which even applies to U.S. giants with billions of dollars in turnover.

Researchers Christian Stadler, Michael Mayer and Julia Hautz examined no less than 20,000 companies in 30 countries, observing what happened when these firms branched out abroad. The results were published in the Harvard Business Review.

The researchers found that on average, these companies had a negative 1% return on assets for as long as five years after launching their expansion. That’s a failure. Only after 10 years in the new location could companies show a modest 1% return on assets, and only 40% of these companies achieved a 3% return.

The researchers cite examples of companies that obtained disappointing returns overseas and gave up. There were many reasons for failing, most of them related to cultural and regulatory differences between countries, and the management time required to address these differences.

High-tech an exception

In the end, the authors warn that few companies have the size and managerial prowess to succeed overseas, and that most should focus on their local markets.

When they examined the performance of companies that opted to remain at home, returns were positive — 1% after five years and 2.4% after 10. No fewer than 53% of these companies obtained a return on assets of 3% or more.

All these numbers prove one thing: Even if no one is giving you a bad time, even if your home-grown regulator isn’t breathing down your neck and the media isn’t whipping up a “populist” frenzy, the chances a midsized firm will succeed overseas are very low.

The Israeli experience bears this out. Except for high-tech, in which the emphasis is on the international market to begin with, there are few international success stories. For years, Israeli banks tried to expand abroad, but their subsidiaries’ return on capital remains very low.

The reasons for Israeli bank branches and subsidiaries overseas are few; one is to provide services for local Jews (some of these services are designed to reduce tax payments in those countries). Another is managers’ desire to fly abroad for board meetings.

Only very few companies have succeeded, like Teva Pharmaceutical Industries and Iscar Metalworking, the company taken over by legendary U.S. investor Warren Buffett. And of course there are also some high-tech outfits.

But in industry, services and commerce, Israeli businessmen don’t have the scale, financial clout or managerial depth to succeed overseas. Even large American companies struggle with such efforts.

The capital-government nexus

Actually, you don’t need quantitative research to realize that the threat to take one’s business overseas is nothing but an idle threat. In many cases, a simple analysis shows that the tycoon or manager’s business is built on an advantage that’s local only.

In most cases, these are semi-monopolists that can extract high prices, a luxury they won’t enjoy overseas. In other cases there are companies that benefit from regulatory protection or natural resources that have been granted as concessions.

The most important factor is that in almost all cases local tycoons have good ties to the government that let them maintain their edge. The good working relations, lobbying and influence on the local media pay off.

Indeed, ties between capital and government constitute the edge that lets many companies maintain high profitability in markets with little competition. But this cozy system is absent overseas, so they have little chance to succeed there.

As any honest person who has tried to do business abroad will tell you, this is precisely the reason it’s hard to succeed overseas. When you get there you have to contend with local companies or foreign ones that have been there a long time. Those companies benefit from the kind of relations with the government, regulators and clients that Israeli tycoons enjoy in Israel.

Ties between capital and government exist everywhere, whether to a greater or lesser extent. In Israel, if you’re a large contractor, you know the officials at the Israel Land Authority, and in the municipality and national governments. They’re the ones giving you the building permits you need.

But you don’t see many foreign developers in the corridors of the Israel Land Authority. In contrast, attempts by Israeli developers to make a real-estate killing in India and Eastern Europe have often ended badly.

Another example is Israeli insurance companies that benefit from a monthly influx of pension funds but would have little to look for abroad. This applies to most other fields.

It’s true that there are some success stories, especially regarding transactions that are more financial rather than strategic, and the developer recruits cheap money from Israeli institutions.

For example, Israeli real estate developers have acquired assets abroad and succeeded. And again there is high-tech, an industry much less dependent on regulators that needs fewer capital-government connections.

So listen close if you ever hear a tycoon complaining about tax and regulations and saying that the capital-government nexus is a myth. He might say he’s thinking about leaving.

You can tell him that these are the connections that made you rich. Until you develop similar relationships with governments abroad, don’t threaten us with leaving.