Innocents Abroad

Tex

an Erle Nye seemed like a sharpshooter when his firm, Texas Utilities, won a bidding war for assets of the British power company the Energy Group in 1998. A respected veteran energy executive, CEO Nye anted up $7.6 billion to win the deal. Soon after, a cartoon in the British press depicted a Texas Utilities meter reader ringing a doorbell — dressed as a cowboy.

Nye would have done better to stay home on the range. He announced last month that Dallas-based TXU (as the company was renamed) would sell the U.K. business to German energy giant E.On for just $2.1 billion and book a write-off that might hit $4.2 billion. In a soft drawl he explains, "We were on the ropes."

Nye has plenty of company. Using cheap debt and inflated equity as currency, scores of firms expanded internationally during the go-go 1990s — not just through exporting, but by making direct foreign investments — and lost big. From tech (Gateway Computer) to financial services (Merrill Lynch) to media (Vivendi Universal) to energy (TXU and others), many firms are scrambling to restore their balance sheets after disastrous foreign campaigns. Partly as a consequence, U.S. foreign direct investment was down 55% in the first half of this year compared with the same period in 1999, when it peaked at $175 billion for the year.

At the same time, other firms, far fewer in number, have succeeded grandly on foreign soil. Now, with a little distance, it's possible to evaluate some of what separated the winners from the losers and formulate a few 21st century lessons.

James Root, a global strategist with Bain Consulting in New York City, surveyed the 1996-2000 financial results of 7,500 publicly traded companies and shared his findings exclusively with TIME. Root analyzed firms from Australia, France, Germany, Italy, Japan, the U.K. and the U.S. that had revenue of more than $500 million. First, he weeded out those that didn't grow total revenue and profit at least 8% annually (slightly above an average combined rate of inflation and economic growth). Then he eliminated firms that didn't report the same 8% growth in foreign revenue and operating profit (which includes exports sold through foreign entities). Conclusion: only about 1 company in 6 grew its foreign sales and operating profits at least as rapidly as its domestic ones. "For many companies," says Root, "expanding abroad was not very profitable."

Root's message is not that foreign investment isn't worth trying. His survey focused on reported foreign operating profits, a figure that doesn't account for the potential cost saving and intangible benefits (like R.-and-D. expertise) that multinationals can derive from global sourcing and manufacturing. In fact, companies that increase foreign sales and profit at a sustained and healthy clip (at least 8% annually) yielded superior shareholder rewards. From 1995 to 2000, their stocks delivered compound annual growth of 36%, vs. 21% for the Standard & Poor's 500 index.

Among the firms Root surveyed, the usual U.S. suspects — such as Dell Computer, GE, Pfizer, Microsoft and Wal-Mart — beat the index and passed all his tests. But so did some less predictable, smaller multinationals such as footwear and apparel maker Timberland and home builder KB Home. Says Root: "Profitable foreign growers come from all walks of life."

So what do the winners have in common? For starters, a strong business at home. Timberland's U.S. sales grew about 30% annually for seven years before the company ramped up its foreign business around 1997, adding stores and improving its overseas product mix. Since then, through subsidiaries and retail outlets in 16 European countries and Japan, its foreign operating profits have grown an average of 40% a year. "A strong domestic business gave us the critical mass to support stronger international growth," says Carden Welsh, a Timberland senior vice president.

In overseas markets, Timberland hired local executives who knew their customers well, and the company tailored products to local tastes. To make this feasible, Timberland uses a homegrown design-and-manufacturing system that lets it make, say, just 1,500 pairs of slim-cut pants for Scandinavia or a run of boots with extra metal hardware for Germans. Explains CEO Jeff Swartz: "Your customers don't care if you have a centralized warehouse. They care about how you face them with a locally relevant brand."

Many U.S. companies, Root found, underestimated how tough it can be to compete against entrenched overseas rivals if you lack a unique product or service. Merrill Lynch might have benefited from a more rigorous "asset test"--analyzing economic and competitive conditions to see how an investment might yield the greatest profit — before spending about $300 million in 1998 to buy the accounts of the failed Japanese brokerage Yamaichi Securities. Merrill wanted to be ready for Japan's "Big Bang" financial reforms, which were supposed to entice Japanese households to remove their retirement money from safe savings accounts and start buying mutual funds and stocks — in other words, the U.S. retail-business model.