Compared to most oil-rich countries in the Middle East, Iran has a diversified economy, such that its tourism sector is on the verge of a major windfall. Senior executives should not lose perspective on the enormous opportunities in Iran, but they must be prepared to navigate some serious challenges, reads an article titled “What to Know About Doing Business in Iran” recently published Harvard Business Review–a Massachusetts-based general management magazine published by Harvard Business Publishing, a subsidiary of Harvard University. What follows is part of the article.
Challenges
Many US sanctions, which were initially enacted in 1979 and strengthened in subsequent years, banning financial, trade and business transactions remain in place, which means that most US companies cannot do business there. For non-US-based companies, many relevant US sanctions have been suspended, and most national– and EU-level restrictions were eliminated after the nuclear deal in January. Within weeks, there was $50 billion in business deals involving foreign companies, including the Airbus agreement (worth $25 billion) to sell 118 planes, and Italy’s state rail company’s $5 billion pact to develop the local rail network. However, remaining US sanctions are delaying these projects being financed. Large European banks in particular are not ready to return to Iran even though they are permitted. Financial institutions remain anxious because of the $15 billion in fines banks have paid for sanctions violations over the last five years and the difficulty of avoiding the US financial system for bank transactions related to Iran.
Iran’s economic woes go beyond sanctions. The country remains reliant on oil revenue, though sanctions have hastened economic diversification: 37.5% of government revenue were derived from energy in the first half of FY 16. This is far lower than the high oil dependency of rival exporters such as Iraq, Saudi Arabia and Kuwait.
However, oil prices have dropped more than 60% since the interim nuclear deal in November 2013. Thus, Iran is collecting less oil revenue than anticipated two and a half years ago, limiting public spending. The situation is encouraging the government to raise revenue through other means, including new taxes and subsidy reform—good news for sustainable economic growth, but bad news for economic recovery in 2016.
Opportunities
Even with these challenges, there are foreign companies seizing the opportunity ahead of their competitors. While the oil and gas sector gets the most attention, Iran’s diversified economy is attracting companies across industries. In particular, consumer-oriented sectors are counting on Iran’s large (nearly 80 million), young (more than 60% under 30 years old) and urbanized (more than 70%) population to be loyal customers in the future. For example, South Korea–based LG Electronics, which maintained an Iran presence despite sanctions, is in discussions to establish a manufacturing plant in Tehran that will produce more than 1.5 million refrigerators, televisions and washing machines per year. French automaker Renault has taken advantage of sanctions relief, assembling nearly 15,000 cars between January and April, which indicates a sevenfold increase from the same period in 2015. And Danish pharmaceutical company Novo Nordisk is building on its Iran presence by doubling local staff to nearly 300 and investing $76 million in a new factory. The country’s tourism sector attracted fewer than five million visitors in 2014 while neighboring Turkey attracted 39 million. Given Iran’s top 10 ranking in the number of UNESCO world heritage cultural sites in the world, this is poised to change. Luxury hotel brand Melia is joining Accor and Rotana to open the country’s first international five-star hotel, the Gran Melia Ghoo.
Looking further into the future, Iran is a potential global trade hub. Already nearly 20% of oil trade pass through the Strait of Hormuz, the narrow waterway off Iran’s southern coast, which is the only sea route out of the Persian Gulf and one of the world’s most strategic transit points. Furthermore, the International North-South Transport Corridor will make Iran a key link in connecting India, Central Asia, and Russia, while Iran’s role as part of China’s new Silk Road (especially with rail links) could boost bilateral trade between those countries to up to $600 billion.
There are lucrative export and investment opportunities elsewhere in the region, such as in Afghanistan, which is seeking to tap mineral wealth, and in emerging giants such as India, Pakistan and Turkey, which need natural gas to fuel economic development.
How to Plan
Based on frequent conversations with Iran-focused multinational companies, there are five notable challenges that deserve immediate attention in order to reap the benefits of the Iranian market:
1. Updating global compliance policies. A comprehensive compliance strategy is the essential bedrock for building and implementing a successful Iran plan. Companies need to confirm that their policies are compliant by consulting with an external sanctions lawyer.
2. Overcoming a lack of market data. Companies looking to enter the market should identify and track leading macroeconomic indicators of specific customer segments. Focusing on data such as population growth, inflation and GDP growth is a way to anticipate market developments.
3. Finding the right local partners. While it is possible to set up a direct presence, using local distributors at first is strongly advised.
4. Reclaiming brand equity. Customers may have distorted views of foreign goods that are in Iran illegally. Senior executives should be ready to trace the origins of and combat grey market trade and counterfeits of their products in Iran. Otherwise, companies risk facing challenges related to pricing, value and positioning against competitors.
5. Accessing foreign exchange. Often, local companies spend weeks waiting for access to foreign currency to import goods from their foreign partners. Without access to the US financial system, this pressure will not ease in the near term. Moreover, this problem is likely to persist because Iran is unifying dual currency exchange rates while also seeking to protect local producers from volatility. Iran presents an important opportunity for multinational companies that operate in emerging markets. But managing expectations about the country’s trajectory is crucial for building an effective strategy. A smart approach will find the sweet spot: advancing ahead of competitors while sidestepping first-mover mistakes that often plague companies in unfamiliar, rapidly changing, high-stakes business environments.