The Vietnamese Business Environment

Published Date: 02 Nov 2017

1. Introduction to Vietnam

This paper provides a thorough analysis of the business environment of Vietnam anno 2013. We focus on a number of elements that have been identified as key to unravel the complex business environment of one of the most promising growing countries on the Indochinese Peninsula. In their report: ‘The world in 2050", PricewaterhouseCoopers states that Vietnam has to potential to become the single fastest growing emerging economy by 2025 with growth rates up to 10%. (PWC, 2008: 3)

The structure of the paper is as follows: Firstly, a brief description of Vietnam’s country profile is provided with a specific emphasis on the PESTEL analysis. Secondly, the fact and figures of the Vietnamese economy will be scrutinized in order to understand the most important economic drivers of the country. Here we look at elements such as GDP, currency, balance of trade, etc. Thirdly, an in depth description is provided of the Foreign Direct Investment climate which will become more and more vital in an internationalizing business environment. Hereafter, an assessment of Vietnam’s competitiveness and the supply chain is made. Lastly, we look at the challenges that Vietnam has and we propose a set of recommendations.

1.1. Country Profile

Vietnam can be situated in the east of the Indochinese Peninsula, where it has the following borders: China is to the North; Laos is to the Northwest, Cambodia to the Southwest and the East-Sea to the East. Vietnam is the 13th most-populous country in the world with approx. 87,84 million people. The Viet (Kinh) ethnic group constitutes nearly 85% of the total population and the official national language of Vietnam is Vietnamese. However, Vietnam’s numerous minority groups speak various other languages.

The added value for this analysis of going back too far in time is limited, so we highlight a small number of important historical turning points, to be divided into a pre- Vietnam War era and a Post-Vietnam War era.

When Vietnam experienced the liberation from the French colonization, this almost immediately divided the country in two, with a communist government in the North and a republic government, which was supported by the U.S. in the midst of the Cold War, in the South.

The North won this Vietnam war and the country experienced a high level of economic deprivation and even almost went bankrupt as the result of diplomatic measures that were mainly driven by the U.S.

After these harsh days of seclusion, the government introduced a plan to achieve ‘Doi Moi’, which literally means renovation. This program appeared to be quite successful and enables Vietnam to get out of the crisis. In 2007 Vietnam became WTO member and re-established a normal relation since 1995 Vietnam with the U.S. Vietnam established a normal relation with the United States in 1995. In 2007, Vietnam became a member and decided to fully liberalize its markets and integrate in the world economy.

1.2. PESTLE Analysis

In order to provide a comprehensive, but short introduction on the different aspects of the Vietnamese reality we provide a PESTLE analysis here, which is a strategic tool that enables the understanding of a countries macro-economic reality to a high extent.

Political:

Figure 1: PESTLE - FrameworkVietnam is a socialist republic with a constitution stemming from 1992. It assigns a central role to the communist party in all organs of government politics & society. The government focuses strongly on achieving domestic stability as the key policy point. This translates to a status of not being a free country on the esteemed Freedom House index. The government compromised gradually in ensuring freedom of press but this is still limited.

Economic

In it’s Socio-Economic Development Strategy (2011-2020), Vietnam focuses on reaching a high level of industrialization and modernization in their economy by 2020. (Worldbank Vietnam Development Report 2012) This should enable Vietnam to be competitive with other strongly growing countries such as Indonesia vis-à-vis more developed markets. The interesting element of this strategy is that it is very clear in the identification of the country’s strategy to meet these targets. The elements are: achieving a stabile economic environment, establishing strong infrastructure, focus on the creation of a competitive and agile labor force and lastly a strengthening of the market-based institutions. (Worldbank Vietnam Development Report 2012) The economic reality of Vietnam will more elaborately be evaluated in one of the subsequent chapters.

Socio-Cultural

When focusing on the socio-cultural reality of Vietnam from the point of view of a business, it is key to look at education since local Human Capita land expertise can be levered in a regional, local business model.

Since the passing of the current education law in 2005, Vietnamese policy makers started focusing on the importance of continuing education which extends beyond formal education in schools in order to develop the countries Human Capital in all layers of society wherever possible. (Source: Worldbank, Education in Vietnam)

What is interesting to note is that a significant part of the curricula/programs, are not directly equivalent to an educational level. The goal here is to update people’s skill-sets and is targeted towards developing stronger Human Capital. Examples of these programs are: continuing education programs or professional training, in-service training, updating knowledge/skills, etc.). (Source: Worldbank, Education in Vietnam)

This makes that the country becomes very attractive for investors to set up operations in Vietnam since there is an availability of cheap labour that is also oriented to achieving high results through more practical education.

Technology

To launch this project, the Government will give top priority to enhancing the competence of scientists and related managers while encouraging the organization of training courses partnered with foreign competent partners. (PESTLE Vietnam report 2011)

Since Vietnam is a rapidly developing country, government has made it a key priority to establish stronger infrastructure and research in the previously described long-term government plan. This focus has strongly boosted the pace of technological innovation that starts in Vietnam itself since these developments also create linkages with achieving technological innovation, which will be key to close the scientific and technological gaps that Vietnam has in comparison to the rest of the world. (Vietnamese Government http://news.gov.vn/Home/VN-seeks-higher-rank-in-worlds science/20115/10587.vgp) From the point of view of a business that wishes to invest in Vietnam, this means that the company will get a lot of support from the government in achieving technological innovation as long as one cooperates with the government and their requirements for sharing the obtained results.

Legal

" 36 years after the end of the Vietnam War, the rule of law exists only in theory in Vietnam. The government has incorporated human rights into its 1992 Constitution. Yet it has also adopted a whole arsenal of Laws, Decrees, Ordinances and Decisions which restrict or even nullify the exercise of these rights, in total violation of the UN Covenant on Civil and Political Rights (ICCPR) to which Vietnam adhered in 1982." – Mr. Vo Van Ai - President of Que Me: Action for Democracy in Vietnam and the Vietnam Committee for Human Rights.

This quote from Mr. Vo Van Ai clearly illustrates the fact that the Vietnamese constitutional system is designed to reinforce the political power of the Socialist party, which means that there is a limited separation in the ‘Trias Politica’. What is especially vague is the distinction between public and private law since public law is seen as prevalent to private law. This makes that when there is a violation of the state of an individuals legal rights, the state can abuse its power over individuals. When thinking from the point of view of a business, this means that there is a high level of corruption, which leads to uncertainty in your business operations.

Environment

Since Vietnam has been able to achieve economic growth at a high pace it is to be expected that this had significant effects on the countries vast natural resources. A 2004 report of the Worldbank states the following:

"A high paced economic growth in Vietnam over the last decade, and its associated industrialization, urbanization, as well as increased exploitation of natural resources, has created significant pressures for the environment." For example, the diverse wildlife is in precipitous decline because of the destruction of habitats, illegal hunting and pollution. In fact, Viet Nam Rhino was officially extinct in 2011. (Worldbank: http://www.worldbank.org/vn/environment)

This quote is pretty self-explanatory and truly stresses the importance of nature/ natural resources management in developing nations like Vietnam. Momentarily the Vietnamese government has not made it a priority to tackle this issue of environmental ‘neglection’, which is quite understandable given their focus on achieving growth to boost their economies.

For companies, this means that it is also attractive to set up their operations in this environment since production facilities that have more proximity to the markets of developed nations will have a very high level of environmental regulation, which is costly. On the other hand there is a strong tendency towards Corporate Social Responsibility with multi-nationals.

Overall, this PESTLE analysis provides a limited introduction to a number of aspects of the Vietnamese society, culture and business environment. In the subsequent chapter our analysis will look at the facts and figures of the Vietnamese economy and will offer a more in depth complement to the introduction on the economic environment of Vietnam that has been described in this introduction. We will look at the following elements: GDP, Imports & Exports, the economic policy & structure, the labor force, the currency, the key markets and we will conclude with a SWOT-analysis on the economic environment.

2. Vietnamese economy - facts and figures

2.1. Gross Domestic Product

A country´s Gross Domestic Product (GDP) equals the value of all services and finished goods, which were produced within a certain time period (mostly 1 year) inside a country´s economy. It is widely used to measure the living standard as well as the productivity of a country (Investopedia, 2013). Below is a graph showing Vietnam´s GDP from the year 2000 until 2010:

Source: http://www.tradingeconomics.com/vietnam/gdp

By looking at the above graph, it can be seen, that Vietnam´s GDP increased quite a lot from US$ 31,2 billion in 2000 to US$ 45,4 billion in 2005. Then it nearly doubled in the four-year period until 2009 and went up to a level of US$ 90,273 and further increased to US$ 97,146 billion in 2010 (Trading Economics, 2013).

According to information from the World Bank for the year 2011, Vietnam´s GDP at purchaser´s prices (current US$) was 123,6 billion, and the annual GDP growth rate was 5,9% (The World Bank, 2013). Based on information from Bloomberg, Vietnam´s annual GDP growth is expected to decline in 2012 and to be in a range between 5,6-5,8% (Bloomberg, 2012). The country´s current GDP composition for the year 2012 is assumed to be as follows: Industry: 40,7%; Agriculture: 21,5%; Services: 37,7% (Central Intelligence Agency, 2013).

The GDP per capita equals the country´s GDP divided by the population of the country. It is especially useful to compare the living standards and the productivity of a country to other countries (Investopedia, 2013). The GDP per capita grew from US$ 403 in the year 2000 to US$ 481 in 2003, then it highly increased to US$ 729 in 2006 and finally, in 2008 it was the first time higher then US$ 1´000 with an exact value of US$ 1´024, it increased to US$ 1´064 in 2009 (Grant Thornton, 2011), in 2011 the per capita GDP was (current US$) 1´407 (The World Bank, 2013). An average yearly 6,1% growth of the per capita GDP is expected until 2050 (PWC, 2011).

By looking at the development of the country´s GDP (as well as per capita GDP) and comparing it to those of leading industrial nations, it can be said that Vietnam´s GDP evolution is positive for the country since its growth number is still quite high. This becomes obvious when comparing it countries as for example the U.S. (GDP growth of 1,5% in 2011) (Lambert, 2012), or Germany (GDP growth of 3% in 2011) (BBC News Business, 2012).

2.2. Major imports and exports

Vietnam´s major import products are petroleum products, machinery and equipment, steel products, cement, cotton and fertilizer. Most of its imports originate in other Asian countries as for example in China, which is the biggest exporter to Vietnam with 23,08%. Singapore is with 14.54% the number two and Japan is number three with 11,69% ( Export Readiness Center Washington State University, 2011).

The US (18%), China and Japan (both 11%) are the country´s main export partners. The main export goods are shoes, crude oil, marine products, clothes (Central Intelligence Agency, 2013), as well as coffee, tea and shoes ( Export Readiness Center Washington State University, 2011).

2.3. Balance of trade

The balance of trade of a country equals the variance of the exports and imports of a given country. A negative value (deficit) implies that a country imported more than it exported, in case of a positive value (surplus), its the other way around: the country exported more than it imported (Investopedia, 2013).

The balance of trade of Vietnam has been gradually deteriorating over the past years (Breu, Dobbs, Remes, Skilling, & Kim, 2012). This was mainly the result of the fact that the domestic demand, translated in imports, has been growing faster than the foreign demand, exports, (BloombergBusinessweek, 2012).

Hereafter is an overview of its evolution since 2005 where it showed a deficit of US$ -139 million (Exports: US$ 2´414 million; Imports: US$ 2´553 million) in the beginning of 2005 and grew further until it reached a level of US$ - 572 million (Exports: US$ 3´759; Imports: US$ 4´331) in January 2007. In January 2009 Vietnam had a surplus of US$ 390 million (Exports: US$ 3´719; Imports: 3´329) for the first time in many years. However, then it changed to a deficit again from April 2009 on and got to a level of US$ -1´300 (Exports: US$ 4´900; Imports: US$ 6´200) in January 2010. The 2011 balance of trade was a deficit of approximately US$ 9,5 billion (Vietnam Report, 2013). This huge deficit means that Vietnam´s domestic demand (imports) is much bigger than the foreign demand (exports). This is not necessarily a bad thing as long as the country´s economy is expanding (Investopedia, 2013) which is the case for Vietnam since its GDP is constantly growing.

2.4. Economic structure

Vietnam´s economy consists of three major sectors. The primary sector is agriculture, which means that the biggest part of the labour force works in this sector (approximately 60% in 2005). This also includes the people employed in fishing or forestry ( Export Readiness Center Washington State University, 2011).

50% of the country´s farmland is used to grow rice, which is the countries major commodity. The rice exports are growing steadily and amounted for around US$ 2,8 billion in the first three quarters of 2011. Coffee is also a growing business among Vietnam´s agricultural sector.

The 2011´s coffee exports amounted to approximately US$ 2,2 billion and this economic sector is still strongly growing. Fishery is another major part of the agricultural sector even though its growth is neither as fast nor as stable as the rice and coffee segments. However, fishery exports accounted for up US$ 4,3 billion in the first 3 quarters of 2011 (VIETRADE, 2012). Although the primary sector employs around 60% of the country´s workforce, its contribution to the GDP is smaller with around 21,5% for 2012 (Central Intelligence Agency, 2013).

The secondary sector, industry also deserves our attention industry ( Export Readiness Center Washington State University, 2011) since it contributes to 40,7% of the GDP (Central Intelligence Agency, 2013).

The most important export industries are textiles and garments, footwear and leather products, electronics manufacturing, wooden products as well as plastic products. The most important out of these sectors are: textiles and garments - export value of US$ 10,3 billion in the first 9 months of 2011 - as well as footwear and leather products - export value of US$ 4,6 billion in the first 9 months of 2011. (VIETRADE, 2012). Since 2008, there is stronger cooperation with Japan, which helps Vietnam to develop certain auxiliary industries. Japan´s financial help is aimed especially towards small and medium enterprises. Japan invested around US$ 180 million between 2008 and 2010 ( Export Readiness Center Washington State University, 2011). Vietnam´s key economic regions are The Northern KER, The Central KER, The Mekong KER, The Southern KER and The Central Highlands Economic Region (VIETRADE, 2012).

The country´s tertiary sectors are the offering of services ( Export Readiness Center Washington State University, 2011), which accounted for 37,7% of the GDP in 2012 (Central Intelligence Agency, 2013). Tourism and software processing services are the two most important industries in the service sector (VIETRADE, 2012). Research related services (scientific research, market research,...) as well as marketing and design are in the first stages of development and do not yet contribute significantly to the GDP ( Export Readiness Center Washington State University, 2011).

To summarize Vietnam´s economic structure, it should be noted that the country should focus more on the sectors industry and services as they contribute more to its GDP with less people employed. However, this will be a long-term process.

2.5. Economic policy

Nowadays, Vietnam has a socialist approach to its market economy. Before the transition started in the 1980´s it had a centrally planned economy (Bhattacharya & Duma, 2011) Vietnam is a member of the WTO (World Trade Organization) since January 11, 2007 and it therefore has to comply with the WTO´s guidelines on international trade especially with regards to protectionism via import taxes en quota (WTO, 2013). Furthermore, Vietnam is a member of the Association of Southeast Asian Nations, which aims to achieve economic growth, cultural development and social progress among its member states through collaboration of the countries in these areas. This is e.g. supported by the AFTA (Asian Free Trade Agreement) in which Vietnam participates. By being a member of AFTA, Vietnam had to lower its tariffs for imports from and exports to other AFTA members. This means a significant advantage for the country as it helps its economy to grow. Other member countries of AFTA are: Indonesia, Philippines, Thailand, Malaysia, Laos, Singapore, Cambodia and Myanmar. (ASEAN, 2012).

Besides striving for regional integration via Free Trade Agreements, Vietnam has several other trade agreements such as the Bilateral Trade Agreement with the United States since 2001 (U.S. Department of State, 2012) Currently, Vietnam is also in talks about a Free Trade Agreement with the European Union (European Union, 2012). Additionally, it also has 55 bilateral agreements with regards to investment. These agreements are mainly with developed nations countries such as Australia, Belgium, France, Germany, Japan, South Korea, Sweden, the U.K., but also with developing countries as for example, Armenia, Latvia, Romania or Ukraine ( Export Readiness Center Washington State University, 2011).

To conclude it can be said that Vietnam is already on a good way with tightening their economic and political relations with other Asian countries, as well as with some more industrialized countries, as this will help them to increase their exports, which in turn will help them to increase their GDP. Furthermore, the participation in ASEAN and Free Trade as well as investment Agreements will also help their domestic economy since imports will become cheaper due to lower tariffs, etc.

2.6. Current economic situation

Vietnam’s economy has been continuously growing but in the future, it might have difficulties in keeping up with its growth targets as a result of problems related to labour productivity and the national currency (inflation). These issues will be dealt with more in detail in the respective sections of this paper. The growth for 2013 is estimated to be around 5,2% which will be the country´s lowest economic growth rate since 1999 (Robinson, 2012). The rise in real wages along with a growing labour force are expected to result in an increase in private consumption which ought to boost the economy as a whole ( Export Readiness Center Washington State University, 2011).

2.7. Labour force

Vietnam´s population was approximately 91,5 million people in July 2012 (Central Intelligence Agency, 2013). The labour force amounted up to 47,7 million, of which 24,5 million were men and 23,1 million were women. Since 2005 the labour force grew twice as fast as the population, which is remarkable. ( Export Readiness Center Washington State University, 2011). The country´s labour force is young and rapidly growing and has low labour costs compared to most industrialized countries. When combining this with the level of education that was briefly described before, this leads to a strong competitive advantage for the country (Bhattacharya & Duma, 2011). By looking at the graph shown below, it becomes clear that a significant part of the population is between 15 & 29 years old.

Source: https://www.cia.gov/library/publications/the-world-factbook/geos/vm.html

By looking at Vietnam´s labour productivity in detail, it can be concluded that its labour productivity increased much slower than that of some other Asian countries regardless of the fact that it has been constantly increasing since 1986. By looking at the reasons for this growth, it becomes evident that it was mainly due to a transition away from the agricultural sector towards industry and services. However, the increase of labour productivity within the respective sectors was weak. (Trung Hai, Porter, Ketels, Nguyen, Nguyen, & Do Hong, 2010). This means that they should trigger the labour productivity and try to increase it.

2.8. Currency

Inflation equals the increase (shown as a rate / ratio) in prices of goods as well as services. Increasing inflation results in a decrease of a country´s purchasing power. A "normal" inflation rate is between 2-3% (Investopedia, 2013). Vietnam´s official currency is the Dong (VND). The Dong has been facing a high level of volatility in its inflation rate for decades. The most notable were the hyperinflation (>300%) from 1986-’88, the strong downward surge of around 10% in 1995 and the strong rise of 25% in 2008 (Bhattacharya & Duma, 2011) For 2013, it is forecasted to be at a level of approximately 6% (Winkler, Nguyen Dieu, Folkmanis, & Ha, 2012). The inflation was 7,07% for January 2013 and 7,02% in February 2013 (Vietnam Report, 2013). Keeping the inflation at a low and stable level as well as managing the currency exchange rate in a stable level to the US$ will be a major challenge for the Vietnamese Central Bank in order to stay competitive in stimulating exports and Foreign Direct Investments and keeping the balance of payment relatively stable through managed import policies. (State Bank of Vietnam).

2.9. Business environment

Vietnam ranks n°99 out of 185 countries for the 2nd year in a row in the World Bank´s ‘Ease of Doing Business’ Index. Some of the areas where Vietnam was ranked among the worst countries to do business in the world are: protecting investors: 169; resolving insolvency: 149; paying taxes: 138. On the other side, some areas were ranked medium or good: dealing with construction permits: 28; getting credit: 40; enforcing contracts: 44 (Doing Business - Measuring Business Regulations, 2013).

It is vital to note that the Vietnamese business environment has been and still is subject to a strong governmental influence and various regulatory issues. On the other hand, the government has already undertaken some important steps as e.g. the laws regarding the protection of intellectual property and the fair/equal treatment of foreign companies compared to local companies (HSBC PWC Guide to doing business in Vietnam, 2011).

As it is the case in many Asian countries, personal relationships are important in Vietnamese business life, which this means that doing business is time consuming since it requires establishing personal relations with business partners before contracts will be signed. Another key point is that the high government presence in the economy and legal litigation leads to a high level of corruption ( Export Readiness Center Washington State University, 2011).

To summarize it can be said that the Vietnamese government should try to improve investor protection as well as tackle tax payment and insolvency resolving issues in order to be more attractive for Foreign Direct Investment.

2.10. Ownership structure of the economy

The state sector is significantly large in Vietnam, even though it has decreased since the transition from a centrally planned to a socialist oriented market economy. The state sector is considered as being highly inefficient. However, the state sector is still bigger than it looks on the first hand since the number of state owned corporations dropped mainly to a consolidation and not as a result of privatization. This leads us to the conclusion that looking at the number of state owned enterprises (SOE´s) does not reflect their size and power in the market (Mishra, 2011). Making a clear differentiation between State Owned Enterprises and the government as law and policymaker is an issue, which the Vietnamese government should try to resolve in order to be more attractive to foreign investors and business partners. Below is a graph illustrating the ownership structure of Vietnam´s economy:

Source: Vietnam development report 2012: market economy for a middle-income Vietnam

2.11. SWOT Analysis

Doing a SWOT Analysis of a country means performing an analysis of the strengths, opportunities, weaknesses and threats of that country. Since an in depth SWOT analysis would clearly exceed the scope of this paper, we will only mention the most important points for each category as a summary of this chapter (Dapice, 2003).

Strengths: Young and growing and workforce (Bhattacharya & Duma, 2011); Constant growth of GDP and exports; Poverty Reduction; Positive Social Indicators; Macroeconomic Stability (Dapice, 2003);

Weaknesses: Huge influence of the government in the economy; Small increase in labour productivity; Highly volatile inflation rate (Trung Hai, Porter, Ketels, Nguyen, Nguyen, & Do Hong, 2010); Growing income inequalities between urban and rural areas; Slowing of the export growth (Dapice, 2003);

Opportunities: State as well as Domestic Private Investments in economically weaker regions of the county; Treat state and private business the same to generate a more friendly investment environment; Sustain growth of private firms; (Dapice, 2003); Growth through participation in organizations like ASEAN and in the AFTA (ASEAN, 2012);

Threats: Growing income inequalities between urban and rural areas; Slowing of the export growth; Need for further progress in IT quality and use (Dapice, 2003);

3. Transition

At the end of the eighties, when the communist era was reaching its end, numerous economies in Eastern Europe and Asia were facing an uncertain future that involved radical economical changes. Vietnam was also one of these countries. At that time Vietnam found itself between a rock and a hard place. The greatest supporter of its centrally planned economy, the Soviet Union, withdrew most of its economic and military support, support Vietnam heavily relied on. Moreover, the tense relations with China, the presence of Vietnamese troops in Cambodia and the embargos imposed by the USA because of this military presence driving Vietnam in a corner, forcing it to look for a different economical and political system. (Tuan, 2009)

3.1. Doi Moi

This change of scenery came when in 1986 the Doi Moi restructuring scheme (literally translated into "restoration") was installed. The main goal of this scheme was to get rid of the negative influences of the central planning system and the country’s isolation after the unification in 1975.

This unification brought the country under a centralized, communist regime, involving Stalinist economic changes. This resulted in a situation where Vietnam had to rely heavily on import with an all time low level of economic activity, making it one of the poorest countries in the world at that time. In 1986, prompted by among others the vast food deficiency of the country, the communist government decided to tackle the problems by means of the Doi Moi scheme. (VIETNAM DEVELOPMENT INFORMATION CENTER, 2011)

Unlike the Eastern European countries, Vietnam was not a highly industrialized and it was in fact the least industrialized country of all the transitional counties. While in Eastern Europe there were massive privatization programs of state owned companies with all the problems related to quick and vast privatization included, Vietnam was able to rely on its fairly traditional economical plan of before the transition.

This meant that in comparison to the other transition economies, Vietnam did not have a significant drop in productivity in the initial years of the Doi Moi Scheme since it could use the present infrastructure whilst other transition economies suffered a lag of several years during which they brought their economies and industries up to speed with the rest of the world. Vietnam was able to take the old institutions it had, reassess and remodel them and adapt them to the changing times and economical climate. (VIETNAM DEVELOPMENT INFORMATION CENTER, 2011)

::::::Desktop:Schermafbeelding 2013-03-04 om 00.30.42.png

Figure 3: Vietnam’s output performance relative to other Transnational Economies

Source: (VIETNAM DEVELOPMENT INFORMATION CENTER, 2011)

The transition in Vietnam followed a very clear bottom-up approach. Instead of looking at new industries and technologies like for instance many Latin-American countries were doing, Vietnam initially focused on the industries that were efficient. This could especially be seen in the agricultural sector, where driven by the reluctance of the farmers to produce more than their families needed, the agricultural plans focused on self-sufficiency before focusing on exporting. From being a country suffering from chronic food deficiencies, Vietnam evolved into the third largest exporter of rice in the world in little over two years. No wonder that the transition of Vietnam is often mentioned in books as literally being a "text-book" transition. (VIETNAM DEVELOPMENT INFORMATION CENTER, 2011)

The agricultural sector registered an annual growth of about 4%, which exceeded expectations. After a while Vietnam was also able to abandon the mere self-suffiency strategy and it could move towards a more diversified sector with high value products such as coffee. (Hau & Dickie, 2006)

However, the most structural and radical changes in Vietnams economic transition were the result of a series of decisions that took place at the political level. These decisions focused on two things: on the one hand liberalization and on the other hand internationalization of the market. Before, central planning ruled the economic landscape of Vietnam, but in the Doi Moi program this central planning came to a halt. More power was given to the private enterprises. Companies were now allowed to set their own prices, determine how much and what they would produce and when and in what they would invest. Since there were no more production quota, excess production was allowed to be sold, both in and outside of Vietnam. Also, employers were allowed to lay off workers even though this could only happen under a set of strict conditions and regulations. In contrast to the reality before the transition, it got easier for workers to freely move within Vietnam from rural areas to more urban areas to work or vice versa.

This equalization of the private and public enterprises had the aim of improving the competition between the two in order to create a spillover from the private logic to the public sector, especially with regards to the sense of innovation and efficiency.

While these aforementioned measures mainly focus on the internal affairs, the external trade was also made easier. The excessive red tape was tackled, whilst the import and export of goods were liberalized. Vietnam tried to get on good footing with countries from throughout the world, realizing that these countries would bring the much needed international trade, tourism and FDI for the success of the transition. Diverse agreements were signed and in 2007 Vietnam joined the WTO. (VIETNAM DEVELOPMENT INFORMATION CENTER, 2011)

The main objective of the amalgam of regulations and changes was the increase of the supply. Before the transition, human capital was definitely present in Vietnam. Even more so, Vietnam was one of the most literate countries of its region, but the central planning resulted in a massive underemployment of this human capital by restrictive measures that limited production and as such crippled the present human capital. (Tuan, 2009)

3.2. Sources of Growth & Key Trends

::::::Desktop:Schermafbeelding 2013-03-04 om 02.09.58.png

Figure : Market per sector (%)

Source: (Tuan, 2009)

After the transition period we see that the market share of industry (of which the majority is manufacturing) in Vietnam increased while the agricultural sector decreased. The same trend can be seen in the growth of each sector.

While the agricultural sector was still growing quite strong in 1992 (6.9%) the growth of this sector in 2008 had already plummeted to 2.1% while the industry and service sector had more steady and larger growths in the same period. This trend is not new since we could see a shift from the rural (agricultural) areas to the urban (industry and service) areas as the development progressed in most developing countries. (Harvard University, 2008)

The steep incline in the market share of the industry sector could also be explained by the presence of skilled labour, low wages and the interest of foreign companies in these two factors, resulting in FDI, supporting the transition. However, there are clouds on the cheap and skilled labour force-horizon. Vietnam has slowly but surely been running out of skilled labour. This is not only the result of a certain brain drain [1] which has been going on in the last years, but also because the labour force that stays behind is exhausted. The only option would be to train new workers, but this is a very time-consuming and costly thing. This I why the government is now focusing so heavily on this like we mentioned in the PESTLE analysis. Secondly, the low-cost factor, which made Vietnam such an interesting place to invest in for foreign companies, will not hold. When looking at the total cost of manufactured goods, only a tiny percentage is made up by the production cost, so making the low-cost factor a long-term plan is unwise. (Harvard University, 2008)

Beyond the labour force issues, there are also other troubles arising. Private companies are still struggling to obtain long-term credit from banks, although the government tried to open up the credit market for private companies. This means that expansion becomes harder than it should be for private companies, which results in a crippled competition. On top of that, Vietnamese companies often find themselves in shortage of know-how that is on the same level of their foreign competitors. In order to remain competitive, the Vietnamese industry will have to strengthen the ties with foreign companies within Vietnam, profiting from their knowledge, which is a necessity to obtain a long-term competitive advantage. Also, the depletion of raw materials that Vietnam used to have will soon become a pressing matter. Looking at new sectors might proof necessary in the near future. (Harvard University, 2008)

4. Foreign Direct Investment (FDI) in Vietnam

4.1. Review and the role of Foreign Direct Investments

As explained in the previous chapter, Vietnams economy before the 90’s was centrally planned and a platform for foreign direct investments (FDI) was non-existing. This all came to an end with the adoption of the previously described Doi Moi, which introduced several reforms. Production, distribution and prices were liberalized, State-owned enterprises were reformed and the private sector was promoted. As a result of these reforms the market was internationalized and opened up for foreign competition. Also the law on Foreign Investments was promulgated and a structure for receiving FDI was introduced. This has led to the first wave of foreign investments, which slowed downed again when Vietnam entered the Asian Financial crisis.

In 2004, a second wave of investments started due to the fact that Vietnam had a very high growth potential. This growth was pulled by the government who actively encouraged foreign investments (e.g. revising the corporate income tax, basing domestic laws on international standards, becoming member of the WTO in 2007). Another factor that pulled this growth was the firm domestic demand. Even during the economic recession, the Vietnamese interest subsidy policy made sure that this domestic demand stayed high.

Figure: Direct investments: Approved amounts, projects

Source: Economic review: Shifting FDI trends in Vietnam

The figure above indicates that the presence of foreign companies in Vietnam has been growing every year. More than 40% of the industrial production value is generated by foreign companies. An increasing amount of FDI’s also has a multiplier effect on the Vietnamese economy. This means that the injection of money by foreign investments in the economy will increase the buying power of the Vietnamese employees. As a result, the overall consumption will rise and the economy will be stimulated. Therefore, one can see that FDI is critical for Vietnam to support a sustainable and growing economy.

4.2. Vietnam as a destination country

Traditionally, Vietnam has been a manufacturing base for export processing. Also the Japanese Bank for International Cooperation (JBIC) reported that, behind China and India, Vietnam is the third most promising investment locale. The reasons for this high interest is firstly the fact that it has a stable government and society, secondly the size of the market and growth potential and thirdly its cheap and abundant labor force. Especially this presence of extremely low laborer wages results in very low overall production costs and makes it therefore interesting for foreign investors to manufacture their products in Vietnam and export it afterwards. For example, the following figure illustrates the labor costs in the textile industry for several countries. As one can see Vietnam is the Asian country with the lowest labor cost.

Figure: Textile labor cost 2011/2012

Source: New Twist, newsletter werner international

In 2009, Vietnam lifted its restrictions on foreign investments into the distribution sector. From that moment on the presence of service industries and domestic demand-oriented companies has been increasing. Foreign companies started to target Vietnam as a costumer market mainly because of the expected per capita growth, which is predicted by the IMF. Also, as already mentioned above, Vietnam has a very high population (87 Mn) where almost 75% is aged 40 years or less and this is supporting the expectation that consumption in the future will rise.

4.3. Issues and risks facing the investment environment

There are several risks why foreign companies are sometimes reluctant to invest in Vietnam. Looking at business related risk, one of the main problems is the cumbersome administrative procedures, which are likely to cause delays and extra costs. Also the Inadequate basic infrastructure (e.g. reliance access o electrical power, bad transportation conditions, difficulties concerning communication) slows down the business process and is a barrier for foreign companies. To continue, a fundamental distribution network still needs to be developed in Vietnam. Nowadays, 80-90% of the consumers buy their goods in street stalls and general stores, which makes it hard for foreign companies to penetrate the market. If they want to penetrate the Vietnamese consumer market they are almost obliged to develop their own sales channels.

On the macroeconomic side of the of the investment environment of Vietnam, the inflation risk is the most important issue. In 2008 Vietnam experienced a period of hyperinflation in which the consumer prices rose with more than 23.1%. The Vietnamese central bank had to intervene to end the inflation by buying USD and selling VND. They learned that, in order to create a sustainable environment for investors, the inflation should be measured more precisely and policy measures should be aligned with the inflation targets. Another macroeconomic issue is the unstable exchange rate of Vietnam. In the beginning of 2008 the VND was strong but plunged very fast due to the hyperinflation. The foreign exchange rate is nowadays settling down due to interventions of the central bank of Vietnam and the increased pressure on the dollar and euro due to the economic recession. However, private companies are still concerned about this highly volatile VND.

4.4. The outlook and issues

In the future the macro-economic issues are expected to improve due the recovery of the overseas economies, which will stimulate the export of Vietnam. Also the Government is focusing more on the promotion of FDI since they have a long term goal of becoming an industrialized country by 2020. However, the inflation and foreign exchange rate should be closely watched by the central bank and corrective measurements should be taken in time in order to create and sustain a favorable investment environment.

Another rising issue is a consequence of the growing Vietnamese economy. This issue is the fact that in the future the low labor cost will rise and thus become less competitive. Vietnam should counter this issue by investing in a stable and attractive investment environment. This can be done by improving their infrastructure (e.g. North-south high speed railway to speed up business, improve road infrastructure for procurement of raw materials and parts,…). Also the completion of plans for economic corridors with neighbor countries will also be crucial in the future. This will persuade foreign investors to invest in Vietnam who before were reluctant due to the shortages of raw materials and parts. Thanks to these economic corridors procurements from Thailand and other neighboring countries will be more easily.

5. Assessing Vietnam’s Competitiveness

National competitiveness has become one of the central concerns of every government due to for instance strong movements in the competitive advantages and the attractiveness towards Multi-National Companies. Most discussions look at the successful and competitive nations from aggregate, economy-wide point of view like the balance of trade. We on the other hand use Michael Porter’s model, which begins from different starting points with individual industries and competitors before coming up with an overview of the whole economy. The level of competition of a nation’s economy and its ability to progress is usually determined by its effective influences on the success capacity of its firms in particular industries. Home countries where internationally competitive firms can be found always offer a set of favorable conditions facilitating the development of the industry (Michael E. Porter, 1990)

By apply the framework to Vietnam’s economic situation in 2010, Porter’s study revealed that Vietnam’s key competitive advantages were created mainly through its geographic location and demographic profile, which are inherited endowments. Apparently, Vietnam shows little effort in creating new, distinctive competitive advantages. The successful story of current development model cannot hide the increasing signs of its fragility. And the need for an economic strategy based on a new development model is obvious more than ever. (Michael E. Porter, 2010: 44)

Determinants of Competitiveness for Nations

E:\HE THONG\DOCUMENTS\Courses\Asian business\Vietnam\1.gif

Source: Michael E. Porter, The 2010 Vietnam Competitiveness Report, Harvard Business School, 30

In Porter’s model, macroeconomic competitiveness is demonstrated by the potential for high productivity. However, productivity in turns depends ultimately on the ability to improve the microeconomic capability of the economy as well as the sophistication of local competition. (Michael E. Porter, 2010: 30)

Vietnam’s National Business Environment

In order to gain access to the WTO membership, Vietnam demonstrated a high level of openness to foreign investors and it sticked to its WTO/ASEAN liberalization commitments; however, some important barriers are conservatively in place. One of Vietnam’s economic weaknesses is the lack of an efficient competition policy and effective enforcement of this policy by the government. This is combined with unequal competition among companies, with SOEs receiving favorable treatment. It was the consequence of the fact that the government couldn’t clearly separate its role as a regulator or an owner. The reform of state-owned sector fell short of expectation as equalizations of SOEs was not oriented towards improving performance and the government neither wanted to let go their control nor give up their monopoly in the backbone industries like banking, insurance and energy. Moreover, competition amongst companies often focused on price instead of quality, which destroys local consumers’ loyalty and create low-end brand images. (Michael E. Porter, 2010: 30)

Porter's National Diamond framework  Factor or input conditions:

Source: http://www.provenmodels.com

Vietnam has decent basic physical infrastructure in place; but further investments, though highly committed by the government, show low effectiveness. The past liberalization and competition brought in a solid communication infrastructure. The financial system is growing but still shallow; lack of experience in management and monitor made it highly volatile and speculative.http://www.provenmodels.com/files/0a6c40f394096bebf866929e71024adf/diamand_model.gif

The education system is expanding but quality was largely far behind international standard, resulting in serious shortage of skilled labor. Performance on administrative infrastructure is quite modest, but there’s high prospect of improvement as major reforms is under way. Poor innovation infrastructure combined with increasing brain drain deters the country from enhancing its R&D capability.

Demand Conditions: Vietnam has a sizeable and growing market. The sophistication of local customers is low, yet improving. As a country at early stage of market economy, quality standards regulation and enforcement is quite weak. The development of related and supporting industries is not sufficient, resulting in high level of imported materials and semi-products. Recently the economy witnesses the natural emergence of some clusters; however, these clusters focus mainly on narrow activities with weak presence of local suppliers and service providers. Despite government’s recent efforts, sector-oriented policies prove to be ineffective and not systematically focused on clusters.

Sophistication of Vietnamese Companies: Vietnamese companies demonstrated high levels of flexibility and responsiveness to market opportunities. However, most of them only follow short-term and opportunistic company strategies due to the lack of mission and vision. Competition focuses primarily on cost instead of quality. Sophistication level of operation is still quite low compared with foreign companies at similar size. Large SOEs operate as individual corporate groups with little co-ordination. In term of operational effectiveness and productivity, there is a huge gap between SOEs, private companies, and foreign MNCs.

(Michael E. Porter, 2010: 41)

References

Michael E. Porter (1990) The Competitive Advantage of Nations, hbr.org

Michael E. Porter (2010) The 2010 Vietnam Competitiveness Report, Harvard Business School

6. The integration into global supply chain

The internationalization of the Vietnamese economy and the openness of the country to the global market year by year, allowed Vietnam to position itself as an important link in the global supply chain and a key strategic point in Southeast Asia. The main reason for this is Vietnams geographical location, which is very attractive for of TNCs. According to Vietnam Report released in June 30, 2011 the country exports crude oil, marine products, rice, coffee, rubber, tea, garments and shoes; mainly to U.S. (22.97%), Japan (15.27%), China (8.81%), Singapore (5.11%) and Malaysia (3.91%).

Having a structure that enables the country to develop an optimal flow of goods is fundamental. According to the 2010 Vietnam Competitiveness report it is constantly reported that foreign investors pointed infrastructure as a bottleneck, the distribution channels are not in the level that allows an optimal flow. The railway roads of approximately 2.600 kilometers are outdated and the lack of quality together with narrow-gauge lines limit train speed and too many crossings at roads in residential areas cause frequent accidents as mentioned in Vietnam´s supply chain challenge of Bangkok post in 2011.

Furthermore the lack of rail lines to connect economic and industrial zones to ports and from Laos to Cambodia as well. The air and sea transportation are also no good. Regarding aerial there is a lack of quality what generates an opportunity for the improvement to create a better air cargo utilization. Sea transportation is not following the growth the pace of the export growth, nevertheless the high customs services present as a barrier. The road infrastructure is a target of constant investment by the government, who invests in a North-South highway system. Those investments are around 10% of GDP of country.

The concentration of the production in Vietnam might result in a in a potential advantage in an economy of scale (due to the cheap labor and resources), however the economy should not rely only in these factors, as mention before there the improvement of distribution channels should be taken into account in order to allow a higher competitive advantage.

7. The challenges now facing Vietnam

7.1. How to sustain growth and increase the volume and quality of FDI

As the emerging of new economies comes, Vietnam presents itself as member of upcoming potential group. Although, there are several risks that should be mitigate by government in order to allow a sustain growth, they can be divided in internal and external risks.

Internal

Inflation ratios:

Inflation and exchange rate; Vietnam’s inflation rate has in the last few years become increasingly volatile, with the trend rate of inflation ratcheting upwards. Large unsterilized capital inflows and rapid growth in domestic credit have created inflationary pressure. Under an exchange rate policy that is oriented towards stable nominal rates, this has led to increasing real exchange rates and has forced Vietnam into repeated devaluations. The high level of dollarization in the economy adds to difficulties in managing inflation and exchange rate fluctuations.

Dependency of export economies

The American slowly recovery from the recent crisis together with the Japanese scenarium post natural disasters had a directly impact in Vietnamese performance growth in the last years. The pursue of new key partners should be take into account, opening up the new possibilities is not a difficult task for Vietnam, especially because the country has a strategic geographical positioning being a border/close of several others countries with a emerging economies and consolidate, such as Malaysia, Singapore, Indonesia and China.

External aspects:

Education

The massive investments in education in order to create a skill work force that could meet all the demands of the local economy presents as one big challenge of the country. That theme was also approached in the "(…) The education system is not keeping pace with the rising demands of the Vietnamese economy. Government’s efforts to manage the education sector through entry barriers for foreign providers and administrative oversight are a hindrance for extending supply and do not succeed in ensuring higher quality standards. Despite improvements in recent years, the overall administrative environment is still cumbersome. This is undermining Vietnam’s attractiveness as a business location.(…)" Vietnam Competitiveness Report 2010 page 15

However, that measure might put the government in a dilemma because it could also lead to the end of investments of production in the country, because the payment range would increase.

Emergig middle class

The emerge of middle class was key success factor in imporving the consumption and heating up of economy in some of the BRIC countries, when compared to the Vietnamise middle class is possible to see a huge difference.

Middle Class Size

Brazil

China

India

Vietnam

Table:X . Size of Middle Class. Source: The Rise of the Middle Class in Asian merging Markets. KPMG, Brazil Gov, Money CNN, The middle class in India - Deutsche Bank Research

Infrastructure

As mentioned in section 6. The integration into global supply chain, the Vietnaminse infrastructure scenario still not in level that can bring to the country all the competitive advantage in order to secure his sustainable growth.

As mentioned in Vietnam Competitiveness Report 2010 page 17 " (…)A new approach for infrastructure investment needs to systematically evaluate public infrastructure projects by their contribution to competitiveness (…) "

8. Implications for foreign Investors

8.1. Starting up a business in Vietnam

8.1.1. Partnering with Vietnamese companies:

State-owned firms are often foreign investors’ favorite partners as they always play the role of substantive players in the Vietnamese economy. However, this type of partnership can create special challenges for foreign investors (Nguyen and Meyer, 2004) since SOEs pursue a broader set of objectives. The governing authorities, such as the relevant ministry or provincial government, usually interfere directly.

On the other hand, the responsible management team of the partner’s firms is often granted a high degree of autonomy and may decide to pursue personal as well as social objectives. One can also never de facto assume that the management team of the partner is either trained for or experienced with the governance structures and common decision-making processes in developed market economies. Thus, a very valid advice for foreign investor is to draw up clear contracts that provide a clear outline of the roles and responsibilities of both partners.

The rapid growth of the private sector in Vietnam has considerably contributed to a more dynamic and market-oriented economy. An increasingly large number of local private SME’s, the majority of the private firms, have evolved into the role of being attractive partners for foreign investors, which is mainly because these SME’s don’t face the restructuring challenges of SOEs. A major drawback that stems from this kind of partnership is that the partner usually can’t be used as an access point to local resources since they are often controlled by SOEs. An additional hurdle is the fact that the governance mechanisms are neither fully developed nor transparent. Many of these governance mechanisms are under family control and managed in informal manner following unwritten rules. Even disputes can be resolved in an informal way.

From foreign investors’ point of view, the informal management style of private firms offers higher flexibility and lower transaction costs. These advantages make this form of partnership quite attractive partners, especially in service sectors like restaurant and food business.

Such a partner can help to start the business quickly at low initial investment and to avoid the complex bureaucratic procedures faced by foreign investors. However, this is an uncertain type of partnership and might be easily broken down when things go wrong.

8.1.2. Marketing and Distribution:

With population of 80 million and rising incomes per capita, Vietnam offers a large potential market for consumer goods. Yet, gaining access to these potential customers still remains a considerable barrier to newcomers as a direct result of the lack of the marketing and distribution infrastructure, which is not well developed. Among the sales and distribution channels, independent stores still remain the most vital, accounting for around 75% of total retail in volume in 2003 (Icon Group International, Inc., 2001); at the same time, shopping malls and supermarkets are expanding in the major cities and winning an increasing share of retail sales, especially in premium segments.

In Vietnam, advertising on billboards, TV or print media are not cost effective. Moreover, unlike in industrialized economies, information to target specific consumer segments is rare. Thus, mass advertising and direct marketing techniques is still an unfamiliar concept to Vietnamese consumers. However, people-intensive sales techniques such as distributing samples, sales promotion or delivering even small volumes to small sales outlets and street vendors may be cost effective. With low costs of sales staff, people-intensive marketing methods may be more efficient than capital-intensive techniques such as TV advertising.

For importers, collaboration with local partners is a must, as the law does not allow foreigners to set up independent stores without manufacturing in the country. Thus, franchising contracts have become a popular penetration method for foreign consumer brands. This is especially the case for fast food eateries such as Revlon, Baskin-Robbins, Kentucky Fried Chicken, Carvel Ice Cream and Texas Chicken. (Icon Group International, Inc., 2001). Also local franchising operators are emerging but the number remains modest.

8.1.3. Production for Export:

Vietnam, as a low-cost production base, often attracts labor-intensive production processes where low or semi-skilled labor force is required. Typical industries for such export-oriented manufacture include textiles, footwear, furniture, and toys. (Jenkins 2004).

Utilizing low labor costs in Vietnam does not require setting up an equity investment into a new production plant. Some Taiwanese and Korean companies now act as specialist subcontractors and develop labor-intensive production under European or North America brand names. This is due to the fact that raising labor costs undermined the competitiveness of certain industry segments in these countries. Vietnam developed a policy framework to encourage this type of export-oriented ventures. Exporters are no longer restricted with regards to the percentage of foreign ownership and they enjoy tariff exemption for imported materials. Moreover, industrial zones are developed with the strategic view of developing export oriented manufacturing. However, there has been a shift in the government’s focus in attracting foreign investment from low-skilled labor utilization to the use of technical skills available in Vietnam. (Hartman & Woktuch, 2004).

8.2 Managing Businesses in Vietnam

8.2.1 Managing cultural differences:

Personal networking is an essential part of doing business in Vietnam. Foreign exporters and investors should always keep in mind the importance of establishing networks with Vietnamese counterparts in order to achieve a successful outcome. In the initial phase of a company’s market penetration planning, frequent visits to the partners would be necessary in most cases. Next to establishing good relationships with direct partners, the company’s network should also extend to government official with high position. Therefore, it is useful to give courtesy calls and maintain a good connection with local authorities and business organizations from the very beginning.

Generally, Vietnamese counterparts are quite informal and helpful towards foreigners. Although visitors’ unfamiliarity with Vietnamese customs can be tolerated, paying attention to customs and politeness towards the Vietnamese counterparts is strongly advised. Anger or even impatience is often taken as being rude and embarrassing.

Even in cases of disagreements, the Vietnamese will often express their point of views in an indirect non-confrontational manner since Vietnam has a high ‘context culture’ in which one has to understand the situation more than what the counterparty is actually saying with words. However, it is extremely important to ensure that contracts or other commercial agreements do not contain unclear wording that may be subject to interpretation. This process is often very time consuming, but the costs to resolve situations in a foreign context, with a foreign court and a lack of enforcement mechanisms will be many times higher. Source: website of the Embassy of Denmark (accessed Jan 1st, 2005).

8.2.2 Informal business practices

Like in other Asian countries, business practices such as networking, reverse commissions, and even bribes are still common. Informal business practices, such as corruption, tend to work against foreign investors who have less extensive local networks. Yet, foreign investors can also use local informal institutions to their advantage. Foreign investors establishing an amicable relationship with the local authorities find it easier to solve bureaucratic obstacles if and when they occur.

Relations with relevant authorities can be developed into cooperative relationships and personal networking and relationship building is highly recommended. Gifts to the appropriate persons and their families may delight the atmosphere and smooth the business process given Vietnam’s gift giving culture.

To sum up, companies considering engaging in business with Vietnam will encounter a business culture that shares many traditions with other East Asian nations and a legal framework that is incomplete but rapidly evolving. Thus, building personal relationships with potential business partners and carefully analyzing the institutional framework that governs the targeted industry may be the appropriate first steps to prepare the business endeavor. (CES, 2005)