Africa’s broadening horizons

April 30, 2012 ( FT Advisor) -- As companies go through their strategic planning processes, African cities should be a priority

Sub-Saharan Africa’s potential for economic growth is no longer a secret.

Some estimates show Africa having as many middle class households as China by 2020.

Matthew Spivak 

The region is expected to set the pace for global growth over the next five years, with economic expansion averaging 6 per cent per year. China increased Africa investment by almost 60 per cent last year, while India pledged to expand trade volume to $90bn (£56bn) by 2015.Much of this investment will be concentrated in fast-growing sub-Saharan African markets like Angola, Kenya and Nigeria. Multinational corporations are increasingly concentrating resources on these types of markets to make up for economic volatility in Europe and political uncertainty in the Middle East and North Africa.

In a survey conducted last year, 42 per cent of senior executives focused on Europe, the Middle East and Africa (Emea) revealed that they are planning to set up a direct presence in at least one sub-Saharan African country in 2012. More than one-fifth of polled executives said they plan to establish an African managing director role within two years to oversee regional operations.

Multinationals intend to capture average profit margins greater than 10 per cent and returns on capital 60-70 per cent greater than in high-growth markets like China, India and Indonesia.

If multinationals want to capitalise on all that Africa has to offer, then a fundamental shift must take place in the way that companies prioritise markets for resource allocation decisions. Africa is far too big and complex to look at as one market, or even as a portfolio of countries. Companies must look at the African opportunity as a portfolio of cities, targeting the urban areas that offer the best opportunities for their business.

Because of poor infrastructure and limited potential for distribution, leading companies focus on the big cities where their customers are concentrated. Africa houses 52 cities with more than 1m inhabitants, which are expected to grow by an average of 32 per cent through 2020.

By 2025, Africa is projected to have 73 cities of 1.5m inhabitants, and a further 84 cities of up to 1m inhabitants. Cities like Dar es Salaam, Kinshasa, Lagos, Luanda and Nairobi will lead the way with rapidly expanding populations for decades. The continent is projected to be 50 per cent urbanised by 2030 and 60 per cent urbanised by 2050.

By prioritising key urban markets, companies will be able to focus sales resources more efficiently to capture growing opportunities for consumers.

Other companies will be able to respond to rapid urbanisation by partnering with governments to face the follow-on challenges of infrastructure and housing shortages.

Companies will also be able to partner with the multinationals that are increasing investment allocations across the continent. Foreign direct investment (FDI) to Africa increased 10-fold between 1990 and 2009. Over the next few years, FDI is expected to continue its steep growth in markets like Ghana, Kenya and Nigeria in particular. As leading multinationals build their presence in Africa’s largest cities to capture growth, they are planning to expand to second and third-tier cities in the near future.

The Big Five and next Five City index guides clients’ investment decisions based on the best opportunities both for today and tomorrow. The ‘Big Five Cities’ – Accra, Johannesburg, Lagos, Luanda, and Nairobi – are major FDI destinations, with increasingly sophisticated commercial infrastructures and generally stable political systems.

The ‘Next Five Cities’ – Addis Ababa, Dar es Salaam, Ibadan, Kinshasa and Mombasa – are large urban areas with rapidly expanding economies and populations. Serious challenges remain for businesses, however, especially with corruption.

One of the biggest challenges that companies face in sub-Saharan Africa is the high cost of expanding into new markets due to deficiencies in infrastructure. As a result, eight out of the 10 cities often recommended to clients are among the region’s most accessible by land (Johannesburg, Nairobi), river (Kinshasa), and sea (Accra, Dar es Salaam, Lagos, Luanda, Mombasa). One of the remaining two, Ibadan, is a natural expansion target for companies active in Lagos because of its large economy and supply of cheap educated labour.

Johannesburg, Lagos and Luanda are the biggest market opportunities today. The large emerging middle class is what underpins Lagos’s consumer opportunity in 2012. The number of Lagos households spending more than $5,000 per year compares favourably to small European countries, such as Denmark, Finland and Ireland.

Lagos’s 11m population, equal in size to São Paulo’s, is what drives this impressive figure. The size of Johannesburg’s economy, roughly $50bn, is not far behind major European city economies like Munich and Dublin. Luanda’s economy is worth $27bn and is expanding rapidly.

The ‘Next Five’ cities will continue to increase in prominence through 2015. Dar es Salaam will emerge as one of the best African opportunities, with economic growth expected to reach 8.5 per cent. This figure benchmarks well against western countries such as France, Germany, and the UK, which are forecast to expand by less than 2 per cent by this year.

Household consumption growth in Dar es Salaam and other east African cities, like Mombasa and Addis Ababa, will average more than 7.5 per cent growth through 2015.

While poverty and an underdeveloped infrastructure reduce market size in Kinshasa, staggering population growth and consistently high economic output means rises in this 10m-strong city cannot remain ignored by multinationals. The city’s informal economy also makes it very difficult to accurately calculate the true size of its GDP.

As companies go through their strategic planning processes this spring, African cities should be a greater focus than ever. Companies that fail to take this bold step will be crowded out by competitors fighting for the last great fast-growing market in the world.

Firms that move first can capture a generation of emerging consumers and keep them loyal to their brands.

Matthew Spivack is a practice leader for the Middle East and Africa at Frontier Strategy Group