Why Trust Is the Gold Standard in Developing Countries

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Harvard professor Tarun Khanna looks a crucial component for business success in developing countries -- trust.

Entrepreneurs in the developing world face a distinct disadvantage over their Western counterparts – a widespread lack of trust. Western nations have spent centuries putting in place customs, institutions and regulations to support new companies. But those structures don’t necessarily exist in places like India, South America, Africa or China. Harvard Business School professor Tarun Khanna believes smart entrepreneurs who want to succeed in places with “rampant mistrust” must build their own microcosm of trust with employees, partners and customers. Khanna, who is also director of the Lakshmi Mittal and Family South Asia Institute at Harvard, details this approach in his new book, Trust: Creating the Foundation for Entrepreneurship in Developing Countries. He spoke on the Knowledge@Wharton radio show on SiriusXM about why a conventional strategy doesn’t work wherever societal mistrust is the norm. (Listen to the podcast at the top of this page.)

 An edited transcript of the conversation follows.

Knowledge@Wharton: What are the challenges when trying to start a business in a developing country where lack of trust is a serious obstacle?

Tarun Khanna: When I have my students here in Cambridge from Harvard or MIT, I ask if they have an idea that they’re really sitting in a luxurious situation. They have armies of people coming by with risk capital, private equity, venture capital. They have lots of schools to draw talent from. They have intellectual property firms, lawyers, contract experts. Most of those things are underdeveloped in the developing world. If you want to be an entrepreneur in the developing world, and God knows we need them in spades, you’re essentially trying to compete with your hands tied behind your back. That’s the problem that I’m focused on as an academic and as an entrepreneur myself.

Knowledge@Wharton: But that component of trust has to be a common thread in having success, correct?

Khanna: Absolutely. Of course, you need to have your investors trust you, your employees trust you, your partners trust you. No one’s gainsaying that. But it’s a question of an order of magnitude more importance. Trust becomes, if you will, the binding constraint. It’s the limiting factor because you’re surrounded by a miasma of mistrust. That becomes a first-order problem for you to solve, as opposed to something that you pay attention to as you go along.

Knowledge@Wharton: Many American entrepreneurs may not expect mistrust as one of the first things they need to tackle in trying to start a business in a foreign country.

“If you want to be an entrepreneur in the developing world … you’re essentially trying to compete with your hands tied behind your back.”

Khanna: That statement hits the nail on the head. At Harvard Business School, we do this, and at Wharton, they do this, and all the leading schools in this country — we correctly tell people that you focus on your so-called core competence. If you want to build a medical device company, you had better be an amazing medical-device person. And that’s certainly true if you’re building it in China or India or Brazil. But what we don’t tell people, in my view, is that that’s not enough. The way I say it in the book is, you don’t just have the luxury of saying, “I’m going to create something.” You first have to create the underlying conditions to create that thing.

Knowledge@Wharton: Why is having that recognition so much more important today?

Khanna: It’s always been important. The reason the developing world has been the developing world in the past several decades is that we haven’t paid adequate attention to how you make creative possibilities come alive relatively seamlessly. That’s not to say that there aren’t interesting ventures. We hear about them all the time coming out of China and India, in particular, in recent years. Multibillion-dollar companies. But relative to the potential and the need, it could be two orders of magnitude more. Goodness knows that the need is there for two or three orders of magnitude more innovation and enterprise creation. So, it’s always been an issue. I’m just trying to direct attention to the lack of the enabling infrastructure within which creative people have to get their job done. The onus on them now is to somehow compensate for these institutional inadequacies in addition to building their own enterprise, which is a tall order. But it can be done.

Knowledge@Wharton: It adds another layer to the process that a lot of entrepreneurs starting a company in the United States wouldn’t necessarily deal with, correct?

Khanna: That’s why I start the book by saying that the first thing you have to do is have a mindset change. Again, to go back to the simple saying: You can’t just create. You have to create the conditions to create before you get on with it. Now, it’s been criticized by some people, for instance in the multilateral institutions in Washington that are saying, “Hey, aren’t you making things really hard for the would-be entrepreneur?” My response to that is, “I’m just calling a spade a spade.” It’s not that I’m making it hard. I’m just saying it is hard, but it’s not impossible. And we had better be smart about it and recognize the problem rather than just throwing good money after bad.

Knowledge@Wharton: One of the examples you give is the Indian dairy sector. Take us into what is happening there and how that buildout has had to rely on trust.

Khanna: I offer a pair of examples. There’s an Indian dairy called Amul, which has been in existence for over 40 years. It’s what I would simple-mindedly call a low-tech approach to building trust among the dairy cooperatives and with the end consumer. Essentially, building all the institutional mechanisms that are missing in the environment in addition to producing really high-quality milk and dairy products. I contrast that with an effort that a friend I got to know in Shanghai and Beijing was building, Huaxia Dairy, which is sort of a high-tech approach to building trust. The purpose of that comparison is just to say that you can produce the best-in-class quality products in the world in these countries, and there are multiple ways to get to that desired level of trust. You just have to be careful about which direction you’re embarking in. Technology can play a huge role in this. But it’s neither a necessary thing for you to have high-tech enterprises to do this right, nor is it sufficient. The pair of examples essentially pulls that off, I think.

Knowledge@Wharton: I can imagine that when you’re an entrepreneur trying to start a business in a particular developing country, you are trying to build a relationship with the people. But you’re also trying to develop a relationship with that government and bridge the idea that the people may not trust the government, or the government may not trust the people.

“There is so much rampant mistrust, which is almost a defining descriptive feature of a developing country.”

Khanna: There is so much rampant mistrust, which is almost a defining descriptive feature of a developing country. In my view, it’s what causes a country to essentially remain underdeveloped. I grew up in India, so you go to these countries and you say such-and-such a thing doesn’t work. People will say, the government is corrupt or incompetent. Look, I’m a practical guy. I say that may or may not be the case, but it’s not helping us solve the problem. What if we roll up our sleeves and take a problem area and figure out how do we build these bridges of trust, in addition to building the enterprise that we actually want to build? Again, creating the conditions to create.

I think a generalized lack of understanding, lack of exposure to new ways of doing things, lack of awareness, is unfortunately a characteristic of most developing countries because people don’t have the luxury of traveling and so forth. So, educating everybody in the ecosystem is part of the precondition of building this trust that allows people to come together to build these compensating mechanisms to deal with the mistrust in the environment.

Knowledge@Wharton: What about the finance side?

Khanna: Risk capital is extremely scarce. What typically happens is, even if you are an entrepreneur in a metropolis in the developing world — say a city like Guangzhou in China, or São Paulo in Brazil, or Johannesburg or Mumbai — you will find angel capital. Which is exactly how it happens in the United States. You find informed friends and family who put in some money into the venture, and you take it there. That sort of exists in pockets.

The problem is that institutionalized venture capital and early-stage private equity is severely lacking, and what does exist has very short time horizons. What I mean by that is that they have fiduciary pressure from their investors to return the money in a very short horizon of time because of the mistrust in the environment. The investors ask the private equity funds to return the money to them pretty soon, but the time scales needed to address these more complicated problems are longer than the time scale available to the institutional investors. So, you’re stuck in this Catch-22 where the money either doesn’t exist, or it exists but it’s very short-time-horizon money. Again, it goes back to building confidence with somebody who can trust you a little bit longer so that you have the time lines to build it.

Lest this sound infeasible, the point of the book is to say that actually it’s not. I think it primary requires a mindset change, and you can see deliberate ways to do it over time.

Knowledge@Wharton: Can you talk about developing that team mentality when you’re building out a business in some of these locations?

Khanna: Take the example of a very close friend of mine who is a heart surgeon in Bangalore, who today is recognized as the provider of the lowest-cost, cutting-edge heart surgery in the world. As good or better than anything you see in the United States, and available at literally a pittance. For him to actually pull that off, he had to build educational institutions. He had to pioneer medical insurance. He had to pioneer satellite-based telemedicine to reach the patients that he needed to reach in different poor countries. Just to maintain quality standards, he had to build the entire soft infrastructure around him in order to be able to do cutting-edge heart surgery. But to do that, a lot of people had to cooperate with him. It’s not that he’s physically going out and doing all this stuff himself. But he’s got a constellation of people who trust him and are willing to work with him because, step by step by step over the last 10 to 15 years, they’ve seen that he can make it happen. And you know what? He’s saved hundreds of thousands of lives and has built a billion-dollar company. So, it’s doable.

Knowledge@Wharton: I would imagine that, once you develop that trust, it’s just as big a challenge to be able to keep that trust.

Khanna: In the book, I use the example of organized microfinance in Mexico to illustrate how, as you rightly point out, trust can be lost in an instant. It takes months and years, sometimes decades, to build it. As the different examples show, once it’s built, it results in sustainable enterprises doing a lot of good for society and making a lot of money for the different stakeholders. But you can lose it in an instant. Sometimes, you lose it by essentially losing sight of your own purpose and making wrong decisions, just like it happens in our part of the world. Remember the 2008 financial crisis here, where I think there was widespread collapse of trust in the United States? This could happen anywhere.

But it could also happen because of shenanigans by less well-meaning actors in the environment. Somebody who’s after a scam, a politician who’s not quite on the straight and narrow, media that’s unscrupulous or wants to fan the flames for something. Unfortunately, that’s part of the ambient constraints that you have to deal with as an entrepreneur. Think about some parts of India, about Indonesia, Brazil these days. Think about Nigeria. There are lots of places where it’s easy to fan the flames and cause distress for somebody else to do something at your expense, and you have to be somehow resilient.

There are some lovely stories in the book that show how, despite being sideswiped by some pretty devastating blows, it’s possible for entrepreneurs who maintain a short-run plan to recover short-term trust. Then over time, build out the institutional infrastructure to allow people to trust you in the longer run, to recover.

Knowledge@Wharton: One of the examples you give is Bolsa Família, a government social program in Brazil to address inequality. With all of the turmoil, political unrest and corruption in that country, I would imagine that entrepreneurs have an especially difficult time getting established there.

Khanna: Brazil is a country where things just got a lot tougher. Hopefully, in the service of a good cause, if the cleanup operation results in genuine cleanup over the next years to come, then maybe they lay the foundation for much less rampant mistrust. The Bolsa Família example goes back to before the current Bolsonaro regime and even the Lula regime. It’s a wonderful program that the government started, a conditional cash-transfer program that puts money in the pockets of poor families to make sure that their kids are educated, fed, vaccinated, things like that.

The problem that I highlight in the book is that even a great program like that has plateaued in its effectiveness. If you think about a poor family that’s been lifted from poverty to a subsistence level, their appetites have been whetted. They have the aspiration to leave the favelas (slums) and enter mainstream society. But that bridge doesn’t exist. The benefits to recipients of Bolsa Família are capped. Again, it’s a consequence of distrust between two very polarized parts of society. And it should not be too much of a stretch for people to see that that polarization exists in our own backyards now.

Knowledge@Wharton: In Venezuela, many believe that a regime change would usher in opportunity for entrepreneurship because there is capital there from the oil industry. What do you think?

“I think we are inadvertently, in a well-intentioned way, cultivating people who think they can make a quick buck in these places.”

Khanna: Venezuela has amazing petroleum assets. Perhaps even more importantly, given that we are moving towards a green future, it has amazing human capital. Unbelievably talented scientists, engineers, entrepreneurs — all of whom are leaving the country. You know that 10% of Venezuela has left in the last years under the Maduro regime. But even prior to that, with the body blows that oil company PDVSA was receiving, there is an entire diaspora of Venezuelans spread through Miami, Central America, Chile. So, you’re absolutely right. I think the fundamentals exist in Venezuela. If we can somehow transition to a more normal governing system, that would be an amazingly nice thing.

Knowledge@Wharton: Let’s go back to the issue of having the right mindset. That’s been a common theme for business for hundreds of years. Are the dynamics different now?

Khanna: Whether you look at Southern Africa, East Africa, Latin America, India, successful entrepreneurs have always built things the way that I’m describing it, which is recognizing the limitations of the context and building into their business plan an ability to do something about that. Quite simply, without that, nothing works.

The reason to articulate the need for a mindset change is that the problem may arise with us, meaning the Harvards and the Whartons of the world. I think we are inadvertently, in a well-intentioned way, cultivating people who think they can make a quick buck in these places. They can go in with a technology, do an app, do an online game, and make a lot of money and exit very quickly. That’s generally not feasible. There are some exceptions here and there, but relative to the scale of the opportunity, that’s the wrong way to think about it.

There are some local sectors where you could manage with the limitations of the infrastructure around you. But by far — when you look at the health sector, education, agricultural technologies, climate issues — you’re talking about system-wide change for which the enabling institutions don’t exist in these countries. So, either we wait for the governments to do it — in which case hell would freeze over — or we get on with it and form cabals of you and me who very much have the wherewithal to do it. But we just need to think about the problem slightly differently.

What I’m advocating for entrepreneurs to do in the Mexicos and the Kenyas and the Nigerias of the world is no different than what the U.S. did over the last hundred years. We were a developing country, too, and we built the infrastructure. It’s just that we’re forgetting that it took us several decades to build it. Sitting today with the benefit of all this stuff that our forefathers built for us, we’re able to do things faster. But we’re asking other countries to do it instantly, without them having gone through that process and without helping them through that process. That, I think, is a mistake.

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