South Africa has long been heralded as the ‘gateway to Africa’ – an appropriate base of operations from which economic connection to the rest of the continent can be formed and business developed. This phrase appears liberally in the City of Johannesburg’s official marketing literature, and has been the subject of numerous articles in prominent newspapers, journals and trade publications.

Cape Town, the second most populous city in the country, has been referred to as the digital gateway to Africa. To be sure, the ubiquity of the idea of South Africa as a gateway has lent the term an air of established fact, but as is often the case, a closer examination reveals numerous factors that complicate the narrative. With its well-developed financial sector – including equity and debt capital markets – and certain infrastructure advantages, there is a good reason why the country has earned the moniker, but South Africa’s advantages are counterbalanced by plenty of disadvantages, ranging from internal social, political and economic problems, to issues that are somewhat beyond the country’s control, arising from geography and international trade deals.

Is South Africa still the best entry point for companies looking to get involved in Africa, and, more importantly, is it the gateway to Africa? The answers to these questions lie in the context and interests of a given company: what markets in other African countries they are attempting to access, infrastructure needs, shipping considerations, and labour-force requirements.

What constitutes a gateway?

Saul Cohen, an American geographer, describes gateways as providing the connection between the regional level and the global level of the world economy, acting as the way ideas, people, and goods flow. Gateway countries take on a greater role within their respective regions, emerging as natural leaders. South Africa seems to fit this description, especially given its outsized role in international affairs, across the African continent and beyond.

Geography matters, however, and South Africa, being at the far southern tip of the continent, is not a natural hub – in a physical sense – for the rest of the continent. But its human capital, infrastructure, and institutions have seemingly overcome this relative disadvantage in the past. As other countries in Africa catch up, (and much evidence exists to indicate that they have), the gateway logic then rests on a less sound foundation.

Business in Africa requires local focus

With thousands of different ethnic groups spread across 54 countries, speaking more than 2,000 languages, the African continent has incredible diversity. South Africa alone has 11 official languages and 13 main cultural groups. In addition to the social, cultural and linguistic diversity, the African continent spans four major climate zones with large differences in flora and fauna. Failure to appreciate this diversity has been a reason for business failures in Africa. What works in one location may not work at all in another.

This idea was reinforced in a presentation at Wharton’s Global Business Week (WGBW) in South Africa in September this year by The Abraaj Group, a global private equity firm managing a portfolio of US$10bn, including over a billion dollars invested across Africa.

Ahmad Mazhar, director for Abraaj’s sub-Saharan Africa investment team, stated that the key to success was being on the ground and understanding local considerations. In the case of Abraaj’s business, having a strong local presence was a key competitive advantage, as they would learn about potential opportunities earlier than those that did not have a local presence in the different countries.

From different political institutions, varying amounts of corruption, and diverse business conditions, the only way to succeed is to understand what one faces in each area. One example Mazhar mentioned was the distribution and marketing of consumer products in West Africa – the process hinges upon trust and relationships. Without it, no matter how superior the given product is to the status quo, the product will be rejected as foreign and dangerous. The only way these relationships are built is by being on the ground.

As such, and depending on the type of business activity, locating in the target market may be necessary. Operating from South Africa might not provide the insights needed to navigate varying social, political and regulatory environments.

Geography and transportation infrastructure

The term gateway implies the transmission of ideas, people, and goods. In the physical realm, a gateway must provide access other regions. The continent of Africa is over 30 million km², large enough to contain the US, China, India, and Europe within its perimeter.

The vastness of the continent significantly complicates access. South Africa’s location at the far southern tip of the continent means that geographically it is close to only a handful of other African countries. Having ports on both the Atlantic and Indian oceans provides easy access to global shipping. While the country boasts well-developed networks of roads, railways, and airports for moving people and goods within the country, the links to other regions on the continent are much more limited – the vision of 19th century imperialists, a continuous rail link from Cape Town to Cairo, remains an unfinished project. Much of the layout of the current rail infrastructure in use today is a legacy of colonial policies that were focused not on economic development, but on shipping raw materials to the coast. As a result, the regions are not well connected by rail or road, and in many cases, air transport is the most viable option.

Such considerations are relevant to business across the continent. The cost to ship items via ground transport across swathes of Africa can be very high, not only because of the distances involved, but because of the condition of the infrastructure. Danie Mouton, general manager of business growth at Exxaro Resources, a South Africa-based mining company, spoke at WGBW South Africa about the fact that his shipping costs for coal and iron ore are four times more expensive if shipped overland than they would be if shipped by sea.

Such considerations are relevant when deciding about whether to base operations in South Africa, especially if products are to be shipped elsewhere on the continent. Because of the high differential in transport costs between land and sea, typically the best strategy is to ship via sea to the closest port of the ultimate destination, to minimise the overland cost.

For air transport, South Africa has outstanding airports with numerous departures to cities across the continent and beyond. But this advantage does not work for products and raw materials that are uneconomic to ship via air. Mouton also described a mine that Exxaro considered developing. The mine was located in the Democratic Republic of Congo, to the north, and after considerable analysis, it was determined that the lack of good transportation options would make the project a losing proposition.

Forex risk

One of the major financial risks of conducting business in diverse countries as a multinational company is foreign-exchange (forex) risk, i.e. the risk that fluctuations in currency value could make business dealings in a foreign country unprofitable when measured against the base currency used in the company’s financial statements.

Unfortunately, such risk is prominent in Africa across the continent. The most egregious example is Zimbabwe, a country that has experienced such severe hyperinflation that in 2009 a decision was made to enable transactions to occur in other currencies alongside the Zimbabwe dollar. While this is particularly extreme, significant currency volatility has also been an issue in the Nigerian naira, the currency of one of Africa’s largest economies. This issue of forex risk is directly relevant to the question of South Africa as a Gateway, as it is a factor that companies will seek to minimise.

As the number of countries in which a company operates increases, the exposure to forex risk increases. While this is the reality of global business, risks must be controlled if possible. Hedging can be expensive and, depending on the market, might be infeasible depending upon the scale. If a company’s primary target market is Kenya, for example, by basing in South Africa, a company now has two forex risks to manage rather than just one.

If the South African rand were exceptionally stable, this might not be an issue, but the currency has been in a secular downtrend in relation to the US dollar for over four years, and political instability has caused gyrations. Given the currency risks that exist across the continent, the additional currency risk of South Africa could be a reason to avoid locating there, unless the South African market is the primary focus.

Foreign direct investment

If the consensus holds that South Africa is the gateway, then a logical conclusion would be that there should be relatively more foreign direct investment (FDI) flowing into South Africa vis-à-vis other regions of Africa. Is that currently the case? In Ernst and Young’s (EY) analysis, presented at WGBW South Africa, southern Africa is first in terms of its percentage share of FDI projects in Africa. However, east Africa was a very close second, behind southern Africa by one percent. In terms of the total value of the projects, the two regions were in a virtual tie. Of note, based upon total value, west Africa was ahead of both southern and east Africa. A look at recent trends shows that South Africa’s FDI growth is decelerating, while other regions appear to be accelerating, with Kenya recording a 52% increase from 2014 to 2015. Overall, the FDI data are mixed; they confirm that South Africa is a significant destination for foreign capital, but that so too are other regions. South Africa no longer can be considered the sole or leading destination for investment in Africa.

Internal problems in South Africa

In the past, South Africa stood out as one of the lone developed countries in sub-Saharan Africa, which made it a natural choice for multinationals. However, today one cannot ignore the long list of internal issues with which the country has struggled recently. The majority of the business leaders who presented during WGBW South Africa commented on the tremendous problem that youth unemployment presents.

This issue could prove a ticking time bomb that might ultimately destabilise the country if economic growth cannot supply the job opportunities required. The AIDS infection rate is another serious problem with far-reaching effects on labour productivity, public health expenditures, and life expectancy. If the growth rate in new infections is not stemmed, South Africa is at risk of losing an entire generation. Providing care to those currently infected through the administration of antiretroviral drugs is an expensive undertaking. The infrastructure of the country, while considered an advantage in relation to the rest of the continent, has not received the investment needed to keep pace with the country’s growth. Crime rates in Johannesburg and Cape Town make the two cities some of the most violent on earth. This is bad for business in nearly all aspects – it is a deterrent to entrepreneurship and capital investment, and the best human capital – highly mobile – will decide to settle elsewhere.

The above list paints a dire picture, and unfortunately, it is not exhaustive in outlining all of the problems internal to the country. But the list of problems must be balanced by the numerous advantages that South Africa presents, from highly developed financial markets to the largest middle class on the continent. Moreover, negotiations to be concluded in 2017 for the development of the Africa Continental Free Trade Area (ACFTA) signal promising movement toward further integration on the continent, which could be highly beneficial to South Africa. Such a trade agreement could provide the impetus to harmonise other policies and regulatory frameworks across regions that would enable market access and accelerate investment. By reducing uncertainty, the huge sums needed for infrastructure development might be put to work.

Business within South Africa’s borders

Viewing South Africa as a gateway misses a critical point – the country is an important market in its own right, much more than simply a headquarters location for overseeing activities elsewhere on the continent. With over 50 million people and the largest middle class in Africa, perhaps the best reason to base a business in South Africa is to be able to do business within South Africa.

Mark Slingsby, the founder of RSAWEB, a Cape Town-based  internet hosting and connectivity company, described at WGBW South Africa the advantages to locating in South Africa and doing business in the country.

First, the relative isolation of South Africa from the US, Europe and Asia means that in some cases there is less competition from the global titans of respective industry sectors. This directly results in entrepreneurial opportunities for start-ups and small business. Cape Town, deemed the ‘Silicon Cape’ by some, has the ecosystem to support new ventures, including a skilled work force, access to capital, and infrastructure.

The list of issues that the country is facing can also be opportunities for able entrepreneurs to address. Whether it is mobile communications, internet, health care, and countless other industries, there is plenty of room for the private sector to play a role in delivering critical services and products – especially in areas in which the government is struggling.

Conclusion

South Africa very much lies at a crossroads, as many economic, political and social currents are moving in the wrong direction. If corruption under the current ruling party, the African National Congress, continues unabated, public services will suffer and the decline in infrastructure already in evidence will worsen. Jacob Zuma, the much-maligned president of South Africa, has used the gateway idea to describe the business position of the country: “Our geographical positions as regional business hubs and gateways into our respective regions provide us with the muscle to increase our economic and trade outcomes.”

While he implies that South Africa’s position as gateway is assured, the gateway idea is very much a relative concept, and hinges upon South Africa’s standing in relation to other African nations. From FDI flows to overall GDP numbers, many other countries in Africa are catching up. For the gateway to continue to be viable, the negative trends in South Africa must first be stemmed and then the country can focus on reversing them. South Africa has overcome insurmountable problems in the past and certainly has what it takes to do it again. Many observers, though, would say that time is running out.

Matthew M. Sandretto is the founder and portfolio manager of Greyfeather Capital, an investment company that uses artificial intelligence to manage a long/short equity portfolio on behalf of its clients.  He currently attends the Executive MBA program at the Wharton School of the University of Pennsylvania and is a guest author at the NTU-SBF Centre for African Studies, a trilateral platform for government, business and academia to promote knowledge and expertise on Africa, established by Nanyang Technological University and the Singapore Business Federation. This report was written for the centre.