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Competing in Emerging Markets

By Mari Sako

Communications of the ACM, Vol. 58 No. 4, Pages 27-29
10.1145/2736289

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The Berlin Wall fell in November 1989. This was a world-shaking event that triggered the disintegration of the Soviet Union, transforming our view of competition between nations. It also altered how we think about innovation-based competition in emerging markets. Now, 25 years later, we can take stock of these emerging markets.

The label "emerging markets" was coined by Antoine van Agtmael in the early 1980s. It remains alluring for investors, innovators, and governments. Yet it remains difficult to characterize them. Our view of emerging markets has changed over time. Precise understanding might help innovators and business managers compete more effectively. This column explores these claims.

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Excitement about Emerging Markets

The interest in emerging markets is in part because they grow fast and have potential for further growth. Growth rates have slowed somewhat since Goldman Sachs started "dreaming with BRICs," referring to the emerging economies of Brazil, Russia, India, and China.2 But as developed economies see little growth in the age of austerity, emerging markets remain important destinations for global corporations to sell goods and services.

Fast growth comes because emerging markets provide low-cost locations for sourcing inputs, processing products, and delivering services. Firms led by giants such as Foxconn in electronics and Pou Chen Group in footwear generate wealth and jobs as suppliers to global brand owners (see my July 2011 Communications column).5 These firms are part of global value chains and have been catching up with firms from advanced economies. They have accumulated capabilities in production but also in research. By 2010, U.S. Fortune 500 companies had 98 R&D facilities in China and 63 in India. General Electric's health-care arm had multiple facilities.

Emerging markets also have innovative firms making new products and services. Sometimes these are dramatically cheaper than their Western equivalents: $3,000 cars by Tata Motors, $300 computers by Lenovo, and $30 mobile handsets by HTC. These firms do not merely imitate U.S. and Japanese firms, but innovate to meet the needs of low-income consumers at the bottom of the pyramid and the rising middle classes. When prices are one-quarter to one-third of developed country prices, economies of scale and incremental process innovation is not enough. Profound understanding of local consumers' needs enables innovators to strip down unnecessary functionalities to reduce costs drastically. "Frugal innovation" focuses on product redesign and the invention of new models for production and distribution, not on technological breakthroughs.7 Healthcare is a hotbed for frugal innovation with General Electric competing with emerging market firms to develop low-cost portable medical equipment such as electrocardiogram and ultrasound machines.

"Local dynamos"1 in emerging markets are suppliers and/or competitors of developed economy multinationals. Already in 2010, 17% of the Fortune Global 500 companies (ranked by revenue size) were headquartered in emerging markets. McKinsey projects this will rise to 45% by 2025.3 Japanese companies with innovation in lean manufacturing posed threats to Western companies in the 1980s. Emerging market multinationals from China, India, Brazil, Mexico, Turkey, and many other countries pose similar threats, but with a material difference leading to greater uncertainty in the risk-reward equation.

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Defining "Emerging Markets": Combining Economics and Politics

The New York Times called van Agtamel a marketing genius when reviewing his book, The Emerging Market Century. The label "emerging market" broke from seeing the Third World as underdeveloped or developing. Economic development had been about helping these countries with international aid and technology transfer. Developing countries protected domestic industries by erecting international trade and investment barriers. Some countries were firmly entrenched in the planned economy with the state owning the means of production. By contrast, emerging markets have free international trade and foreign direct investment (FDI) and thriving private sectors as engines of growth.

The fall of the Berlin Wall in 1989 created "transition economies" in Central and Eastern Europe, moving from planned to capitalist models. There was a strong belief that capitalist economies would thrive only if entrenched in multi-party democracies with free elections. The Washington Consensus of the 1990s saw the International Monetary Fund (IMF) advance financing only if countries would move toward open, liberalized, and privatized economies. However, China, Russia, and Brazil endorsed options other than liberal democracy, giving rise to the label of "state capitalism"6 in which state-owned enterprises are an alternative to private-sector firms. Emerging market leaders believe that state capitalism is a sustainable alternative to liberal market capitalism. Economics and politics in emerging markets come in different colors and stripes.

Defining emerging markets today is more difficult than when the Berlin Wall fell. Low and middle-income countries with high growth potential remain part of the definition, but the expectation of 25 years ago that they are all moving toward liberal capitalist economies has changed. Some governments of emerging markets control resources and political freedom in ways liberal democracies do not.

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Emerging Markets: Are They Behind or Ahead?

It is useful to examine the notion of innovation catch-up by emerging market companies. Some branches of science and medicine might give Western firms an edge, but a broader meaning of innovation shows emerging market multinationals gaining ground in innovation that meets the needs of emerging market consumers. MTN from South Africa appears stronger than Western mobile operators in providing services to other African countries. Such south-south tradethe movement of goods and services from one emerging market to anotherhas been on the rise; it accounts for approximately half of total trade for China, and almost 60% of total trade for India and Brazil. Much is in agricultural products and minerals. But it is spreading to manufacturing, especially in renewable energy products (solar photovoltaic cells and modules, wind-powered generating sets, hydraulic turbines).


The interest in emerging markets is in part because they grow fast and have potential for further growth.


It is also useful to examine who is ahead or behind in implementing institutional reforms. Many emerging market countries suffer from unstable, weak, and inadequate institutions for tax collection, enforcement of intellectual property rights, and other functions. Yet global institutions are increasingly led by nationals from emerging market countries. These leaders set the global policy agenda and influence the global rules of the game. The fifth BRICS summit in March 2013 launched a New Development Bank to be headquartered in Shanghai as an alternative to international financial institutions such as the World Bank.

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What This Means for Developed Economy Multinationals

To operate successfully in emerging markets, multinationals must navigate both host governments and the needs of local consumers. They must make clear choices about how best to do this. Archrivals Procter & Gamble and Unilever provide a good comparison. P&G is bigger (84 billion USD revenue) and more profitable (12.9% net profit margin) compared to Unilever (67 billion USD revenue and 9.6% net margin). Yet, Unilever has higher sales turnover (57% as compared to P&G's 38%) in fast-growing emerging markets.

P&G is global, operating in 80 countries and touching the lives of people in 180 countries. However, P&G centralized R&D and other functions to speed up product roll-out and to reduce the cost of operations (by 10 billion USD by 2016). This was done to compete globally, but it means less adaptation to local markets and strategic decisions not to enter new markets. P&G focuses on 10 big emerging markets (Brazil, Russia, India, China, South Africa, Nigeria, Poland, Turkey, Mexico, and Indonesia).4


Global institutions are increasingly led by nationals from emerging market countries.


Unilever sells products in 190 countries, facilitated by a long history of adaptation and customization in local markets. It has built a large portfolio of relationships with local joint venture partners and distributors. This raises overall costs, but Unilever can reach market segments not normally touched by multinationals from high-income countries. Unilever packages shampoo and toothpaste in small sachets to be sold to low-income consumers, and its decentralized subsidiaries help develop a deep understanding of both consumers and host governmentsthe latter essential for anticipating regulatory and institutional changes.

Which will succeed best in emerging markets, P&G or Unilever? Any excellent company might combine aspects of these strategies, but the choices are difficult and involve trade-offs. The jury is still out on the best pathway to profitability and growth in emerging markets. P&G seeks to reduce cost by exploiting global economies of scale. Unilever seeks to adapt to local consumer needs through low-cost business innovation.

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Conclusion

When the Berlin Wall fell 25 years ago, emerging markets were believed to become liberal market economies. Now we know better. Some emerging market countries follow different political arrangements, including state capitalism. Emerging markets present multinational corporations with unprecedented opportunities, providing large markets for their products and low-cost locations for increasingly skilled labor.

Balanced against these opportunities are the challenges. There are two, both of which appear to give emerging market firms an upper hand over multinationals from developed economies. The first is the challenge of engaging in low-cost or frugal innovation that requires a profound understanding of unmet consumer needs. In China, Alibaba's lead over eBay, Baidu's lead over Google, and Xiaomi's lead over Apple are just a few examples to suggest this. One reason is that business innovation requires attention to distribution and logistics networks as well as to designing products and services.

The second challenge lies in understanding host governments. They impact business operations through granting of permits and licenses, protecting intellectual property, regulating foreign direct investment, and so on. Successful companies anticipate changes in regulation and rules. The unstable nature of the rule-making institutions in emerging markets adds uncertainty and risk. It pays for companies to understand these things.

Emerging markets require companies that understand frugal innovation and how to influence regulation and rules in localities that are unstable or unpredictable. Having antennae on the ground via subsidiaries in decentralized multinational corporations and/or through use of local emerging market firms as partners, seems to be a winning formula.

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References

1. Chin, V. and Michael, D.C. BCG local dynamos: How companies in emerging markets are winning at home. Boston Consulting Group, 2014.

2. Goldman Sachs. Dreaming With BRICs: The path to 2050. Global Economics Paper No. 99. 2003.

3. MGI. Urban world: The shifting global business landscape. McKinsey Global Institute, 2013.

4. P&G chief hopes his mea cupla will help turn the tide. Financial Times (June 21, 2012).

5. Sako, M. Driving power in global supply chains. Commun. ACM 54, 7 (July 2011), 2325.

6. The Rise of State Capitalism, special report on emerging market multinationals. The Economist (Jan. 21, 2012).

7. The World Turned Upside Down, special report on innovation in emerging markets. The Economist (Apr. 15, 2010).

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Author

Mari Sako ([email protected]) is Professor of Management Studies at Saïd Business School, University of Oxford, U.K.


Copyright held by author.

The Digital Library is published by the Association for Computing Machinery. Copyright © 2015 ACM, Inc.

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