Manufacturers from developed nations have been capitalizing on the low labor costs of emerging economies for a long time. It’s a familiar story: Product design happens in, say, the United States, and manufacturing gets cranked out in Southeast Asia. Then the products are shipped to the developed world for final sale. But in recent years a new trend has emerged. Many of these same companies are now moving R&D, distribution, and sales to China, India and elsewhere in the developing world because they see market opportunities where the GDP is growing dramatically and household incomes are on the rise. For example:
- GE CEO Jeffrey Immelt said recently that he expects 60% of company revenue growth to come from emerging markets over the next 10 years.
- Big Pharma expects about 70% of future business to flow from developing countries, says Adam Farber, partner and managing director at The Boston Consulting Group (BCG).
- S&P 500 large-cap companies that break out sales and profits earned abroad (roughly half of that group) reported that 47% of 2009 sales (some $2 trillion) originated outside the U.S., up from 45% in 2007. Many analysts expect to see 50% soon.
- China, in 2009, surpassed the U.S. for the first time to become the world’s top market for new vehicles, according to the market research firm ReportsandReports.
- The growth of China’s middle class is expected to increase at an 11% compounded rate over the next five years, according to independent brokerage and investment group CLSA. That’s more than $2 trillion in incremental discretionary spending capability.
Welcome to “the new normal” — a two-speed world in which two types of economies are emerging: low-growth and high-growth. On the one hand, rapidly developing countries such as China, India and Brazil are characterized by high growth but low average household income. With GDP ranging from 8% to 12% and some 2.6 billion people, these markets are hard to ignore.
By contrast, the low-growth countries — most of the U.S. and Western Europe, for instance — have a slower rate of economic growth but higher household incomes. With GDP growth of only 1% to 4%, these economies are expanding more slowly but their populations have higher salaries — and more to spend.
The two types of economies present two very different business environments, each with different needs and challenges. Success in each market requires different products, different ways of operating and different ways of looking at the world. In this article, business leaders, Wharton professors, and experts from BCG consider how this two-speed world will affect global business strategies — and what it will take to thrive.
To compete successfully, companies must understand the needs of each market and create a strategy for meeting those needs cost effectively, all while differentiating themselves from their competitors — both local players and multinationals. Building a low-cost global production network that draws on the strengths of each geographical region is critical. So too is innovating products, processes, and business models to stay one step ahead and increase margins wherever possible.
No Step-by-Step Process
There’s no step-by-step process for positioning a company to excel in both worlds, no one-size-fits-all strategy, even for players in the same industry. The key is to retool strategies when necessary, implement lean principles, and rethink where and how to conduct value-chain activities such as manufacturing and R&D. For instance, GE Healthcare designed, developed, and built budget-priced MRI machines in India and China for sale in India. But potential demand for the machines proved strong in the U.S. as well, so the company is currently awaiting FDA approval to begin selling them.
According to Joe Manget, BCG senior partner and global leader of the firm’s operations practice, the two-speed economy is forcing companies to develop new operating models to successfully compete. “Take Tata Motors’ launch of the Nano car,” he says. “The rapid pace of product development and the extremely low product cost will have Western companies struggling to improve their operating models to catch up.”
Ultimately, success in a two-speed world depends on having a flexible organization — one that can tailor different approaches on the basis of market needs, product characteristics, cultural differences, available resources and strategic goals, according to experts at Wharton and BCG.
Wharton management professor Lawrence G. Hrebiniak believes that the two-speed equation should always begin with senior management decisions about which countries are attractive and which are not. “Corporations have to decide which countries to invest in,” he says. “If we focus on developing countries, how? Strategic alliances? Acquisitions?” It depends on the attractiveness of these countries in terms of their laws and regulations — and whether there’s already a market to tap.
Corporate strategy, as well as an organization’s architecture, helps senior management focus on what is critical, says Hrebiniak. “If the product is big enough, you focus on the product,” he says. An Apple product, for example, is the same everywhere. Before selling it in China, India, Brazil, or any other high-speed economy, Apple will invest in customer segmentation and market analysis to see if will fly. But if your product can be customized for different markets it becomes a question of where you focus. It starts with due diligence at the corporate level, says Hrebiniak. “Business leaders must decide how to organize to do this — by country, by product, by strategic business unit.”
Sometimes, gaining market share fast is paramount, says Gang Yu, PhD, chairman of The Store Corporation — China’s fastest-growing e-commerce company — and former vice president of Amazon.com’s supply chain. Amazon wanted to gain market share quickly in China, but building its brand there would take too long. “Amazon felt it was easier to enter China [through a partner] that already had a large market share,” says Yu. So instead of starting from scratch in a country where it was not well known, the e-commerce giant acquired Joyo (which means “excellence” in Chinese) in 2004 when e-commerce was revving up in the developing world. At the time, however, Joyo didn’t meet Amazon’s quality standards. So at first the partners operated as two separate businesses. Eventually, when Joyo improved its service level to Amazon’s standards, they integrated their two Websites. In other words, Amazon took a two-stage approach. First it grabbed market share by acquiring a local partner. Then, it built its brand. “It uses both names right now,” says Yu. “People know that Joyo is Amazon.” Web shoppers can go to either site today.
The key lesson: Amazon didn’t follow a prescribed rule for winning in a high-growth economy. It looked at the market where it wanted to gain share and crafted an acquisition strategy based on its existing strengths, weaknesses and target time frame.
Companies should expect to fine-tune their strategies if they want to change speeds, just as racecar drivers must adjust their strategies for different tracks. According to Benjamin Pinney, a principal in BCG’s Shanghai office, what works at one speed won’t always work at another. As an example, he mentions a fast-moving beverage company that built a strong position in China through acquisition. In the past and in other markets, the company had succeeded through disciplined integration and cost-cutting, driving lean operations and standard sales-and-marketing playbooks into acquired companies.
But the company had to adjust its approach in China: “When you bring business systems, mindsets, and behaviors driven by cost and efficiency into a high-growth, dynamic market, you’re setting yourself up to lose,” Pinney notes. The playbook for winning in developing market is different. It’s not that efficiency doesn’t matter, but if a management team in a fast-growing economy turns inward and spends its time installing structures and systems mandated by headquarters in the developed world, it takes its eyes off the market. In a slower moving market, this might not matter. But in this case, it took many quarters and decision cycles just to get permission to re-focus on growth. And in each quarter that passed, more agile competitors were taking market share. In effect, each passing quarter diminished the value of the company’s costly acquisitions.
“China’s in a go-go-go mode, especially in consumer markets,” says Pinney, comparing the situation to a U.S. land rush in the 1880s, when 50,000 people lined up on the Missouri border to get free homesteads. “When the bell rang, everyone grabbed a parcel of land.” Of course, this era won’t last forever in China any more than it has in other economies. In some industries, consolidation and efficiency are already the name of the game as policy makers in Beijing focus on economic restructuring and factor costs. Companies need to be operating at multiple speeds even just within China.
Balancing fast- and slow-growth markets demands different skills and new approaches. Companies that do it successfully are able to differentiate themselves at both speeds. “Companies that want to win at two speeds may need to adjust basic strategies,” says Pinney, “even choosing where lean products and processes considered part of the ‘company DNA’ are not the right answer.” The question, he says, is how to design your operations to compete in fundamentally different markets against competitors from both low-cost countries and developed economies. When it comes to manufacturing, you need to “clutch” between different approaches.
For instance, some companies use the same facilities to manufacture parts or sub-assemblies that are later customized according to market need and demand. “Postponement strategies such as delaying customization allow companies to buy time until demand signals are clearer,” says Pinney. Based on specific orders and close-to-market signals, they often do assembly for high-end and low-end products at the same plant, then customize for either high-growth or slow-growth markets in a different facility. With this approach, final assembly, finishing, or packaging can be done separately — and closer to the end-market. This requires attention to detail, a careful analysis of every step of the process, and a thorough knowledge of the markets served. The worlds of the small craft shop and the mass production line are far apart, and it requires significant management skill to run both as a part of a single value chain.
Better Localization, Better Acceptance
Yu says that localization is a key to successfully navigating the two-speed world. Segmenting customers and understanding demand at the local level (in both high- and low-growth economies) is required. “When Dell entered China,” he says, “no one believed that its direct sales model would work there.” It was a new model — direct sell, not through a retail channel. This was new in China, where sales typically come through computer stores or department stores, not from the Web or a call center. Dell’s model didn’t fit China’s buying habits. “So when Dell entered China, the company had to operate Chinese style,” says Yu. Dell revised its model. It began to make some sales through channels, and much less through direct sales. It gained a name and reputation by lowering server prices by a whopping 40%. “Then a lot of Chinese companies began to know about Dell,” says Yu. Before that, he says, Sun and HP dominated the server market. But when Dell entered the market with decent quality and lower prices — “Chinese companies are sensitive to price,” says Yu — Dell began to gain market share.
In addition to customizing products for specific markets, every company entering an emerging, high-growth economy has to localize the business model to fit the local customers, says Yu. One way to do this is to hire local people who know the countries and the customer segments, who trained locally but understand the developed world as well. That’s what Dell did, says Yu. “It knows how to combine the two cultures,” he says. “The better the localization, the better the acceptance.”
BCG senior partner and managing director Hal Sirkin agrees. “It sounds like a cliché, but companies really do need to master the ability to think globally but act locally. Customizing everything for local markets is key.” He offers four other guidelines for companies that want to compete successfully in both high- and low-growth worlds:
- Profit vs. growth — In a two-speed world, companies must differentiate themselves in different ways for each market, says Sirkin. They must focus on profits in slow-growth markets, increasing their margins wherever possible through lean operations and by developing new products and services that can command a premium price. But in rapidly expanding economies, they need to focus on growth, on laying the groundwork for future profitability.
- Best price vs. best value — In the emerging economies, many people are buying their first cell phone or their first car, so companies need to develop “best price” offerings that are affordable at lower income levels. But buyers in developed markets are looking for the best value, which may be lowest price, but could be the best quality at a premium price. “In either market, companies need a fundamentally better value proposition than their competitors,” notes Sirkin.
- Differentiated product design — Because of their different needs and income levels, high-growth and slow-growth markets require different types of products. Sirkin contends that companies must design products for the “current billion” consumers in the U.S., Western Europe, and Japan at the same time that they design products for the “next billion” consumers in China, India, and other emerging economies.
- New reward systems — The projections of single-digit growth in mature markets and double-digit growth in emerging markets mean we’ll need to rethink how we structure growth-based incentive and compensation plans to keep them fair, says Sirkin. For instance, increasing business by 5% in a market that’s only growing at 2% is better than a 5% increase in a market that’s growing at a rate of 10%. But current systems would tend to reward both equally.
Still, there’s no clear-cut approach for doing business at both speeds. Different companies do it differently. “Take a look at Apple Computer vs. Research in Motion (RIM),” says BCG’s Manget. RIM manufactures Blackberries in each region. They manufacture in Mexico for the North American market and in Asia for the Asian market. Apple builds everything in one mega factory. Which one is better?” he asks. “If you believe that it is all about cost, Apple has a better model. If you believe it’s all about efficiency, maybe RIM has a better approach.”
The big tradeoff is cost vs. local customization. “If you make Blackberries in Mexico, but you don’t understand Chinese demand or the currency changes,” says Manget, “you’ll have problems.”
A Different Challenge
According to Wharton management professor Mauro F. Guillen, some high-growth countries such as Russia and Brazil are thriving because they have natural resources. China, on the other hand, imports natural resources and has positioned itself as the low-cost manufacturing hub of the world. “But that is an ephemeral advantage,” says Guillen. “When household income catches up with GDP, China may lose its manufacturing edge.” If and when that happens, China will still be an attractive consumer market. But since its consumers behave differently than those in the developed world, success will require more than just manufacturing and selling there. “You want to keep an eye on your R&D. You want to keep it close to your manufacturing center.”
For mature products that require less innovation, it can be a different story, notes Wharton management professor Olivier Chatain. When innovation is critical, companies from developed countries have an edge because they generally have access to more resources and better technology. But when products are mature and need less innovation, manufacturers from low-cost, emerging economies can steal market share. “Take the aircraft industry,” he says. “Embraer, a Brazilian aircraft maker, is gaining global market share because the basic technology is mature and less innovation is required.” Meanwhile, major players such as Boeing and Airbus are not as advantaged in the world market as they were 50 years ago when they had more innovation and experience under their belts.
Bottom line on the two-speed world: The basic principles of how to succeed globally have not changed. Successful companies will keep costs low by manufacturing in developing countries when it makes sense and applying lean tools and techniques; they will move R&D to high-growth nations with burgeoning markets for innovative products; and they will become experts in the local laws, customs, and cultures of those countries so that they can compete against — and when appropriate, acquire — local companies.
What has changed, says Chatain, is that a lot of the economic growth today is not in the western world. “That’s what’s new. It’s a different challenge.” And it’s more complex, he says. “There may be a renewed sense of urgency, but doing the work of succeeding abroad hasn’t changed.”
One thing is clear, says Manget: You can’t just export your operating model to an emerging economy. “To compete successfully, you have to develop a fundamentally new model — one that embraces the cultural and growth differences,” he says. ”Then you can take some of those key insights you gained and use them to reinvent your Western operating model.”
In a two-speed world, each market has lessons for the other.