Two types of economies emerging, old business models need a rethink

Manufacturers from developed nations have been capitalising on the low labor costs of emerging economies for a long time. It's a familiar story: product design happens in, say, the US, 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. 

GE CEO Jeffrey Immelt said recently that he expects 60% of company revenue growth to come from emerging markets over the next ten years. Meanwhile, big pharma expects about 70% of future business to flow from developing countries. China, in 2009, surpassed the U.S. for the first time to become the world's top market for new vehicles and the growth of China's middle class is expected to increase at an 11% compounded rate over the next five years. 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. On one hand, rapidly developing countries such as China, India and Brazil are characterised 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 have higher household incomes. With GDP growth of only 1% to 4%, these economies are expanding more slowly but their populations have 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. 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 US 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 organisation — one that can tailor different approaches on the basis of market needs, product characteristics, cultural differences, available resources and strategic goals. 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 organisation'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 customised 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 organise to do this — by country, by product, by strategic business unit." 

Sometimes, gaining market share fast is paramount, says Gang Yu, 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. 

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 race car 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. 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. 

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 customised according to market need and demand. "Postponement strategies such as delaying customisation 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 customise 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 Localisation, Better Acceptance 

Yu says that localisation 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%. Before that, Sun and HP dominated the server market. But when Dell entered the market with decent quality and lower prices, Dell began to gain market share. 

In addition to customising products for specific markets, every company entering an emerging, high-growth economy has to localise the business model to fit the local customers. 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 localisation, the better the acceptance." 

BCG senior partner and managing director Hal Sirkin 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 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 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. 

Differentiated product design -- Because of their different needs and income levels, high-growth and slow-growth markets require different types of products. 

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. 

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. "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," says Manget. 

One thing is clear: you can't just export your operating model to an emerging economy. To compete successfully, you have to develop a new model that embraces the cultural and growth differences/ "Then you can take some of those key insights you gained and use them to reinvent your Western operating model," says Manget. In a two-speed world, each market has lessons for the other.