Our thoughts

Profits and perils of growing in the emerging markets

Author Sukhendu Pal

The rational for investing in the emerging markets is simple. However, entering the emerging markets successfully require considerably more than just tweaking the domestic or developed market strategy. As we work with CEOs of large companies in Europe and theUSA, we see a mixture of enthusiasms and lack of insight of the emerging markets. So many companies from the developed countries try to take shortcut to learning by applying the domestic formula or entering into a partnership of convenience. While only a handful of these partnerships become successful long-term growth stories, most fall apart due to an asymmetry of interests. As a result, any scepticism about the future of the emerging markets held by many senior executives of large companies from the developed countries is born out of ignorance. We see many companies falling into a trap of legacy leadership and management practices that are no longer aligned with the opportunities presented by emerging markets. All facts show that emerging markets will play even a greater role in the global economy and, therefore, the fate of many large companies in the USA and Europe will be determined by how they enter the emerging markets. In fact, the companies, who have taken an opportunistic and short-term view or who lack an integrated strategy for the giants of emerging markets, are likely to suffer most.

Our research shows a remarkable growth story. The gradual opening up of markets in Brazil, Russia,India and China (BRIC countries) is the main reason for us to be confident. For example, emerging markets have recorded a combined annual growth rate of 5.5% over the last two decades while the developed markets grew only by 2.3%. Emerging markets are also made up of an economically diverse group of people that accounts for about 60% of the world’s population. The combined total of flow of funds into the emerging markets is closer to $100 billion since 1995. If nothing else, these numbers speak for themselves.

So, how should companies from the developed world profit from the emerging markets and what do they need to do to avoid disappointment? Here are some of our findings after working and helping grow businesses in the emerging markets since 1987:-

First, many CEOs from the developed countries find the very idea of the distributed operating structure discomfiting. But they run a terrible risk of disappointing shareholders if they do. Some CEOs have understood, in principle, the importance of a global operating strategy, but they consistently underestimate the value creation potential of the emerging countries. The assumptions persist that emerging countries do not represent viable markets, because their consumers cannot afford to buy expensive products, when the household spending in Asia alone is estimated at £102 billion in 2009, offsetting the plunge in spending in theUSA andEurope.

Second, senior executives also tend to underestimate the skill base and talent in the emerging countries, often on the grounds that potential employees lack the education and training to meet standards of the USA and Europe. And they overestimate the prevalence of corruption, quality flaws, IP protection, risky supply chains, and unreliability when sourcing from these countries.

Third, the new model for global operations is based not on the priorities of home, but on the needs of the marketplace and on locating work wherever it can be conducted most efficiently and managed most profitably. But adopting this new operating model needs courage and conviction. When it comes to crafting a global operating strategy, most CEOs make two assumptions: (a) the central challenge is to strike the right balance between economies of scale and responsiveness to local conditions, and (b) the more emphasis they place on scale economies in their worldwide operations, the more global their strategies will be. These assumptions are inherently limited. Some successful companies (e.g., GE, HSBC, Vodafone, Oracle and Microsoft) have found significant opportunities for value creation in exploiting, rather than simply adjusting to or overcoming, the differences they encounter at the borders of their various markets. As a result, we see value chains of successful companies spanning multiple countries including China and India. It is easy to spot the advantages of treating China and India synergistically and getting the best of both worlds but very few companies from the USA and Europe succeed in leveraging value from both. It’s not surprising that companies from Europe and theUSA find it hard to develop an integrated operating strategy for China and India. But they can learn from successful companies in other industries who navigated this path before. Over the last ten years, we studied 13 companies across the world spanning multiple industry sectors. These companies include: GE, HSBC, Vodafone, Oracle, a pharmaceutical company from Europe; an Anglo-Dutch consumer packaged goods company, five financial services companies from Europe, a bank from the USA and an electronics manufacturer from Asia-Pacific region. All have operations in both countries. However, most of these companies have customised their operating models to the local institutional context, which makes it hard for them to generate synergies from their operations in the two countries. Another barrier to developing an integrated operating strategy for China and India arises from success. For example, at the European pharmaceutical company, there is a hotline from the Chinese operations to the European headquarter. Because the pharmaceutical company has not sold enough medicines in India nearly as long, and the senior executives belief in the myth that IP protection is harder in India than China (when facts suggest otherwise), that market is starved for attention. The converse is true of the Anglo-Dutch consumer packaged goods company – their success in India means that the Indian subsidiary has a direct line to theUK and the Netherlands, while the China operation doesn’t enjoy the same privileges.China shines in the pharmaceutical company’s world and India sparkles in Anglo-Dutch consumer packaged goods company. Both companies have neglected one of the two significant markets and both have achieved less than they could have, and it gets reflected in their performance. It may proved difficult for the pharmaceutical company and the Anglo-Dutch consumer packaged goods company from Europe to make the best use of China and India, but it isn’t difficult as GE, Oracle, Vodafone, GSK, HSBC and Microsoft show.

Fourth, consider, for example, one large, well-established European pharmaceutical company, which has an annual growth rate of 26% in the emerging markets, and only 2% in mature, developed-country markets. Already, almost 18% of its revenues and nearly 23% of its profits come from emerging markets, and those percentages are increasing every quarter. Relative to other companies’ leaders, the top executives of this company are somewhat advanced in their thinking; they say they aspire to sell their medicines around the world. But their actions tell another story. Their center of gravity remains in North America and Europe: That is where 85% of the company’s assets are located and where 98 of the top 100 senior executives grew up. These executives have lived their lives primarily in developed markets; they socialise largely with people from similar backgrounds; at work, they put individuals who resemble them on the fast track for promotion; even the person, who heads China and India, has been implanted from Europe; and they all share a dominant logic in the way they make decisions. It is no surprise that they think of developed and emerging markets as distinct from one another, and that they have neither a structure nor a strategy to integrate them.