Gearing Up for the Two-Speed Global Recovery

October 2010

The rising economic tide that follows a global recession typically swells highest in developed countries. Not this time.

In the aftermath of the worst recession in a generation, Western businesses continue to be dogged by stubbornly slow growth and depressed domestic demand. Persistent unemployment, higher taxes and continued volatility in asset values only aggravate their task. Meanwhile, having experienced only a mild crisis of consumer confidence and subsequent quick recovery, a number of emerging economies are now enjoying world-beating growth.

A new, two-speed global economy is emerging, and it seems likely to become an enduring reality. Going forward, long-term economic fundamentals suggest emerging markets such as India, China, Brazil and parts of Africa will generate most of the new demand in many industries. Projections for demand in the oil sector, just to take one example, currently indicate virtually all future growth will come from developing economies.

Beyond strong current growth driven by a rapidly expanding middle class, these up-and-coming economies hold huge untapped potential for the future.

For example, one emerging economy’s planned transformation of its rural postal network will bring universal banking services and access to life insurance to its massive base of rural customers—and simultaneously stimulate further growth. That’s because one dollar invested in life insurance translates into an estimated 1.65 dollars in overall local GDP growth.

Here’s how: Studies by The World Bank suggest a direct correlation between insurance consumption and economic growth, because life insurance encourages long-term saving that can be invested in infrastructure development and other areas. In rural regions, increased insurance coverage encourages people to consume more because the greater financial security it offers reduces the instinct to hoard cash to guard against a disaster. It also enhances risk-taking ability, promoting entrepreneurship in rural areas and triggering a multiplier effect in terms of employment.

1. Multinationals with positions in emerging markets are already outperforming their peers.

Access to higher-growth emerging markets has been an important driver of multinational performance throughout the downturn. In 2009, while Honda Motor Co.’s global automotive and power product businesses saw unit sales declines of 10 percent and 14 percent, respectively, its motorcycle operation enjoyed increased unit sales (up 8.5 percent) because of the company’s positions in emerging-market economies such as India and Vietnam.

Similarly, consumer products firm RB saw its revenue grow strongly, helped by a robust emerging-market presence that generates 19 percent of its global sales. The company makes acquisitions to expand its distribution networks in these markets a high priority because it sees substantial growth opportunities to serve new middle-class consumers.

RB also wants to expand its offerings in these regions beyond such staple products as Dettol disinfectant or Vanish stain remover to include products more commonly found in developed markets, such as Finish dishwasher tablets, which could appeal to consumers now contemplating their first dishwasher purchase.

Companies lacking a foothold in emerging economies must choose whether to participate in this growth as followers or remain at home and fight for share in a stagnant domestic market. Latecomers will need to take shortcuts to build market presence quickly, which probably means pursuing acquisitions and joint ventures rather than taking a more time-consuming organic, greenfield approach. US adult stem-cell player NeoStem took this route in 2009 when it acquired China Biopharmaceuticals Holdings and a resulting controlling interest in Suzhou Erye Pharmaceuticals Co.

However, the road to emerging-market success can be rocky, and not all entry attempts have been successful. Failing to anticipate the distinctive needs and expectations of local customers is a common problem. For example, one well-known Western luxury jewelry maker’s China entry has been unable to replicate the success the company enjoys in most other countries. Why? Its stores are too small. Chinese consumers dislike little stores, which make them feel unwelcome.

Understanding the often unwritten rules of engagement is equally important. In China, for example, winners plan their strategies to coincide with the government’s cycle of five-year plans (the country is currently operating under its 11th such plan), and understand that a longer time horizon may be required here than in other emerging markets. This means addressing the long-term concerns of China’s markets as well as Chinese customers, with a reduced emphasis on quarterly reports geared to shareholders’ concerns.

For example, Vestas, the Danish wind power company, is building a value chain in China capable of fully supporting the construction of wind turbines in its factories there. Vestas, which has been in China for about 25 years, works continuously to improve its Chinese sourcing capabilities and expects to produce 100 percent made-in-China wind turbines soon. The company’s long-term strategy of establishing wind power technology leadership meshes well with China’s focus on environmental protection and sustainable development.

2. At the same time, emerging-market players are expanding beyond their borders.

Many domestic companies in these markets have taken advantage of the recession-driven slowdown in global M&A to accelerate their own cross-border purchases.

With enviable capital availability and favorable exchange rates, Brazilian companies are looking to markets in North America and Europe for growth. A notable early example: In 2006, Brazil’s Vale outbid US players Falconbridge and Phelps Dodge to take over Canadian mining giant Inco.

More recently, the acquisition of US food distributor Keystone Foods by Marfrig Alimentos for $1.26 billion could almost triple the size of the Brazilian meat processor and make it a lead supplier to McDonald’s Corp., ConAgra Foods, Campbell Soup Co., Subway, Yum Brands and Chipotle in a dozen countries (the deal was pending approvals by antitrust agencies at the time of writing).

When it comes to shopping sprees, however, Chinese companies have had the greatest appetites and the deepest pockets. Together they made a record 298 outward investments in 2009, worth almost $43 billion, placing China third in cross-border M&A behind the United States and France. A variety of motives drive these acquisitions, with access to energy sources and natural resources at the top of the list, followed by market expansion and the ability to secure new technology and R&D capabilities.

With less competition (the recession having sidelined many players), these companies have found more good deals. In the beleaguered auto industry, Chinese conglomerate Zhejiang Geely Holding Group picked up Volvo Cars Corp. Auto industry insiders are alarmed at the progress Chinese automakers have been making, and some have revised dramatically downward the assumed 10 to 15 years that these companies will need to become globally competitive.

China appears ready to make global expansion a keystone of its next five-year plan, with the explicit goal of accessing skills, technology and management expertise through cross-border acquisitions. But similar objectives are evident among other emerging-market multinationals as well.

Crompton Greaves, part of India’s Avantha Group, has made a number of international acquisitions with the aim of establishing itself as a first choice global supplier of high-quality electrical equipment. Targets have included Belgium’s Pauwels in 2005; Ganz in Hungary in 2006; Ireland’s Microsol Holdings in 2007; Sonomatra of France and MSE Power Systems in the United States in 2008; and the United Kingdom’s Power Technology Solutions in 2010.

Acquisitions in developed markets have brought access to technology and management expertise. However, a notable feature of this M&A wave is that much of the action focuses on other emerging markets, where the acquirer’s domestic experience is immediately relevant.

In 2006, Brazilian bus manufacturer Marcopolo agreed to form a joint venture with Tata Motors of India to produce buses for the Indian domestic market. The plant, which began commercial production in 2009, will ultimately be able to produce 30,000 vehicles a year.

Bharti Airtel, a leading integrated telecommunications player in India, played to its emerging-market strengths by purchasing mobile operations in 15 African countries from Zain for $10.7 billion in 2010. The company’s home-market experience in dealing profitably with customers who generate low average revenue per user gives it distinct advantages over Western players attempting to enter these markets.

While cross-border acquisitions present new opportunities, they also put new demands on emerging-market companies, which typically have little experience managing in an international environment. Firms are adopting a variety of approaches to bridge this gap, with some looking to import experienced managerial talent from around the world and others using foreign postings and exchanges to educate their management teams and build bench strength.

3. Within emerging markets, domestic players continue to develop new sources of competitive advantage.

Three trends deserve particular attention in this arena.

Playing technology leapfrog
Vast markets such as China and India have nurtured correspondingly outsized domestic enterprises capable of making large-scale investments in R&D, capital equipment and new technology. China’s investments in new steel mills, for example, have enabled it to become the world’s largest steel producer, and key players have begun to upgrade existing plants with new technology.

China’s ability to coordinate and direct investment across its huge economy plays an important role in burnishing its world-beater credentials. The Chinese government has signaled its desire to have 60,000 alternative energy vehicles operating in 10 cities by 2012, providing the incentive for companies to invest in these green machines.

Take BYD Co., a Chinese manufacturer of automobiles and rechargeable batteries that has developed technology for producing safer lithium-ion batteries. In March 2010, the company’s automotive subsidiary offered its first plug-in hybrid-electric vehicle to the general public in China; expected to be available in the United States and Europe in 2011, the plug-in hybrid sedan could potentially sell for half the price of PHEVs developed elsewhere.

The relatively recent establishment of many emerging-market companies is also an advantage, because firms aren’t burdened by expensive legacy infrastructure or received wisdom about success that often constrain the thinking of perennial incumbents. Many of these companies are bypassing conventional technology and re-imagining entire industries.

In Africa, for example, telecom operators like Kenya’s Safaricom have capitalized on consumer willingness to adopt mobile phones as the accepted communication standard over fixed-line copper networks. This, in turn, has triggered the rapid adoption of innovative, mobile-based services such as banking, agricultural trading and health care that can be delivered at a fraction of the cost of traditional, brick-and-mortar versions.

Developing deep specialization
The emergence of highly competitive clusters of focused specialists in large emerging markets could ultimately make it impossible for new entrants to achieve comparable performance.

For example, the Chinese town of Qiaotou manufactures 60 percent of the world’s clothing buttons and 80 percent of its zippers. The combination of enormous scale and fierce competition among local players has resulted in performance levels other competitors can’t hope to match. By combining forces at a pre-competitive level, these companies are using technology to collaborate in ways that generate growth for all.

Qiaotou Button City recently set up China’s largest business-to-business website to display and sell its products and collect and exchange market information. Other similarly focused manufacturing clusters abound in China, including “Underwear Town” in Foshan’s Yanbu district, with its hundreds of factories, or Datang, known as “the sock capital of the world” because it makes approximately 13.5 billion pairs of socks annually—two pairs of socks for every person on the planet.

A similar game is played in other emerging markets, but with different cards. Brazil, for example, has become the world’s No. 2 producer and No. 1 exporter of ethanol, capitalizing on its large sugarcane harvest to become a model of biofuel sustainability.

Counting up cost advantages
Growing demand in emerging markets results from the new entry-level class of consumers who aspire to a middle-class lifestyle but have very limited cash to spend—for now. This creates a huge incentive for local players to find ways to deliver products at the lowest possible price points, stripping out all unnecessary costs and establishing highly efficient distribution networks capable of reaching these consumers wherever they are.

The pressure to reduce costs affects all parts of the value chain, from product design to go-to-market strategies. Companies thus eliminate many of the design features found in Western products. For instance, laundry detergents featuring state-of-the-art enzymes create no value for customers who lack access to hot water. Package size is also affected; with limited cash on hand, consumers prefer to buy small quantities for immediate use.

Likewise, distribution needs to be both low cost and capable of overcoming the constraints of limited infrastructure. Mobile banking services illustrate this well. Mobile phone users in Kenya, for example, transfer money via their handsets without the need for bank accounts, paying bills and buying goods and services with them. Mobile banking is convenient, offers proven security, keeps costs low both in terms of transaction fees and the need for physical bank branches, and reduces the cost of poor credit for merchants, since consumers typically pre-pay before purchasing via their phone.

As a result of such innovations, we are seeing the emergence of companies capable of operating profitably at prices well below Western competitor cost levels. For example, in 2009, the average revenue per user for Indian mobile operators was less than $7 per month, compared with more than $35 in Europe and more than $50 in the United States. But even at such low per capita revenue levels, India’s mobile players have remained solidly in the black, delivering operating margins of around 40 percent—similar to those of successful Western operators.

The global implications
The two-speed recovery clearly has implications for players worldwide.

To remain competitive in the long term, Western multinationals that are focused exclusively on developed markets need to establish positions in high-growth emerging markets, and time is not on their side. They must compete against rapidly evolving domestic incumbents as well as other established multinationals already benefiting from the higher growth that the emerging markets offer.

Operating across both developed and emerging markets creates new challenges for many of these companies. Different customer needs, at times unclear local rules, diverse competitive environments and often unfamiliar governance requirements mean that a one-size-fits-all approach to country management will probably fail. As a result, many firms are already struggling to adapt to the unique needs of multiple local markets while attempting to exploit the scale advantages of a global organization and at the same time keep complexity costs to a minimum.

Incumbent emerging-market players similarly need to prepare for a rapid evolution of the local competitive environment as new entrants create both risks and potential rewards. Forming partnerships that combine a strong local market presence with world-class product designs and brands is one way to take advantage of this wave of market attackers. However, local players that lack specific competitive advantages will likely come under increasing pressure as consumer choices multiply and price competition heats up.

Current and aspiring emerging-market multinationals need to clarify their strategies for geographic expansion. The M&A market remains relatively quiet, and good opportunities exist for cross-border acquisitions for companies with sufficient means. Reasons for expansion can be as varied as acquiring managerial talent, establishing beachheads in other high-growth markets, securing access to resources and technology, and obtaining new design capabilities.

But in pursuing these goals, caution is in order. Players in all categories can easily destroy value if they lack a coherent growth strategy, undertake poor due diligence, overpay or engage in clumsy post-merger integration. As a result, building strong in-house M&A capabilities can be an important source of competitive advantage.

Respondents in a recent survey of Chinese companies that have made cross-border acquisitions reported that their No. 1 challenge was the lack of management experience in handling overseas investments; local regulations and cultural differences came in second and third, respectively.

In this new two-speed global environment, companies that simply react on an ad hoc basis as they attempt to get on the right side of each new competitive issue will not survive. Instead, they should craft a comprehensive and innovative strategic response to the new global equilibrium—one that recognizes the likely enduring nature of this upside-down competitive reality—and gear up for what could be massive disruptive change.

For further reading
“Brazil on the move,” Outlook, October 2010
“Where will the jobs come from?” Outlook, October 2010

Sidebar
Complexity, volatility and disruption

Regardless of their provenance, size or ambition, companies around the world share one critical consideration as they operate in a two-speed global economy: the need to prepare for an era of permanent volatility as the complex links between emerging and developed markets drive more rapid fluctuations in exchange rates, asset values and commodity prices.

High demand from China and India for commodities such as coal, paper and cotton is already driving up prices, and squeezing margins for all players. This creates new challenges for many Western companies, which simultaneously face lower revenues and rising input prices. In the newspaper industry, for example, declining readership and increasing paper costs are accelerating the demise of many publishers.

Whereas commodity prices have traditionally been correlated with demand in developed markets, they are now tracking demand in emerging markets, increasing margin volatility for companies in the West that have become “price takers” rather than “price setters.”

Economic uncertainty in the West combined with high growth in emerging markets is driving volatility in other ways. As emerging economies grow, wages are increasing, driving up the costs of services moved offshore to India, China and other countries. In addition, wider fluctuations in exchange rates, combined with increased exposure to international markets, are creating greater uncertainty on both the revenue and cost sides for all multinationals.

While high levels of volatility have been an ongoing reality in markets such as Brazil, this is a new challenge for Western companies whose governance and financial management strategies evolved in an era of greater stability. In response, Western companies will need to increase their agility, learning to manage risk in new ways and adapt to a world of greater uncertainty in which rapid decision making and flexible options for resource deployment are a day-to-day reality.

Companies in all industries should also prepare themselves for new, disruptive business models. In emerging markets, the combination of new technologies, huge demand, stronger domestic competition and intense pressure to reduce costs will inevitably produce radically different ways of doing business, which could make traditional business models obsolete.

About the author
Caroline Firstbrook is the managing director of Accenture Strategy in Europe, the Middle East, Africa and Latin America. Ms. Firstbrook has extensive experience in M&A strategy and target evaluation, merger negotiation, positioning for privatization and new market entry strategies across a wide range of industries. In addition to her consulting experience, she spent five years as an entrepreneur, setting up and later selling Easychem, an Internet retailer of crop inputs to farmers, and partnering with life sciences company Syngenta to explore biotech venturing opportunities. Ms. Firstbrook is based in London.

To Top

Download this article in full [PDF, 323KB] PDF Help

 This Article is Tagged: Strategy. Emerging Economies.