Fundamental Changes in How Emerging Markets Innovate

This blog first appeared as Steve Wunker's piece for Forbes

By Steve Wunker

For a word that seems about as objectionable as motherhood and puppies, “innovation” is a term that wasn’t heard much in Brazilian boardrooms a decade ago.  The same applies to executive suites in South Africa, Nigeria, India, and China. This is something of a puzzle. After all, if innovation springs up to tackle latent demand, emerging markets are packed full of unmet needs.  Even in an advanced city like São Paulo, where I am writing this, inconveniences abound. Moreover, there are huge numbers of poor citizens inadequately addressed by businesses traditionally focused on a relatively thin strata of wealthier individuals. You would think that if we would see innovation flourish anywhere, it would be in environments like these.

To be sure, innovation has thrived in these settings, but it has been the sort of process improvement innovation that makes existing industries function better rather than the type that creates new markets, caters to new consumers, or pioneers new business models. Why is this? (Before the comments start pouring in, let’s be clear that any generalization about 5.6 billion people will have exceptions, and the press writes frequently about outstanding programs undertaken by CEMEX, Safaricom, Tata, and others. Yet these companies are unusual, and it is the very rare emerging markets executive who will contend that their country is remotely as innovative as the US, UK, or Japan, even outside of high technology, capital-intensive fields).

Simply put, it has been too easy to succeed without undertaking the sort of disruptive innovation that builds new market space. Banks have grown through building out their branch networks and product offerings. Retailers have planted big box stores. A host of companies enabling export-led economic strategies in the biggest emerging markets have been riding the updraft of fast growth, supplying goods and services to surging local firms and a mushrooming middle class.

In this environment, companies have prospered through executional excellence. They have not needed to generate new approaches to target initially small markets, because mainstream markets have been quite profitable. In many countries (India and China largely being exceptions), competition has been modest, and firms have not needed to best each other through coming out with boldly novel offerings.

Emerging markets have also lacked risk capital. Institutional venture capital is largely a North American and Northern European phenomenon, but wealthy individuals and conglomerates mobilize investment funds across the globe. In developing countries, these sources of finance have not targeted new markets because they have not needed to take those kinds of risks. When core businesses that you understand well are growing 10-15% a year, new markets can lack allure.

Yet the world is changing, fast. At least four factors are converging to create a rapidly-increasing demand for disruptive, market-creating innovation:

1. Competition from China – Here in Brazil, quality and process improvement have been key buzzwords for two decades. Yet now that Brazilian firms include some world leaders in manufacturing excellence, they find themselves shaken by low-cost Chinese imports (Brazil’s strong currency isn’t helping matters either). These companies need to differentiate their offerings in commoditized markets.
2. Innovation Infrastructure – With increasingly well-developed banking, retail, distribution, and other business infrastructure, companies in the largest emerging markets can rely on an enabling ecosystem of firms that eases the task of introducing fundamentally new products and services. Remote villages and poor consumers how have better access than ever before to new offerings, credit, and even mobile-enabled websites to review their purchases.
3. New Routes to Market – The world over, superstores are unfriendly places for innovators. They have little reason to push something new and scant capability to do that as well. Similarly, small general stores try to be many things to many people, and they can’t pay much attention to creating new markets for unfamiliar products.  Boutiques and niche B2B resellers, however, are a time-honored channel to market for innovation – distinctive offerings can be a big draw for their customers.  The Internet also offers a powerful way for novel ideas to get discovered. As retail sectors mature and Internet usage grows, new concepts have many more ways to become popular.
4. Demonstrated Profits – South Africa’s banks have noticed that their small rival Capitec, with its downmarket focus, is one of the world’s most profitable and fastest-growing financial institutions.  U.S. investors are eyeing Beijing Jingdong Century Trading Company, which runs 360buy.com, as it prepares the largest Internet IPO in history.  Airlines across the globe have witnessed Brazil’s innovative Azul become the most quickly-successful carrier in history.  A surefire rule of capitalism is that capital will rush to profitable markets.

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We are just starting to see the impact of these environmental shifts. Many of today’s breathless headlines about innovation in emerging markets are overblown. But not for long.