This blog first appeared as Steve Wunker's and Clayton Christensen's piece for Forbes
By Steve Wunker and Clayton Christensen
How smart companies create wealth in emerging markets.
The math is clear: more than 80% of the world's population lives in developing countries, and these markets account for 40% of the world economy, adjusting for purchasing-power parity, which takes into account the relative cost of living and inflation rates by country. However, less than 12% of the S&P 500's revenue comes from emerging markets. Even for a global giant like General Electric the figure is a mere 19%.
This imbalance simply cannot hold. The opportunities in the rapidly developing economies of Asia, Africa and Latin America are too big to ignore. They're also very easy to mishandle. A few companies have decided that these markets are too poor to justify investment. Still others have tried to compete by selling the same product they sell in the developed world but for lower prices by shrinking the package size or by stripping out features.
There is another path: designing a profitable business that enables customers in developing economies to be more productive and financially secure. Succeeding with this strategy requires that a company shift its focus away from redesigning its current offerings and toward creating new businesses from a blank slate. Those new businesses will perform jobs that customers in developing countries are struggling to get done. Unless a firm truly comprehends the jobs that developing-country customers want to get done, it risks importing assumptions from abroad that will sink the overseas business.
You can find companies thriving at the bottom of the pyramid in markets as diverse as mobile telephony, chicken farming, banking and brewing. Often the winners are local firms that can see opportunities without the distorting perspective that comes from being headquartered somewhere else. The Tata Group's Ginger discount hotel chain in India is an example of this.
But some multinationals are skilled at finding new markets in poor countries. General Motors , in partnership with the Chinese firm SAIC, has found great success in China with its Wuling Sunshine minivan, a small vehicle with a tiny engine, a top speed of 81mph and passenger seats that are one-third as thick as those found in U.S. models.
For small distributors ferrying goods around China's congested cities, the job is to carry a modest cargo cheaply. The distributors aren't much concerned with power, speed, comfort or capacity. They do, however, care about the price, and here GM has it right. The Wuling Sunshine starts at under $5,000, and the vehicle gets 43mpg. The Wuling has 37% of the small-minivan market.
Entrepreneurship is part of daily life in emerging economies, because often there is no other option. The poor understand that commerce--selling handmade crafts or running a small shop--is the way to improve income levels. Some of the most successful firms in emerging markets, such as cellular carriers, have exploited this insight. One African carrier, Celtel, created so much value it was recently sold to Kuwaiti wireless phone company MTC for $3.4 billion. Celtel allowed families and friends in remote countries like Chad to keep in touch, but it also created significant business value. If a repair to a commercial dishwasher is needed, no longer does the restaurant owner have to travel to the township where the repairer lives and hunt for the person. Nor does the owner need to engage middlemen with whom these maintenance laborers contract. Rather, the repairman can be in business himself, responding by mobile as work arises. Partly because of these efficiencies, increasing cell phone penetration by 10% in a country adds half a percentage point of GDP growth, according to a study by McKinsey & Co.
Many firms expanding into emerging markets from developed countries struggle because they're often bound by the business strategy and close operational supervision of their parent companies in the West. As a result, they stand little chance of blazing fundamentally new paths in developing markets.
Citibank has been operating in Zambia since 1979, emphasizing its corporate banking services and opening two branches in Lusaka, the capital, and Ndola, the country's second-largest city. It has reasoned that corporate customers do not need dozens of branches, and therefore it can save on branch operating expenses. The bank also realizes that several multinational customers value one particular job that Citibank helps to get done: simplify financial systems by keeping funds in one global bank, no matter what countries the customer operates in.
Yet there are many functions offered by Citibank, which, while valued by corporate customers elsewhere, have less relevance to Zambians' job requirements. Zambian companies often do not value long-term investment and lending services, and if they do seek loans, they often go abroad to avoid local interest rates that can exceed 20%.
Many Zambian businesses transact in cash, so they benefit little from Citibank's sophisticated reporting systems. Cash transactions could be handled through local Citibank branches, but Citi's emphasis on the corporate market--and its conclusion from developed countries that branches are of limited value--severely limits this offering.
In contrast, Zambia's Finance Bank has grown rapidly in recent years with an entirely different business model. The firm has 33 branches in Zambia, drawing long lines of customers depositing or withdrawing as little as $5 at a time. The bank recognizes that its customers often rely on unreliable public transportation and that it can win their business by being close to them. It allows wholesalers of consumer goods such as beer or soda to pay their suppliers through its branches, rather than having to transact large sums in cash with a delivery-truck driver in a busy public market. This service gains the bank a foothold at some of Zambia's largest corporate customers. Finance Bank serves the retail market very profitably, earning $17.3 million last year on $57 million in revenue. Its efficiency ratio, or total operating costs divided by revenue net of interest expense, was an admirable 53% in 2007. Prior to the current banking fiasco, Citibank's ratio was in the mid-50s.
The principle of redesign applies to products as much as to business models. In markets like India where some incomes are rapidly increasing, there is strong demand for products tailored to local market conditions. Air conditioners, for instance, are considered a luxury for most Indian homes, and even those Indians who can afford them rarely turn them on because electricity is costly. LG last year introduced in India an affordable air conditioner with electronic controls that vary the speed of the compressor in accordance with cooling demand. LG claims it can cool or heat a room 50% faster than old models, with 44% less energy usage. Cummins has introduced a low-cost diesel generator with dirt guards to keep the engine running more cleanly in India's dusty towns.
The challenges of distribution in emerging markets can foil even brilliantly conceived ideas. Conversely, effective distribution can give a tremendous leg up to new concepts. Supermarkets are a rare sight in many emerging markets. Small grocers, many operating in the informal economy, serve most of the population. These grocers collect their supplies from entrepreneurs who operate storage trailers in markets spread widely throughout cities, often in the midst of the townships where the poor congregate. Transport being relatively expensive, lengthy and awkward, grocers may simply carry goods by hand from the wholesaler's trailer to their premises, or load them precariously on a bike.
It is not easy to start distributing to these entrepreneurial wholesalers. Existing ones are often locked up by manufacturers in exclusive relationships. Brewer SABMiller ($21 billion in worldwide revenue) has benefited immensely through taking control of distribution systems for beers and soft drinks. SABMiller demands that its distributors work exclusively with its brands or brands SABMiller approves. Any distributor that wants to compete with SABMiller's network has massive obstacles in getting working capital, bank loans and trade credit.
Success at building disruptive growth companies in the poorest countries boils down to four areas on which to focus action. First, gain a deep understanding of the jobs that customers in developing countries need to get done. Twice a year Nokia sends marketing, sales and engineering employees from its entry-level phone group to spend a week in people's homes in rural China, Thailand and Kenya to observe how people use phones. Nokia has the highest market share in phones in India or Africa.
Second, disrupters must develop blank-slate solutions that solve problems better or differently. AllLife is a South African life insurance firm that issues policies to people who are hiv positive, a population of 2 million in South Africa. Competing policies tend to have steep premiums and a $12,000 coverage maximum. AllLife, by monitoring policyholders' health and medicine regimes, is selling cheaper coverage up to $360,000.
Third, subsidiaries must be able to operate freely. Even being dependent on the parent company for IT systems can constrain an in-country manager. In the name of efficiency, banks such as Standard Chartered often centralize emerging market it operations in countries like Malaysia, but when push comes to shove the priorities of relatively large, more developed markets such as the ones in Southeast Asia typically vault ahead of what operations require in some of the smaller, poorest nations such as the countries of Africa.
Fourth, businesses need to be patient for growth, but impatient for profits. The surest sign of a subsidiary's success is whether it makes money, which also signals it is evolving toward a sustainable business model. Managers can adjust their business model many times, but there is a limit to how badly things can go astray if profitability is mandated.
Together these steps can help a company recognize the innumerable inefficiencies and difficulties of developing economies and use those problems to its advantage. Successful firms are those that win the loyalty of frustrated consumers and can turn nonconsumers into new sources of revenue.
Clayton M. Christensen is a professor of business administration at the Harvard Business School. Stephen Wunker is a senior partner at Innosight, the innovation strategy firm cofounded by Christensen. Hari Nair is a partner at the affiliated investment firm Innosight Ventures.