When Bob McDonald took over as chief executive officer of Procter & Gamble (PG) earlier in 2009, he used simple math to demonstrate the importance he was going to place on emerging markets. In his first call with analysts, he described how if the consumer products titan could just grow per capita consumption of its products in India and China to the levels of per capita consumption in Mexico, it would represent 50% growth (or an incremental $40 billion in revenue).
Just about every company needs to step up efforts to compete in emerging markets. Want proof? Eighty percent of the world's population and 40% of the world's economy (adjusting for purchasing power parity) constitutes just 10% of revenues for Standard & Poor's 500 companies.
University of Michigan Professor C.K. Prahalad has long urged companies to tap into the fortune at the bottom of the world's economy pyramid. What once was a strategic nicety is increasingly a competitive necessity. Companies that don't find ways to love low-income markets will struggle to meet growth targets and increasingly cede the innovation agenda to companies based in those markets.
In The Silver Lining, I argued that companies seeking to win in emerging markets need to fundamentally rethink their strategic approach. In yesterday's "era of optimization," companies could succeed by selling tweaked versions of their existing products or services to relatively wealthy consumers in emerging markets. They could further succeed by shrinking or de-featuring those solutions to reach less wealthy consumers.
This approach is akin to saying: "We've made a meal that customers in developed markets find delicious. Who wants it? Can't afford the whole thing? Maybe a bite will do!"
The "Missing Middle" The heart of disruptive innovation is finding a way to address an important job-to-be-done of a "nonconsumer" who lacks the wealth, access, or ability to consume existing solutions. As Clayton Christensen, Harvard professor and Innosight co-founder, puts it: "You can't walk 100 feet in India without running into a nonconsumer with a critical job-to-be-done."
We've experienced that firsthand through Innosight Ventures, a business we started in 2007 to build and invest in disruptive growth businesses, particularly those in the developing world. Our work in India over the past two years has highlighted how many markets feature a "missing middle."
For example, you can stay at a world-class, five-star hotel or an incredibly cheap hostel. But affordable luxury is still a foreign opportunity in many markets, creating substantial opportunity for growth.
Companies need to create satisfying meals that customers in emerging markets consider delectable. The recipe starts with understanding the unique problems facing developing world customers.
For example, Tata Group Chairman Ratan Tata saw millions of Indian consumers turning to unsafe scooters because they couldn't afford existing automobiles.
The Nano Model He challenged his organization to develop a "people's car" that would sell for less than $2,500. His team developed the Nano from the ground up. They followed innovative approaches, such as outsourcing an unprecedented 70% of components or developing a mechanism to distribute almost-finished kits that could be assembled by rural entrepreneurs. These approaches allowed Tata to lower its price point and increase its odds of reaching its target customer.
It isn't always about stripping features out to lower price points; sometimes it is about adding features given the unique needs of customers in developing markets. For example, several years ago engine giant Cummins introduced a relatively simple, cheap generator set (gen set) in India. The gen set provides more than enough power for small retailers, farmers, and local hospitals looking to affordably obtain low levels of reliable power. Cummins added new features that were tailored for the local environment, such as dirt guards that allow the engine to run in dusty towns.
Winning in emerging markets isn't just about developing the right products or services. It's about considering broader business model levers, such as different approaches to build, deliver, or support the solution.
Consider Hindustan Unilever Limited, an Indian consumer products company that is majority-owned by global conglomerate Unilever. In the 1990s it created a team to identify women in rural Indian villages who could be the company's direct representatives. It used a variety of means to train and educate the women, such as having trained actors perform skits communicating key brand messages. The women then told villagers of the importance of hand-washing and shampooing.
Delivering the Solution Hindustan Unilever created drop-off points where the women could pick up soap and other goods. By 2006 the close-to 50,000 women in the program had increased Hindustan Lever's rural penetration in India by more than 50% and were generating more than $100 million in revenue. The company plans to reach 100,000 villages in India by 2010 and replicate the model in Bangladesh.
Success in emerging markets could require different partnership arrangements. While General Motors certainly has no shortage of struggles in the U.S. and Europe, its Chinese business is booming. One of its keys to success was forming a partnership with the Shanghai Automotive Industry Corporation (SAIC) in the 1990s. That approach helped GM tap into local knowhow and build relationships with key government officials.
Companies that rethink their approach to emerging markets can create the seeds of powerful growth businesses that can "trickle up" to developed markets. For example, over the past decade, Procter & Gamble's Pantene-branded hair care products have grown substantially. Some of this success traces back to work in Taiwan to re-ignite the brand in the early 1990s. The Taiwanese market proved to be a good laboratory for experimentation that helped reinvent the global brand.
Similarly, in early 2008, General Electric's health-care division launched a very simple echocardiogram machine that was uniquely attuned to the needs of the Chinese market. The product was about 90% cheaper than existing products. In 2009 the device "trickled up" to the German market.
GE, GM, Unilever, and others have found novel ways to prosper in emerging markets. Companies that follow the pattern of combining deep market understanding with innovative approaches to create, deliver, and capture value can also realize that long-elusive fortune at the bottom of the pyramid.
A shorter version of this article appeared on Scott's Harvard Management blog.
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