Battling for the Middle in Emerging Markets

To expand in rapidly developing economies, Boston Consulting's Jim Hemerling says, global companies can't limit themselves to the market's top end

Consider the following five countries: China, India, Brazil, Russia, and Mexico. With a combined population of approximately 2.9 billion people, they have nearly 10 times the U.S. population. Their combined gross domestic product approaches $5.8 trillion—nearly half the U.S. GDP. Several of the economies are growing at breathtaking rates: approximately 11% last year in China and more than 9% in India, far exceeding the 3.3% U.S. growth rate. They have expansive industrial sectors—accounting for 48% of China's GDP, 19% of India's, 20% of Brazil's, 26% of Mexico's, and nearly 37% of Russia's. And their domestic markets are hungry for Western products and technology, with China alone importing some $780 billion worth of goods last year, Mexico importing $253 billion, India $188 billion, Russia $171 billion, and Brazil more than $91 billion. (These statistics are from the CIA World Factbook and the Economist Intelligence Unit.)

These are the kinds of hard-nosed facts that have driven Western companies and investors to stake out huge financial positions in the rapidly developing world. These are also the kinds of compelling facts that don't tell the entire story and can't predict the future.

While some Western companies are doing business in these and other rapidly developing economies (RDEs) strictly for the low-cost sourcing advantages they provide, most international companies also are lured by the size and potential of the RDE markets. Not only the current and the "next billion" consumer market, but the business-to-business (B2B) market as well—perhaps even more so.

Local Competitors

Western companies typically have attacked RDE markets from the top down, especially the B2B market. Local companies, on the other hand, typically build their businesses from the bottom up. Both approaches have worked well. At the top of the pyramid, you find companies that want, value, and can afford Western brands and technology. At the bottom of the pyramid, you find thousands of widely dispersed companies for which the main considerations are usually cost and convenience; if something isn't inexpensive and available locally—including maintenance and repair services—it might as well not exist.

The problem is, the top of the market is limited in size and getting more crowded all the time. International companies that focus narrowly on the top-end market are running out of room. If they want to expand their presence in the RDEs, they will have to join the battle for the middle.

Unlike the high end, in the middle only a small percentage of their competitors are other Western companies. The majority of their competitors are indigenous companies—we call them RDE challengers—that barely registered as a blip on their radar screens in the past. While the mid-market is far bigger than the high-end market; accounting for 30% to 50% of total spending in most cases; many local firms that started at the bottom are now capable of competing for mid-market customers and are effectively and aggressively doing so. The infotech, telecom, and numerous industrial sectors are crowded with them.

Opposite Challenges

Foreign and local competitors bring very different strengths and capabilities to the market, however. Local firms bring low cost, broad distribution networks, and a solid firsthand knowledge of what local business customers want and need, which leads them to produce "good enough" products offering functional benefits that meet customer needs at rock-bottom prices. Often these products have been designed locally to meet specific requirements of local customers.

In the B2B market of the future, however, today's "good enough" may not be good enough to guarantee the sale. Many growing businesses will demand better performance. The challenge for local companies, then, will be to develop the superior technology and marketing savvy that will enable them to serve more-demanding customers while building their brands.

Foreign firms provide a reverse image. These companies typically have superior technology, sophisticated marketing capabilities, and highly desirable marquee brands, but their costs, driven by highly featured products, uncompetitive local operations, and global overheads, are high and their RDE distribution and service networks weak. To win the battle in the middle, their challenge is to lower costs and deliver suitable products, while broadening their distribution and service capabilities.

Custom Approach

To get there from here, global companies will have to change their mindset about the RDE markets and face the reality that "global" products designed ostensibly for high-price Western customers typically won't cut it in the middle markets of India, China, Vietnam, and other rapidly developing countries. They need to segment the market, focus on segments that are more attractive, and then develop products that are more durable, less complicated, offer fewer features, and cost less: products that offer features customers are willing and able to pay for—and are better and no more expensive than the "good enough" products offered by the local competition.

In many cases, these products will have to be customized: designed and manufactured specifically for the RDE market. Distribution and service networks will have to be created or vastly expanded in-house or through distributors. Entire new business models may be required, involving every step from research and development to sales and service.

If you want to visualize the changes that might be necessary, consider farm equipment, such as tractors. Agriculture still accounts for a significant percentage of GDP in many developing economies: about 20% in India and Brazil and just under 12% in China. But agriculture in these countries is labor-intensive. A company that manufactures tractors will not be selling to a large agri-business firm such as Archer Daniels Midland (ADM); it will be selling to a farmer, or possibly a village or farm collective.

Growing in the Middle

Agriculture is very different in the RDEs than in the U.S. A U.S. farmer in California, Iowa, or Nebraska, where the fields and farms are large and the crops grow tall, wants big tractors with all of the latest bells and whistles: air-conditioning, sound systems, even navigational aids.

But money is a huge hurdle in places such as India. Indian farmers don't need big, fancy, high-tech tractors costing tens of thousands of dollars; they need small, durable tractors they can both afford and rely on. And that's what they get from Mahindra & Mahindra, a homegrown Indian company with more than 500 dealers and nearly 1,200 service locations around the country—and, not surprisingly, a 90% share of the Indian tractor market.

The lesson for many Western industrial and technology companies is simple: If you want to continue growing in RDEs, hang on to the top, but aim for the middle; segment the market; reexamine all of your assumptions; deliver competitively priced products that are good enough; and do not under any circumstances underestimate the local competition.

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