Avoiding the Premium Trap

Western companies that prize quality can underestimate the threat posed by "good enough" products in rapidly developing economies

Most Western companies understand the benefits and challenges of global sourcing, but they haven't paid nearly enough attention to the complicated challenges awaiting them when they start selling in rapidly developing economies (RDEs). This can have serious consequences, one of which we call "the premium trap."

When they enter these huge markets, Western companies typically bring with them U.S., Japanese, or Western European quality standards, dismissing local goods as inferior. They forget that relatively few RDE customers can afford high-end Western goods. They fail to appreciate the fact that local products, while not up to Western standards, are good enough for most RDE customers. And they often don't realize that the local companies making these "good enough" products are serious challengers and will produce ever-better products as they gain scale, lower costs, and invest in R&D.

These products, costing up to 75% less than Western brands, will inevitably start attracting customers, some of whom had been purchasing Western brands. For Western companies unwilling to compromise their "standards," it can easily become a downhill roller-coaster ride.

Targeting Customers in Big Cities

When they arrive in RDEs, most Western companies have done their market research and understand who and where their most likely customers are. (Hint: people living in the biggest cities.) They also know there is a great hunger for Western goods—the same wares consumers might buy in San Francisco, London, or Tokyo, or a business might purchase in Toronto, Taipei, or Seoul.

The attractiveness and potential of these markets is beyond dispute. China, for example, has a population of 1.3 billion, more than four times the size of the U.S. India's population is 1.1 billion. Indonesia: 235 million. Brazil: 190 million.

The U.S. population, by comparison, is 301 million. Japan's is 128 million, and the combined population of the European Union (EU) is 490 million, less than half the size of India. (Source for all population stats: CIA 2008 World Fact Book).

Lured by High Growth Rates

Not only are there far more people—meaning potential customers—in these rapidly developing countries, but many of their economies are growing faster than the Western economies, with 2007 growth rates well above America's sluggish 2.2 %, Japan's anemic 1.9% and the EU's 3%.

China's economy last year grew an estimated 11.4%; India's and Vietnam's by approximately 8.5% each. Many other RDEs also chalked up impressive gains: Poland's economy was up 6.5%, Bulgaria's 6.1%, Turkey's by more than 5%, and Brazil's 4.9%. No wonder Western executives see the RDE markets playing a critical and expanding role in their long-term growth strategies.

In our forthcoming book, Globality: Competing with Everyone from Everywhere for Everything, we examine how many Western and RDE companies have wrestled with the challenges of the new economy. One such story involves Nokia. The world's largest supplier of mobile handsets, the Finnish multinational sells about 1.2 million handsets daily at an average price of about $150. Its 2007 revenues exceeded $74 billion.

Following Nokia's Lead

Nokia entered China early, in 1991. It did everything by the book: identifying distributors in the wealthiest cities and selling them product "by the container load." And it worked: By 1999, the company claimed a 30% share of the handset market, more than any other company, domestic or foreign.

Then Nokia found itself in the premium trap. While Nokia was selling Western-grade handsets in the biggest cities, local challengers were selling "good enough" handsets in the populous countryside. Nokia's market share fell from 30% in 1999 to the low teens in 2003. The local challengers' share, meanwhile, jumped from just 2.5% in 1999 to nearly 30%. Nokia was paying the price for focusing its China strategy on the high-end market.

To escape the premium trap and reignite its rapid growth, Nokia skillfully reinvented itself, setting up its own distribution and sales network across China and introducing cheaper new handsets with fewer bells and whistles. From 10 cities, Nokia expanded into a hundred, then twice that number, then twice that number again. By 2005, the company had more than reclaimed its market share, selling 51 million—or 35%—of the handsets sold in China.

A Wake-up Call for Westerners

Like Nokia, many Western multinationals have entered RDEs ready to sell existing high-end products to increasingly prosperous city dwellers. For a while it works. But all the while the RDE challengers are circling, getting ready to make their move. When it comes, it often comes as a surprise. One day company A appears to be on top; the next day it is left with a very small slice of the market.

The Nokia story should serve as a wake-up call. This is not a contest big Western companies are programmed to lose. They have many options. Misunderstanding the competitive environment in the RDEs is not one of them.

One viable option for Western companies is to re-engineer their products. If local consumers can't afford $150 handsets, design a durable, attractive $50 handset. Nokia understood the importance of having the right products at the right price. And today, 42% of the company's sales involve handsets costing less than $65.

Lower Price Points Rule

Another option is to purchase an up-and-coming local challenger. If a Western company can't build the right product at the right price for the huge RDE middle market, perhaps it can find an available challenger company that can. Or it could start a new company to go head-to-head with the challengers.

The reasons for doing business in rapidly developing economies have not changed. For many Western companies, it's a must. To succeed, however, they need a new frame of reference.

Most RDE businesses and consumers can't afford premium products. If Western companies want to increase their market share in the RDEs, they need to embrace new "good enough" products at lower price points. If they don't, they will put their fate in the hands of RDE challengers who, sooner or later, will come after them.