Center for Management of Emerging Companies

Emerging Companies Face Potential Challenges in Meeting Demands of Developing Markets

HSBC and Standard Chartered have both recently issued reports on their view of where the world economy is going over the next 20 to 40 years and they agree that rich nations will grow more strongly than emerging ones, due to primarily to the much slower rate of population growth in the developed world.  An article summarizing the reports in Businessweek quotes Standard Chartered as advising that "the continuing success of developed countries will depend more than ever on creativity".  Among other things, this means that emerging companies in the US and in other industrialized countries will need to plan for meeting the expected surge of demand in emerging markets for sophisticated goods and services.  Perhaps just as important, managers of those emerging companies must also take into account the especially challenging scenario that firms in developing countries such as China and India will, as Businessweek says, “move so fast up the learning curve that they provide their own sophisticated goods and services”.

Emerging Companies in Developing Markets Teaming Up in Strategic Alliances

Our last post focused on a recent article that appeared in The Economist relating to a Boston Consulting Group report on the “rising stars of the developing world” relating to the extraordinarily rapid progress that firms from emerging countries have made in challenging traditional industry leaders from the West.  One particularly interesting aspect of the report was the decision of these challengers from developing countries to rely on strategic alliances with other emerging-market firms rather than multinational companies headquartered in the West.  As noted in the article, these partnerships allow the participants “to share knowledge, penetrate new markets and spread the risk of especially hair-curling investments.”  The financial rewards can be huge since partnering in emerging markets today means tapping into the dynamic growth of countries such as Brazil, China and India.  Assuming that the alliances are effective, more and more firms will soon be able to negotiate and collaborate with large Western countries from what the article described as “a position of strength”.

Others have studied the use and impact of strategic alliances in developing markets including alliances between local partners.  An article on “The Changing Face of Strategic Alliances in Latin America” written in 2002 and appearing in Strategy + Business noted many of the large multinational companies in Latin America grew through cross-border alliances and acquisitions with local firms to increase market share, gain access to synergistic assets and other resources and create a portfolio of products and markets that will be perceived as having “value” to foreign investors who might then be willing to provide new capital.  Alliance activities among emerging markets firms also allows them to build a company that is seen a regional leader and thus achieve greater leverage when dealing with larger multinationals from the industrialized world.  Finally, companies in emerging countries that are involved in alliances with partners in several other countries are perceived as less “risky” by investors who are otherwise concerned about having all of their “eggs’ in a single country basket that could be tipped over without warning by currency issues or political instability.

Developing Country Firms Challenging Traditional Industry Leaders from the West

An interesting article on the extraordinarily rapid progress that firms from emerging companies have made in challenging traditional industry leaders from the West appeared recently in The Economist.  The article cited the findings of the latest annual report published by the Boston Consulting Group (“BCG”) on the “rising stars of the developing world” that the number and size of cross-border acquisitions by firms in emerging economies had surged in 2010.  The BCG report also included an analysis of 100 leading firms from emerging economies, over 70 of which came from one of the BRICs (13 companies from Brazil, six from Russia, 20 from India (six of which are part of the Tata empire) and 33 from China), and noted that the revenues for the group had grown at an average annual rate of 18% over the last decade (three times faster than non-financial firms in the Standard & Poors 500) while also achieving profit margins of 18% (6% high than non-financial firms in the Standard & Poors 500).  BCG attributed the success of these firms to several factors including their ability “to resolve three trade-offs that are usually associated with corporate growth: of volume against margin; rapid expansion against low leverage (debt); and growth against dividends.”  However, while recognizing the impressive performance described by the BCG report, the Economist sounded a cautionary note and detailed the following challenges that the firms it referred to as the “tiger cubs” will need to overcome in the years ahead to really catch up with their entrenched rivals from the US, Europe and other parts of the developed world:

• The recent growth in China and other emerging markets—as well as much of the continuing growth that is projected for the future—is tied to heavy investment on infrastructure that inures to the benefit of low-cost construction and heavy-equipment companies in those countries.  Obviously, roads and bridges are being built at record pace in China, India and other emerging markets and Chinese firms are even winning large contracts in the US; however, if capital for these projects becomes scarce or too expensive the gold rush may come tumbling down.
• Firms based in emerging markets tend to rely on the conglomerate model as their preferred form of organizational structure and while this has been successful up until now many question whether the model is sustainable from an efficiency perspective.  If Chinese and Indian firms wish to continue using this model they will likely need to borrow and implement new technology and management techniques that have been deployed by “old multinationals” in the West such as General Electric.  A related challenge for these growing challengers will be coping with more and more operations taking place far away from their headquarters office.
• It remains to be seen whether firms from emerging markets, which have often relied on the acquisition of established brands from the developed world (e.g., Lenovo/IBM PCs), can build their own global brands that will be accepted and valued by consumers in the US and Europe.  Simply put, firms based in Brazil, China or India probably have their work cut out for them in exporting products that are favorites in their local markets to Western countries and their success in doing so will determine just how well they will do in terms of revenue growth and associated profit margins.
• There are certain industries and market sectors where firms from emerging markets have been content to follow a rapid revenue growth strategy while sacrificing margins in order to achieve market share.  For example, low-margin generic drugs are common offerings of pharmaceutical firms from the developing world and the same holds true with respect to consumer goods in many instances as firms from emerging markets lead with low-cost products.  The result so far is that established global brands continue to dominate in niche markets with higher profit margins.
• As they push to build a larger presence in Western markets firms in emerging markets must also cover their “rear guard” and fend off the advances of global multinationals from the West into emerging markets.  For example, the Economist noted that the Times of India had reported that IBM has become the second largest private-sector employer in India.