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The New Frontiers

DBR | 1호 (2008년 1월)
In 1893, American historian Frederick Jackson Turner declared that a frontier isn’t just a place; it’s also the process of adaptation and change that shifting borders force on people and institutions. The young Wisconsin professor was describing the role that the frontier had played for three centuries in creating the American nation, but the Turner thesis applies to modern business, too. Over the past three decades, the borders of the corporate world have constantly shifted as developing countries opened their economies to foreign businesses. As a consequence, multinational companies have had to cope with runaway growth, intense competition, greater complexity—and constant change.
Even so, little they have learned has prepared Western companies for the impact of today’s great recession on globalization. Not only is the worldwide slowdown hurting developed economies more than emerging economies, but it’s affecting the latter differently and substantively altering their role in the global economy. By the time the slowdown ends, the frontier will have shifted again in unexpected ways.
Today’s great crisis is forcing change at three levels. First, the developing countries are becoming relatively bigger markets. Defying the odds, they seem likely to expand by 1.6% overall in 2009, with the International Monetary Fund projecting in April 2009 that China’s economy would grow by 6.5%, India’s by 4.5%, and the Middle East’s by 2.5%. The pace is much slower than the spanking 6.1% at which the emerging markets grew collectively in 2008, but it’s remarkable considering the IMF’s forecast that the developed economies will shrink by 3.8% this year. “Emerging markets will account for a larger share of the world’s output when the recession ends than when it began,” concludes Antoine van Agtmael, who heads the investment firm Emerging Markets Management. “That will make them even more attractive.”
Second, governments are reshaping the contours of economic development even as they stoke growth through monetary and fiscal policy measures. No government is doing that more than China’s, which is using the $586 billion stimulus package it announced in November 2008 to influence demand and supply in 10 industries that together account for 50% of the country’s GDP. For instance, in January 2009 the China Auto Stimulus Package unveiled several measures—including a 50% cut in the sales tax on vehicles with an engine capacity of less than 1.6 liters—to boost demand for small and fuel-efficient vehicles. Companies that don’t launch such vehicles or focus on making bigger automobiles will find themselves at a disadvantage. “The government calls it a stimulus, but it’s really redesigning industries,” says David Michael, the Greater China head of the consulting firm BCG. “That’s why 9% GDP growth in China tomorrow won’t be yesterday’s 9% growth. The ‘new normal’ in many rapidly developing economies will be different after the recession.” Edward Tse, Booz & Company’s managing partner for Greater China, agrees: “The China of the next 10 years will be very different from the China of the last 10 years and so will require a very different approach for companies doing business there.”
Third, competition in developing countries has become more intense. With exports shrinking, companies in those countries are concentrating more on growing their sales at home. The rivalry is particularly heated in markets for commodities, such as steel, cement, and aluminum, and for upmarket and middle-market consumer segments. With multinational companies trying to squeeze more revenues out of developing countries, too, only the fittest businesses seem likely to survive the slowdown.
Smart companies in emerging markets have started responding to the challenges these changes pose. In fact, a few of them saw the downturn coming and modified their strategies quickly. (See the sidebar “Emerging Strategies to Beat the Slowdown.”) Companies in these countries already have an edge because they’re the world’s cheapest manufacturers and don’t need to develop low-cost business models. But before the downturn began, rising resource costs and appreciating currencies had eaten away at their profit margins. Many businesses are using the recession as a pretext to do some spring cleaning and reduce costs. “Between 1995 and 2008, Indian companies grew so quickly that many bad habits crept into their operations,” says Nirmalya Kumar, a London Business School professor. “They’re trying to eliminate them. After more than a decade of growth, they are taking a breather to restrategize.”
Many emerging giants are restructuring portfolios, halting iffy diversification plans, and consolidating operations. They’re introducing quality systems such as lean Six Sigma so that they can manufacture better products at a lower cost. In China, India, and Turkey, companies are taking a hard look at talent and firing (or not hiring) and halting bonuses and raises to freeze salary bills at last year’s levels.
Some businesses are using the cash they’ve freed up to develop value-for-money products and services, particularly for rural consumers and those in the lower middle class. Several Chinese manufacturers are using the slackening of demand as an opportunity to develop advanced products of their own, so that they won’t always have to serve as subcontractors. “Some costs, like talent costs, are lower today, so it’s a good time for companies to invest in developing innovation capabilities,” points out Peter Williamson, a professor at the University of Cambridge’s Judge Business School.
In India, Tata Motors’ March 2009 launch of the world’s most inexpensive car, the $2,000 Nano, has made low-cost innovation a priority for companies and entrepreneurs. There’s even a name for the trend: the Nano Effect. And in China, BYD Auto’s December 2008 launch of the world’s first mass-produced plug-in electric car, the F3DM, which sells for $22,000, has created a similar BYD Effect.
Clearly, the companies in these economies will be much more competitive at the end of the recession than they were when it began. This is the conclusion I came to after interviewing 30 or so academics and consultants in Argentina, Brazil, Bulgaria, China, Egypt, Hungary, India, Mexico, Russia, and Turkey during the first four months of 2009. I also spoke with senior executives working for local and multinational companies in emerging markets and reviewed recently published research.
Most Western companies are preoccupied with the crisis in their home markets, but they need to start focusing on the next phase of global growth. If they want to avoid being blindsided tomorrow, they must track five tectonic shifts that are emanating from the developing world.
Shift 1: A Growing Divide
Many executives are convinced that the manner in which the recession unfolded across the globe last year underscores the close connections between developed and developing economies. Since the 1990s, countries have become tightly interlinked, primarily by trade and financial flows. A contraction of the developed economies will set off shock waves in emerging markets and send stock markets all over the world tumbling—as has happened in the past year. In this view, it’s unlikely that the emerging markets can continue their rise when the advanced economies are falling.
Yet, more and more evidence shows that today’s recession will make decoupling a reality.
Because demand and investments from OECD nations have fallen at an unprecedented rate, governments of several developing countries—including Brazil, China, India, and South Africa—are trying to reduce their economies’ dependence on international trade. They can afford to do so because over the years, they’ve bolstered their national balance sheets by accumulating foreign exchange reserves. Policy makers are concentrating on boosting domestic demand, especially outside the major metropolises. Their governments are investing in infrastructure and reducing taxes, particularly on products for low-income consumers. If they succeed in increasing consumption at home—a big if during a global crisis when consumer confidence is low—they will be able to sustain growth even when demand from the OECD nations falls.
Don’t forget, the developing nations have also discovered one another. Trade between emerging markets accounted for 40% of their exports and imports in 2007—double the level two decades ago. In fact, half of China’s exports went to other developing countries. The longer the recession lingers in the developed world, curtailing demand for natural resources and manufacturing, the more the trade between the developing countries is likely to grow. For instance, China’s Evoc Intelligent Technology, which makes control systems, currently sells 80% of its products in the developed world but finds that 80% of new demand is coming from India, the Middle East, Russia, and, of course, China. The company has recently set up companies in the Middle East, Russia, and India to distribute its products, and because those regions have been less affected by the financial crisis, Evoc continues to grow. “People don’t realize it, but this recession also provides an opportunity for China to strengthen its links with Latin America,” notes Guillermo D’Andrea, a professor at IAE Business School in Buenos Aires. “Many Chinese companies are already doing that.”
Recent findings by economists M. Ayhan Kose, Christopher Otrok, and Eswar Prasad align with these trends. Their research, published by the IMF, shows that the economies of developed countries reach a peak or a trough around the same time, and that emerging markets also rise and fall more or less in unison. However, emerging and developed nations don’t experience their highs or lows at the same time anymore.
Financial markets the world over are intertwined, though, so when the rich economies’ stock markets tank, they will roil financial markets in poorer countries, causing their stock markets to fall even if their economies are growing. “Main Street is getting decoupled but Wall Street isn’t,” says Frank-Jürgen Richter, the president of Horasis, a Geneva-based think tank.
Emerging markets and the United States may part ways in another fundamental manner after this recession. Politicians and policy makers have traditionally believed that the United States boasts the best model of a market economy. But American-style capitalism is under fire because of the financial crisis, and the U.S. government bailout has changed the system so much that it’s scarcely recognizable. As a result, policy makers in the developing world are likely to slow down the pace of deregulation and consider creating European-style welfare states. “There’s a growing feeling in Mexico and indeed all of Latin America that the American model isn’t the only one. This is stoking a debate about the nature of future development,” points out Carlos Mota, a professor turned economic commentator based in Mexico City. For a long time, “capitalism with local characteristics” has been the buzz phrase in China; it soon may become one in the rest of the developing world.
The Response: Stay Focused on Emerging Markets
Western companies that keep investing in developing countries despite their problems at home will grow businesses that will help them ride out future recessions in a decoupled world. They may also be better positioned to survive this recession if it persists. These companies will gain a critical first-mover advantage in new market segments, such as the rural segment, that are tough to break into. Those that set up export bases in the developing world will benefit from the low-tariff trade flows between emerging nations, especially if protectionism rears its ugly head.
Shift 2: The Return of Family-Style Leaders
Out of crisis springs opportunity; out of adversity, new leadership paradigms. In developing nations, the new paradigm will come from family businesses and state-owned enterprises.
Many emerging giants are run by families, especially in Brazil, India, Mexico, and Turkey; in China, the state is a surrogate for the family. Succession often becomes an issue in such businesses, so bringing in “professional” management has traditionally been a priority for stakeholders. The established wisdom is that families should list their companies on stock exchanges, hand the reins to corporate executives, and have founders play only supervisory or ceremonial roles. Family conflicts have bedeviled business groups, particularly in India and Latin America, and family-managed companies have been terrible about governance, as the recent Satyam Computer accounting scandal in India shows, so bringing in the pros has appeared to be the best practice.
However, the crisis is stirring up fresh debate about leadership styles and bringing a new breed of quasi-family, quasi-professional leader into the limelight. In emerging markets, the notion that family members and the bureaucrats who run state-owned companies can provide good leadership, particularly in an uncertain environment, is earning greater acceptance. According to a recent Economist Intelligence Unit–Barclays Wealth report, the family business model is likely to emerge stronger after this recession because stakeholders tend to trust entrepreneurial leaders during crises. Adds Kelin Gersick, a senior partner of Lansberg, Gersick & Associates, a family-business consulting firm that works in emerging markets: “From the executive’s point of view, the security and long-term strategies of family businesses have never looked so inviting, and the status of working for a family company has risen tremendously.”
In Asia and South America, the heads of family-owned businesses wield a great deal of power, which enables them to make decisions and modify strategies quickly—just as entrepreneurs can. Their influence allows them to deal deftly with policy makers, cut through red tape, and use social networks for their companies’ benefit. The leaders of government-run enterprises are equally powerful. For instance, Chinese oil companies have often won deals by promising to open the spigots of government aid to African nations.
Enterprises managed by families or governments also find it easy to adopt a long-term perspective. Driven by personal pride or national interest, they don’t dance to the tune of the stock market. They pursue long-term strategies even when economic growth collapses, especially because their controlling equity stakes insulate them from takeovers. CEOs like Kumar Birla of the Aditya Birla Group, Pat Davies of Sasol, and Naguib Sawiris of Orascom have stuck to their ambitions during this recession, reassuring stakeholders that they are in it for the long run.
One thing that has helped such enterprises: Before the recession, smart families decided to groom young inheritors for leadership roles. Most scions of family groups studied in business schools, usually abroad, and worked in multinational companies before returning home. Like Mahindra & Mahindra’s Anand Mahindra, they worked their way up from the bottom or set up new ventures where they could cut their teeth. The process allowed them to develop working relationships with the company’s nonfamily executives, who served as mentors. Over time, some scions stepped aside to make way for nonfamily CEOs while others grew into the best candidates for the top job. Consider Aditya Mittal, the Wharton-trained CFO of ArcelorMittal. He will most likely take over as chairperson from his father, L.N. Mittal, without a hint of controversy about the appointment. The quest for professionalism appears to be taking a different path in emerging economies.
The Response: Change Your Leadership Criteria
Multinational corporations may want to rethink the kind of leaders they appoint in emerging markets. Many have been operating in China and India for close to two decades, and their businesses are becoming bigger, so the temptation is to appoint organization builders and develop more systems—à la HQ. However, tough battles over consumers in emerging markets lie ahead, and CEOs would do better to invest in entrepreneurial local managers who are willing to take risks. “For breakthrough performance in developing countries, you need breakthrough leadership,” pointed out a recent Accenture research report on the global operating models of the future.
Shift 3: A Reversal in M&A
Many emerging giants are in a rush to become global industry leaders, so the moment the liquidity crunch eases, they will hit the takeover trail in developed economies. With Wall Street almost halving companies’ values, those predators will be vying to acquire commodity producers, old brands in sunset industries, and state-of-the-art technologies in sunrise industries.
The next reverse M&A wave will differ from the previous one in three ways. One, Indian companies set the pace for cross-border deals in 2007, but companies from China, Brazil, and even Russia will take the lead in the future. Those companies are cash-rich and less leveraged than Indian companies, which borrowed heavily from banks before the recession to complete several major deals—such as Tata’s purchase of Jaguar Land Rover and Corus, and Hindalco’s purchase of Novelis.
Two, Chinese and Latin American companies will use M&A to internationalize rather than globalize. They will try to buy several businesses in the same country or in neighboring countries instead of hankering after one company with worldwide operations. The number of cross-border Latin American deals done by Brazilian companies, for instance, jumped significantly in the past few years, going from just two in 2005 to 11 in 2006 to a record 25 in 2007, according to the Zephyr database. In 2008, Brazilian companies acquired 23 more enterprises to create pan–Latin American leaders, or multi-Latinas. Similarly, from 2002 to 2007, Mexico’s Mexichem bought several companies in South and Central America and became the largest producer of plastic pipes in Latin America. Indian companies think differently; they prefer to head out of the region, since their neighbors are small. They, like other emerging giants, are likely to stalk European companies rather than U.S. corporations after the recession.
Three, companies will acquire more small and midsize businesses overseas instead of acquiring giants. Indian companies may not have much of a choice; they’re busy digesting the big companies they took over before the financial crisis erupted and so will focus on small and strategic acquisitions. The shift has also become perceptible in China since global acquisitions left both TCL and Lenovo with hangovers. TCL purchased the TV business of France’s Thomson and parts of Alcatel in 2004, but after a few years of losses, it had to pull out of Europe. Lenovo tasted some success after buying IBM’s PC business, but counterattacks by Apple, Dell, and HP have eroded its margins and diminished its zest for large international acquisitions. “Chinese companies have learned that it’s tough to operate foreign companies, and now they’re also worried about the quality of assets they will get,” says Frank-Jürgen Richter of Horasis. “They will avoid big deals and go after small and medium companies that will be easier to assimilate.”
Emerging giants will also experiment with new ways to strike up partnerships overseas, particularly to secure raw materials in other developing countries. For instance, China’s banks have been buying stakes in or extending loans to foreign companies. China Development Bank recently lent $10 billion to Brazil’s Petrobras in exchange for a long-term supply of oil. The bank also provided $15 billion to Russia’s state-owned OAO Rosneft Oil, and $10 billion to the state pipeline monopoly Transneft, and in return, China was promised 15 million tons of oil annually for 20 years.
The Response: Join Forces with Emerging Giants
Multinational companies, knowing that emerging giants are keen to buy companies in overseas markets, can benefit by teaming up with them. For instance, many Western companies need help from local companies to go into China’s lucrative hinterland or Indian’s rural market. They can enter other countries by partnering with emerging giants and offering them knowledge and assets—a strategy called triangulation. In 2008, for instance, Japan’s Kawasaki Motors struck a novel deal with India’s Bajaj Auto. The Indian motorbike maker plans to market high-end Kawasaki motorbikes in India while Kawasaki sells Bajaj Auto’s small motorbikes across Asia (except in Japan). Both parties will benefit, but neither has taken on the other head-on—yet. Similarly, Spain’s Telefónica, one of the world’s biggest telecommunications operators, is helping Huawei Technologies, the Chinese telecom solutions provider, enter the Latin American market, where Telefónica is a major player.
Shift 4: Higher Stakes in Sustainability
Money is often colorful in emerging markets, but it is turning green everywhere. Many enterprises recognize that if they don’t develop eco-friendly products, packaging, and manufacturing processes by the time the recession ends, they may be shut out of premium segments by multinational rivals. The drive into nonurban markets in China and India is reinforcing the message with a twist: Sustainable solutions are essential to people who don’t have access to water, electricity, or clean air. For these rural customers, companies need to develop products that can work with small quantities of water or electricity or that use alternative sources of energy such as solar power. NGOs, labor organizations, and governments are also compelling companies to develop more sustainable products; their environmental standards have become business norms in export markets.
Points out University of Michigan professor C.K. Prahalad, “The current economic crisis is similar to the collapse of the dot-com economy a decade ago in one respect. A few companies, such as Amazon, eBay, and Google, emerged from the debris and have thrived ever since. Similarly, companies that understand the opportunities engendered by sustainability will come out of this recession ready to capitalize on the low-carbon and clean-energy economy of the future.” Many emerging giants think they can leapfrog rivals in developed countries, which are just starting to get serious about eco-friendly products. That creates a level playing field—for the first time. For instance, BYD was able to launch its plug-in hybrid two years before GM, which will launch the Volt in 2010, and a year ahead of Toyota, whose plug-in hybrid is due in late 2009.
Stung by Western criticism, governments of some developing countries are tackling environmental problems and pressuring local companies to go green. Take China, where automobiles are responsible for as much as one-fifth of carbon emissions. The Chinese government has recently imposed tougher emission guidelines and created a carbon-based taxation system. Its goal is to have 10,000 hybrid, electric, and fuel-cell vehicles in 10 cities by 2010. The State Grid Corporation of China is setting up charging stations for the cars in Beijing, Shanghai, and Tianjin initially. With demand for hybrid, electric, and fuel-cell vehicles in China likely to reach 100,000 a year by 2012, the Chinese automobile company Chery has already followed in BYD’s footsteps and launched a plug-in hybrid car in February, and its rival Geely plans to unveil its plug-in hybrid later in 2009. In addition to the American, European, and Japanese majors, they’ll face competition from India: Tata Motors is developing an electric version of the Nano, and Bajaj Auto is working on its own cheap small car. These Chinese and Indian companies are willing to make such bets because small, inexpensive, and green automobiles can also help them make inroads in developed markets.
The Response: Go Green Globally
Multinational corporations have traditionally taken their best-selling lines into emerging markets and created new brands for them later. That cascading strategy may not work in the future because of the speed at which governments and consumers in developing countries are becoming environmentally conscious. If they’re to keep up with local rivals, Western giants will have to kick-start the development of sustainable products for emerging markets right away and launch eco-friendly products all around the world at the same time.
Shift 5: The Call of Africa
Africa is bound to beckon when emerging giants hunt for growth again. The developed nations will return to health slowly, and emerging markets are tough to crack, so the lure of the world’s second-largest continent will be inescapable. The IMF forecasts that Africa’s economy will grow by 2% in 2009. Although that’s below its 2008 growth rate of 5.2%, the decrease is due mostly to a fall in the prices of commodities that Africa exports.
Africa isn’t integrated with much of the developed world, but it does have trading relationships with developing countries in Asia, so it will probably recover in tandem with those markets. In later years it may start catching up with them: According to a Goldman Sachs report, South Africa’s per capita GDP will surpass the per capita GDPs of Brazil, Russia, India, and China by 2050, even though the South African economy will be smaller than any of the four BRIC economies.
Africa is a market of around 1 billion people, just shy of India’s 1.1 billion. Cynics will say it isn’t a country but a continent. They’re right, but then people say the same thing about China and about India, whose regions differ as much as African nations do. Those differences haven’t prevented companies there from learning to adapt to local conditions. African nations share common languages, cultures, and trade routes, and companies that cluster them together can create viable markets.
Many multinational companies, such as Coca-Cola, Unilever, and Novartis, already do business in Africa. Several Chinese and Indian companies have also found it easy to operate there; they’re accustomed to dealing with regional variations and can adapt the business models they use at home. Africa’s large population of Indian immigrants has been facilitating trade with India; India-Africa trade was an estimated $20 billion in 2006. China’s trade with Africa shot up from $10 billion in 2000 to $32 billion in 2006. While India had invested some $2 billion in Africa, China had committed more than $8 billion by 2008. In his recent book, Africa’s Silk Road, Harry Broadman wrote: “China’s and India’s newfound interest in trade and investment with Africa presents a significant opportunity for growth and integration of the sub-Saharan continent into the global economy.”
According to Vijay Mahajan, a University of Texas, Austin, marketing professor who wrote the book Africa Rising in 2008, the continent’s premium segment, which he calls Africa One, consists of about 50 million to 150 million people, and the bottom-of-the-pyramid segment, Africa Three, consists of about 500 million to 600 million. Both segments are tough to crack, he says. Companies should target Africa Two, the middle-class segment, which, at somewhere between 350 million and 500 million people, is bigger than India’s middle class. “Companies that can create products targeted at middle-class consumers will create major businesses in Africa. With aspirations outpacing income, Africa Two is already consuming products meant for Africa One,” says Mahajan.
The Response: Tap Africa’s Potential
It’s time multinational companies went on consumer safaris, as Unilever executives call exploratory forays into Africa’s markets. Take the case of the Diageo beer brand, Guinness. Although its sales started falling some years ago, they were increasing steadily in some African countries, such as Nigeria, where Guinness has been a leader for years. In July 2007, CEO Paul Walsh formally announced that Diageo would move deeper into Africa to grow the market for its Irish stout. “The future of Guinness may lie not in Ireland’s pubs but in Africa’s bars,” Mahajan says.
In recent weeks, economists have been wondering what shape a recovery might take in developing countries. Will it be a V—a sharp rebound? Will it be a U—a gradual recovery? Or will it be a W, as economies rise and fall before rising again? Whichever it might prove to be, the recovery will spell “threat” with a capital T because many emerging giants will come out of the recession lean, mean—and green.