Increasingly companies are looking for their future growth in emerging markets. Up to now the recommendation has been that only way that companies can prosper in these markets is to cut costs relentlessly and accept profit margins close to zero.
The companies that are cracking these markets realise that opportunities in these markets don’t require companies to forgo profits, but it is not simply transplanting their existing business model and products into a new marketplace. This requires a new operational reality to make it work.
The key realisation should be that things like transferring money through cell phones, running hand-wash laundry services and improved distribution of traditional produce is typical of innovation that drives a new economy that requires a business unusual approach that makes commerce work in emerging markets.
That may sound overly simplistic; given the difficulty Western companies have had entering emerging markets to date. But we believe they’ve struggled not because they can’t create viable offerings but because they get their business models wrong.
Importing foreign business models.
Many multinationals simply import their domestic models into emerging markets. Through reduced functionality and branding changes, lowering prices and perhaps selling smaller sizes or by using lower-cost labour, materials, or other resources – these companies believe that they can take marginal profits and take market share. Sometimes they even design and manufacture their products locally and hire local country managers. The fundamental financial and operating models remain unchanged, limiting these companies to selling largely in the highest income tiers, which in most emerging markets aren’t big enough to generate sufficient returns. What they do not realise is that these upper tiers are spoilt for choice in most emerging markets where there is typically two economies and while they inch away at market share in these markets that typically represent at most 10% of the market, the remaining 90% does not have access to these products.
Many companies have already been lured by the promise of profits from selling low-end products and services in high volume to the very poor in emerging markets. And high-end products and services are widely available in these markets for the very few that can afford them: You can buy a Mercedes or a washing machine, or stay at a nice hotel, almost anywhere in the world. Our experience suggests a far more promising place to begin: between these two extremes, in the vast middle market. Consumers there are defined not so much by any particular income band as by a common circumstance: Their needs are being met very poorly by existing low-end solutions, because they cannot afford even the cheapest of the high-end alternatives. Companies that devise new business models and offerings to better meet those consumers’ needs affordably will discover enormous opportunities for growth.
To supply products in new markets requires both the supply chain as well as the customers. When you do not have the suppliers to can give you the raw products, then it is very expensive as it needs to transported or manufactured in that market. Many organisations move the product to a new market without the supply chain being in place. This is another key reason why local innovation is a key strategy.
Innovating for success
Leading scholars suggest that the best strategy in these markets is to find an idea where there are people that need a service in line with your core business, prototype and execute it. The aim is to build a new business model and to make it work. If you want to link this in time to your existing product range – this is great – but innovation requires local relevance as much as it requires the bells and whistles.
Back to the business model
So to move into these markets requires a lot of situational awareness and back to basics thinking. The very basic of any business model is to answer how plan to make money.
Behind that question is a line-up of other questions:
- Who’s your target customer?
- What customer problem or challenge do you solve?
- What value do you deliver?
- How will you reach, acquire, and keep customers?
- How will you define and differentiate your offering?
- How will you generate revenue?
- What resourcing (HR, Finance, Operations) supports this model?
- What’s your cost structure?
- What’s your profit margin?
- How will your customers pay?
These fundamental business questions need to be rethought when entering new markets.
Sophisticated business models can follow later and a lot of innovation may go into making this work but it must be back to the basics of the business model.
Understanding the basics of costs
For most large organisations the idea of fixed cost recovery and variable cost is already in place due to economies of scale. For smaller operations it is important to consider that start-up thinking is required.
Expansion into a new market means that there is a growing fixed cost base and also a variable cost to each new product that is produced, that initially is very high and later becomes lower. The refine a localised business model requires a clear understanding of this and to keep on linking the price to the cost and quantity being sold.
Some definitions that may assist for those unfamiliar with this include:
- Marginal cost is defined as (Fixed Cost + Variable Costs) / Number of products
- The marginal revenue is the additional revenue a firm gains by selling an additional unit of a good or service.
- Fixed costs: Your business will have plenty of costs — from renting an office and buying equipment to paying salaries and buying supplies. Some of these costs — office rental or salaries, for example — don’t change often and must be paid on a regular basis. These are fixed costs or overhead.
- Variable costs: Other costs, called variable costs, fluctuate with your sales volume. They include the materials that go into producing your product or service.
When marginal revenue is greater than the additional costs associated with producing an additional unit, known as the marginal cost, revenues will increase. Profit-maximizing firms seek to produce the quantity at which marginal revenue is equal to marginal cost.
Your sales must also cover your fixed and variable costs as well as your profit expectations and to know which is which. In start-up situations fixed costs increase and variable costs goes up initially and later decreases as production processes become more efficient.
On the ground, remote management or partnerships
When deciding to expand it is critical to decide if you are committing to a market. Without commitment you are setting up to fail. Emerging markets require commitment and a lot of initiatives fail because people seek local partners, do not commit to get their own staff and believe that they can manage the market the same as their domestic market. It is critical to think through the skill sets required, the people to do it, complex arrangements such as taxation, currency transfers and supervision and to do this while accepting that your business model will have to adapt to local conditions.
Most organisations are looking at to build their international presence and a lot of companies are betting on the fact that growth will come from the 5 billion people in emerging markets and the developing world. This market requires careful study and deliberate strategy in order to succeed. While there is money to be made – it requires an innovation mind-set and not simply the transplanting of what you do at home to a new place. If you are not thinking about your international strategy yet – maybe it is time to consider it.