Large emerging markets (LEMs) and international strategy

The Authors

Peter Enderwick, Auckland University of Technology, Auckland, New Zealand

Abstract

Purpose – The purpose of this paper is to explore how the rise of large emerging markets (LEMs) has affected the business strategies of multinational enterprises. The growing importance of emerging markets has encouraged considerable research on strategy development when entering such markets. However, little attention has been paid to the question of how the rise of international businesses from LEMs will impact on strategy more generally, and in particular how established multinationals might be expected to react.

Design/methodology/approach – This conceptual paper evaluates international strategy impacts of the rise of LEMs from the perspective of alternative market entry motives – for market access, for lower costs and learning opportunities. It discusses both strategic opportunities and likely impacts on strategy and structure.

Findings – The discussion suggests that the rise of LEMs has stimulated the internationalisation of international business and has increased specialisation within the world economy. A number of Asian “dragon multinationals” are using emerging markets to advance their global competitiveness.

Originality/value – This paper offers a more balanced perspective on the impact of the rise of emerging markets on international strategy. Analysis highlights a range of strategic benefits resulting from engagement with LEMs. The discussion is illustrated with numerous examples.

Article Type:

Conceptual paper

Keyword(s):

Operations management; Emerging markets; Multinational companies; Management strategy.

Journal:

International Marketing Review

Volume:

Number:

Year:

2009

pp:

7-16

Copyright ©

Emerald Group Publishing Limited

ISSN:

0265-1335

Introduction

The growing importance of the so-called emerging economies is now well documented (Enderwick, 2007; Prestowitz, 2005; Shenkar, 2005). For international businesses, emerging economies – and particularly the largest two, China and India – are attractive in a number of ways. Firstly, their population levels and high rates of economic growth offer considerable opportunities for the marketing of goods and services. Much of the future sales of consumer durables such as automobiles and mobile phones will occur in emerging markets. Second, for a number of industries including electronics, clothing and footwear, and business services, the large emerging markets (LEMs) offer significant opportunities to lower costs through global sourcing or local production. With China acknowledged as the “world's workshop” and India as the “global back office” the cost savings can be considerable. For example, Wal-Mart's reliance on sourcing from China has been estimated to save US consumers $US20 billion a year ( Business Week, 2003). Cost savings can be used to competitive advantage and are likely to feature strongly in the strategies of firms facing strong levels of competition. Third, the distinctive characteristics of LEMs – economic and social dynamism, high levels of competition, pervasive market failure and institutional differences – encourage learning. Many of the lessons learned in the more sophisticated emerging markets may be of competitive value in other developing economies as well as developed country markets. For all these reasons we would expect the rise of emerging economies to significantly affect the strategies of international businesses. There is certainly considerable anecdotal evidence to suggest that the majority of international businesses incorporate the LEMs into their strategic decision-making (A.T. Kearney, 2005; UNCTAD, 2007).

There have been a number of general assertions which suggest that such markets are becoming increasingly important in strategy formulation, are influencing the composition of multinational top management teams, and are related to more complex and integrative strategies (Harvey et al., 1999; Hitt, 2006). However, on a more detailed level, most of the research focus has been on strategy adaptation for successfully entering emerging markets (Hoskisson et al., 2000; Arnold and Quelch, 1998; Khanna and Palepu, 1997). What has not been explored to the same degree is the interesting question of how the rise of LEMs has affected business strategy more generally, particularly the strategies of established multinational enterprises. That is the intention of this paper. To achieve this, the following section examines the principal ways in which the rise of LEMs might be expected to impact on business strategy. It develops a classification of the likely major impacts based around the motives for involvement in emerging markets. The final section offers concluding thoughts.

Likely impacts of LEMs on international strategy

There are a number of possible classificatory approaches that could be used to examine the likely impacts of the rise of LEMs on international strategy. One of the simplest is based on the three key motivations for engagement with such economies: as markets; as lower cost sources and as learning opportunities. Considering the principal impacts within such a framework generates Table I.

Table I suggests that international strategy is likely to be affected in a variety of ways as a result of the growing importance of the LEMs within the world economy. The impacts are seen to vary according to the principal reasons for a firm to become involved with emerging markets. We will explore each of these in more detail. It is important to note that while we discuss these reasons as separate categories, we recognise that in many cases firms are attracted by a combination of motives and that the relative importance of these motives can vary over time. For example, an international business may initially see an emerging economy as a means for lowering the costs of production, only to then discover that a potential market for its product may also exist.

New markets

For a large number of international businesses the principal attraction of LEMs is that they offer new markets which are both large and growing rapidly. This has a number of implications for strategy. At the simplest level it could mean further international expansion as international businesses seek to enter these newly available or increasingly attractive markets. For example, both China and India with strong income growth and an explosion in entrepreneurial activity, now offer attractive markets for luxury goods such as fashion products. As an illustration, LVMH, the luxury products group, now has almost a quarter of sales revenue coming from the Asian region and sagging sales of luxury jewellery, wines and spirits and leather goods in Japan and the USA have been more than offset by strong sales growth in China and India ( Business Week, 2008). More generally, a number of industries such as automobiles have maintained sales only through an increased focus on the strongly growing LEMs when demand has turned down in home or traditional developed markets.

A second implication is the opportunity for rapid internationalisation of firms and industries where previously this was limited by market size. The clearest example of this is probably infrastructure. With the largest ever investment boom currently underway, a boom driven by the bigger emerging economies, there are huge new opportunities for investors in power generation, highways, sea and airports and water management ( The Economist, 2008). International investors, many of which traditionally have focused primarily on their domestic markets, are now moving rapidly into these economies (UNCTAD, 2008). This clearly implies several changes in strategic thinking: from domestic to international markets; from developed to developing economies and towards public-private partnerships.

A further strategic implication of increased involvement with emerging markets is the need for consumer education and market development. In many cases, emerging markets are likely to be considerably underdeveloped in terms of brand awareness, loyalty, distribution and after-sales service. For many international firms involvement in these markets carries a price: the need to invest in making and developing markets. The experience of a number of international investors has been that simply transplanting older technology and product offerings from developed to developing markets is fraught with dangers. Success generally requires careful market research and detailed understanding of consumer needs. For example, Nokia developed a highly successful mobile phone handset for the Indian market which reflected local operating conditions – it was dust-proof, had a non-slip cover and included a light – all attributes valued by rural users. Such market adaptation and development often comes at a significant cost. In most cases, targeting middle- and lower-income consumer segments in LEMs calls for products that are 30-50 percent less expensive than premium ones. Furthermore, successful strategies usually imply considerable additional marketing expenditures. In marketing strategy terms they may require a greater focus on value appropriation, perhaps at the expense of value creation.

A third strategy implication arising from the attraction of LEMs as markets is the opportunity to extend product life cycles, perhaps by transplanting established products from developed markets to emerging ones. Such a strategy does however, carry considerable risks if the product is not suitable for the less sophisticated markets, or costs cannot be lowered sufficiently to meet prevailing price expectations. An example where this has been successful is Volkswagen. Because of a lack of competition at the time, VW was able to establish the Santana, an older model in European terms, as the standard for taxis in mainland China. At the same time, through cost savings resulting from a relocation of production to Brazil, the company was able to keep extend the life of the original Beetle to over 60 years. With such a strategy it is, however, essential to make the necessary investment in updating technology and introducing new models to maintain market share in the most advanced markets.

A fourth implication identified in Table I is a result of the recent aggressive outward investment being undertaken by Chinese and Indian firms. As well as providing a direct competitive threat where emerging market firms acquire competitive assets such as brand names, technology or distribution systems, perhaps the types of investment most likely to trigger a strategic response from international businesses are those prompted by a desire to acquire resources, typically commodities. Both India and China have, for example, invested heavily in African oil resources. Such investments are likely to trigger a reconsideration of these resources by the oil majors and a number are now rethinking their strategies in countries such as Sudan and Iraq, both sources of untapped reserves.

Finally, we can also expect organisational changes to occur as international businesses realise the growing importance of LEMs. The most likely effect, given the size of the major emerging markets, is the development of regional headquarters based in China or India. In many cases such operations are a direct result of the growth of sales and the increasing share of these markets within total sales. More recently, as international firms have begun to shift higher value activities such as engineering or research and development to the LEMs, this has changed the nature of reporting, learning, communication and control. A number of international businesses such as Continental Corporation and WABCO have opened regional centres within China or India in response to the changing role that LEMs have assumed. More generally, a very large number of the world's leading corporations have established Asian regional headquarters in centres such as Hong Kong and Singapore which are well placed to manage the explosive growth within the Asian LEMs.

Lower costs

The second major rationale for international business involvement with LEMs is the opportunity to lower costs and to take advantage of specialist resources. For a large number of businesses, the primary attraction of LEMs is as a new source of supply. This motive manifests itself in the huge increase in global sourcing of manufactured products, mainly from China, that has occurred in recent years. For example, sourcing from China is at the very heart of Wal-Mart's low cost competitive strategy. In the USA at least 70 percent of items sold in Wal-Mart stores have a Chinese component. Wal-Mart accounts for ten percent of all US imports and is China's eighth largest trading partner, ahead of Russia and Germany. Wal-Mart's ability to drive down prices through sourcing from China is estimated to bring US consumers' direct savings of $US20 billion a year (BusinessWeek, 2003). We have also seen a similar increase on the offshore sourcing of back-room business services, primarily to India, again prompted largely by the opportunities for considerable cost savings (Blinder, 2006). Offshore sourcing is spreading from the simple IT functions where it began towards more specialist and knowledge-intensive activities.

Both of these processes reflect a more general strategic trend in which LEMs are playing a significant role, and that is growing organisational specialisation as value adding activities are increasingly fragmented, performed remotely and re-integrated closer to final markets. This growth of “fine slicing” enables international businesses to take advantage of both lower costs and new sources of resources, including land, labour and local knowledge. Both China and India offer large supplies of labour, some of it highly-skilled, and this is now enabling international businesses to consider the relocation of higher-order functions including design, product engineering, research and development and customer service to emerging markets (UNCTAD, 2005).

The growing capability evident in LEMs coupled with the ease of managing far flung activities is also encouraging international businesses to reconsider the geographical dispersion of corporate competencies. This manifests itself as new centres of expertise, many now forming world product mandates – specific locations charged with developing or producing for world markets. Given its resource and cost structure it is not surprising that China has developed a general mandate for the production of end-of-life electronics products such as microwave ovens, calculators and watches. More specifically, Intel has focused its Channel Platforms group in Shanghai, GE Medical Systems has granted China a world product mandate in CT Scanners which are now subject to increased cost competition and Philips operates its global TV business, from R&D through to marketing, in China.

In a number of cases it is not just the lower costs that China offers that are attracting such investments. For example, Nokia's decision to relocate significant parts of its third generation software to Hangzhou was prompted by both cost savings and the dynamic nature of China's telecommunications industry which offers rapid feedback and truncated prototyping cycles. The huge potential market and advantages of localisation appear to lie behind Microsoft's decision to focus research on the next generation of voice and handwriting systems in China. The potential (Chinese language) market for such applications is both huge and important in influencing world standards. Cummins has concentred its development of smaller diesel engines for a range of applications within India and is able to then service similar demand in neighbouring markets such as Nepal and Bhutan.

Cost and risk considerations as well as the availability of significant economies of scale within LEMs are also influencing strategic decisions, particularly with regard to the development of new products or services and the focus of competition. A recent example is Nissan's announcement of its commitment to provide an electric car for world markets by the year 2010 (Vlasic, 2008). While the new vehicle will be available in the USA by this date, an important consideration behind development and initial market penetration is the strong demand for new vehicles, and increasingly low emission vehicles, in emerging markets such as China and India. These markets provide a relatively low risk strategy for developing new products before they face considerable competition in more established markets such as Japan and the USA. At the same time, China's tariff structure has made the production and sale of hybrid vehicles uncompetitive in the home market. In this way, the LEMs are becoming the preferred market for the development and launch of new products. This is in marked contrast to the thinking of a few decades ago, best epitomised in the idea of the product cycle (Vernon, 1971), where new products were pioneered in the most advanced markets first.

Building a global position from LEMs is a strategy of particular appeal to later movers in many industries. A clear example is provided by Hyundai and its considerable ambitions in the car industry (Moon, 2008). Hyundai aspires to become one of the top five car producers by 2011. Its strategy to achieve this is based on a build up of its position in India and China, markets which currently account for about a fifth of total sales. The company is already the number two brand in India and is the country's largest exporter of cars. The build up is to be achieved by increasingly integrating operations – design, manufacturing and exporting – within LEMs. India, for example, will become the global hub for small cars with, eventually, half of total production being exported. Success in China and India is expected to assist sales into less developed markets including Russia, the Middle East and Africa. Domestic firms are also capitalising on the opportunities for building a critical mass in LEMs. This is precisely the strategy of Chinese car producer BYD which is striving to build its home market share as a foundation for eventual international expansion.

The rapid growth of LEMs has also made these markets increasingly attractive in terms of integration with local suppliers. It is widely acknowledged that LEM suppliers can offer substantial cost savings, achieved through access to low cost labour, land, capital and machinery. At the same time, the quantity and quality of the local supply base in both China and India is increasing dramatically. India has more CMM-rated software suppliers than any country other than the USA as well as a significant number of FDA-approved pharmaceutical plants. While China's reputation has suffered recently with a number of incidents of quality failure (Enderwick, 2008), it has a world class supply base in industries such as clothing and textiles and electronics. As the car manufacturing industry has developed, China has attracted more than 500 foreign-funded auto parts companies including some of the world's leaders including NGK Spark Plug Corporation, Bosch, Delphi and Visteon. This deepening of the LEM supply base has affected strategic thinking by encouraging global sourcing, the integration of manufacturing operations with local suppliers, and the possibility of establishing low-cost export platform within LEMs.

LEM suppliers are becoming increasingly sophisticated in both their offerings and operations. This is well illustrated in the case of the Indian company Bharat Forge which is one of the world's leading manufacturers of forged and machine components, many for the automobile industry. The company supplies the world's top five vehicle producers and virtually every automotive OEM and Tier 1 supplier. Bharat operates in 12 locations across six countries. It has developed a highly sophisticated business model offering both full service supply capability (from product conceptualisation to design, manufacturing, testing and validation) as well as dual shore manufacturing whereby it has established more than one manufacturing location for all core components. Typically this would include one location close to the buyer and another in a lower cost, but technologically competitive location such as India. The high level of capability which Bharat Forge has developed means that it is increasingly seen as more than simply a component supplier; for many international buyers it is considered a preferred technology and engineering development partner.

Finally, particularly in the case of China, there are increased opportunities for developing highly efficient regionally integrated operations which capitalise on the economic differences that exist between Taiwan, Hong Kong and the rest of Mainland China. Each of these locations offer specialised resources and capabilities – Taiwan in R&D and engineering expertise, Hong Kong in financing, logistics and business services and Mainland China with low-cost land and labour. The strategic integration of these locations can offer cost and efficiency benefits which exceed those attainable in any one location.

Learning effects

The third major benefit of involvement with LEMs, and area likely to impact international strategy, is the opportunity to learn from these markets and to transfer and incorporate such learning within strategic decision-making.

A major learning opportunity provided by LEMs is in the management of rapid change, transition and economic upgrading. A defining characteristic of emerging market is that they are enjoying strong growth and experiencing change. In most cases the change is both more rapid and more complex that that typical of the most developed economies. Consider the case of China which is simultaneously experiencing several transitions: from rural to urban; from agricultural to industrial; from planned to market and closed to open. Learning to manage such multifaceted and rapid change offers valuable lessons which can be applied in other markets, particularly other emerging markets which might be expected to experience similar change. The lessons are particularly powerful for international marketers. If we consider the market for automobiles in China, the pace of change in just a few years is staggering. Sales of motor vehicles in China has grown at 40 percent a year since 2005, for India, annual growth at 20 percent has been lower but far in excess of that experienced in the advanced markets. As the market has shifted from one dominated by institutional buyers (government officials, senior management of state-owned enterprises) to private vehicle buyers, the type of vehicles demanded and their key selling points have changed significantly. As demand has moved to favour smaller vehicles, domestic manufacturers have gained market share as well as foreign producers who are perceived to offer greater value for money. The result has been a significant change in market shares as well-established early entrants such as VW and GM have lost ground to more recent entrants such as Toyota, Hyundai and Honda. The opportunities to mould the market are also considerable. A staggering 80 percent of new car buyers in China are first time buyers and have display little brand loyalty. However, there is also considerable competition. China now has more car brands than the USA, while India has 41 automobile companies.

A second area where valuable learning could occur is with regard to institutional and market failures, conditions which are endemic in many emerging markets (Enderwick, 2007). The characteristics of LEMs such as China's weak intellectual property laws have encouraged the development of novel business models, a number of which could appeal to international businesses. Examples are provided by the gaming and music industries. Because of lower average income levels and problems of protecting intellectual property, the electronic gaming industry in China has developed a distinct business model. Rather than expecting consumers to purchase a gaming platform and individual games, the industry focuses on the use of gaming centres where players pay to use machines and games are provided over the Internet. This model offers individual consumers with a low cost entry method as well as protecting intellectual property by discouraging the illegal copying of games.

The Chinese music industry is also quite distinctive in its approach. Because of widespread illegal copying of CDs, singers cannot rely on music sales to provide a viable income stream. Instead music artists make their money from personal appearances, opening public events, signing and selling merchandise, advertisements and touring. They are managed “360 degrees” whereby recording and artist management companies take a share of all revenue streams. Similar trends can be seen in the more advanced markets where electronic downloading of music has eroded CD sales. We also see artists taking the initiative to manage their careers (buying out of record contracts, releasing material on the Internet, selling individual music tracks, etc.) and, of course, a massive revival in touring by established acts. The strategic indecision apparent on the part of the major music labels in recent years suggests that few have used knowledge available in LEMs to anticipate likely market trends and respond appropriately.

The rapid change typical of LEMs also provides interesting lessons in the management of risk. Risk in these markets does not always follow the patterns apparent in the least developed economies where political and economic risks are widespread. Rather, the risks of LEMs stem from the transition process and the strains of brisk economic, social and policy change. A current example is provided by the quality failures apparent in a range of Chinese sourced products including toys, food products, pharmaceuticals and vehicle tyres. While a range of responses to such problems exist (Enderwick, 2008), a number of companies are experimenting with a “China + 1” strategy whereby newer, emerging sources of supply such as Indonesia, Cambodia or Vietnam, are developing as shadow suppliers to operations based in China.

Learning to manage in the face of pervasive and evolving regulation may be a further lesson offered by LEMs. Particularly in the case of India, regulatory controls, and their possible future relaxation, make clear new business opportunities. Examples are provided by proposals to allow foreign representation in legal services and the relaxation of controls on foreign ownership in multi-product retailing. Companies such as Wal-Mart have already developed joint ventures at the wholesaling level in anticipation of a easing of restrictions on retailing at a later date. LEMs also offer valuable experiences in dealing with central and local (state or provincial) policy makers. Such experience can be invaluable as Enron discovered with its ill-fated Dabhol plant and dealings with the Maharashtra state government. These lessons not only assist an international business when entering other emerging markets, but may also be relevant in the more developed markets as the regulatory authorities struggle to deal with emerging issues such as environmental sustainability, governance concerns, technological convergence and the emergence of monopolies in knowledge-intensive industries.

Finally, requirements or a preference for joint venture arrangements in entering LEMs offers valuable opportunities for international businesses to increase their understanding of distinct business systems and coexistence with culturally diverse partners. As more and more international businesses develop complex alliance arrangements around the world, such knowledge is both valuable and potentially transferable.

Conclusions

Our discussion suggests a number of conclusions. First, rapid growth within LEMs has provided a new impetus to the internationalisation of business. The large emerging economies of China and India have provided new markets and low cost sites for international businesses. At the same time, a number of LEM enterprises are beginning to internationalise. Second, the emergence of the LEMs has encouraged increased specialisation within the world economy and the “fine slicing” of value-adding activities. Third, international businesses marketing products and services in LEMs are becoming increasingly aware of both the opportunities and threats that such markets bring. LEMs are being used both to extend product life cycles (as a result of lower costs and new market segments) and to develop and launch new products (as a result of increasingly affluent consumers). However, a number of Western firms have experienced difficulties in maintaining market share in the face of rising competition and increasingly discerning consumers within these markets. The real competitive threat may come from Asian dragon firms, particularly those from Korea, who are using the LEMs to advance their global competitiveness. Fourth, the rise of emerging economies has been accompanied by the growing competitiveness of LEM enterprises. While this is an area of strategic thinking we have not considered in deal, these firms are utilising their home country advantages (scale, lower cost) while also seeking to overcome competitive weaknesses (technology, brands, management skills) through aggressive internationalisation. Considerable strategic interaction is now apparent with regard to the strategies of MNEs and LEM economies as well as between LEM enterprises and global MNEs. Our discussion suggests that the rise and evolution of LEMs has had a profound impact on business strategy for all firms.

Table IPrincipal impacts of the rise of LEMs on international strategy

References

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