Growing BeyondInnovating for thenext three billionThe rise of the globalmiddle class – and howto capitalize on it
Growing Beyond   Innovating for the next three billion
IntroductionA   t a time when major developed markets    are struggling to sustain an economicrecovery, it is easy to forg...
Executive summaryThe rise of the globalmiddle class — and howto capitalize on itB     etween now and 2030, the number of p...
Innovating for the next three billion is a major opportunity, but               Low-cost innovations are not just for rapi...
AcknowledgementsWe conducted a series of interviews with some of the world’s leadingentrepreneurs, senior executives and t...
About this reportThe findings for this report are drawn from two studies conducted in       We surveyed developed market c...
Section 1:An unparalleled opportunity6     Growing Beyond   Innovating for the next three billion
O   ver the next 20 years, global economic    trends will completely transform thecustomer base for most industries. Risin...
“The new consumer does not                                                    have to adjust to the market.               ...
“Increased private consumption in many rapid- growth markets will play an important role in rebalancing the economy and cr...
“The emerging middle class is the number one                                                             driver of innovat...
“Running a business during years of volatility has given us the ability to adapt and come up with a new plan quickly.”    ...
It is also striking that companies in the surveywith higher-than-average EBITDA growthseem more likely to recognize the sc...
Reaching a new customer baseat Tata ChemicalsW     hen India’s Tata Group launched the      Swach water purifier in 2009, ...
Section 2:The four capabilitiesof innovation14    Growing Beyond   Innovating for the next three billion
Innovating for the next three billion will require companies to develop a set of keycapabilities. Our research has identif...
“Qualitative research is the most powerful                                                                      way to gai...
“Global resources and capabilities are an important advantage for multinationals seeking to unlock the opportunities in ra...
“Western companies tend to place                                                                  greater importance on pr...
“The main advantage for multinationals is that they have global resources and capabilities. But they must apply these effi...
“Globally integrated R&D will be a crucial driver                                                                    of su...
“Big multinationals need to look at what has already been developed locally and then partner with entrepreneurs to scale u...
The importance of an open approach                Joint-venture partnerships betweenA more open approach to innovation, wh...
Microsoft:A platform for competitivenessT   he dissemination of technology in rapid-    growth markets has been a vital ca...
“Multinationals are just looking at the margins                                                                  and not t...
“Creating low-cost but high-quality products and services for the middle class in rapid-growth markets will require compan...
“Failure to scale will only give our competitors                                                                product de...
“Companies seeking to innovate in rapid-growth markets need to find ways to empower local managers to make decisions quick...
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
Earnst & Young: Innovating for the next three billion
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Earnst & Young: Innovating for the next three billion

  1. 1. Growing BeyondInnovating for thenext three billionThe rise of the globalmiddle class – and howto capitalize on it
  2. 2. Growing Beyond Innovating for the next three billion
  3. 3. IntroductionA t a time when major developed markets are struggling to sustain an economicrecovery, it is easy to forget that opportunities We believe that this emerging demographic, which we call the next three billion, offers companies a rare and highly valuableabound in other parts of the world. Rapid- opportunity to seize a new market ofgrowth markets in Africa, Asia, Eastern unprecedented size by thinking differentlyEurope, Latin America and the Middle East about how they innovate. Although thecontinue to expand rapidly and play an emergence of this demographic is still at anincreasingly dominant role in the global early stage, companies must act now to createeconomy. Many of these economies are attractive products and services, establishbecoming major hubs of entrepreneurship, a presence, and build market share and scale.innovation and trade, as well as investment Those that can sustain both a long-termfrom multinationals from around the world. commitment and the ability to innovate for the next three billion will be well positioned as thisUntil recently, growth in these markets was market swells in the next 20 years.dominated by investment, infrastructureand exports, but in the next decade, it is In this report, we examine the emergencelikely this picture will start to change. Major of the next three billion and explore therapid-growth markets will start to steer capabilities that companies must buildtheir economies away from a dependence to align their businesses with the needson exports toward a model of increased of this demographic. The report forms partprivate consumption. Although not rich by of Growing Beyond, an ongoing Ernst & Youngthe standards of developed countries, a program that explores how companies canhuge middle class is already saving less and grow more quickly by expanding into newspending more, creating big opportunities for markets, finding new ways to innovate andcompanies that can serve them with relevant implementing new approaches to talent.products and services. Maria T. PinelliThese markets are vast. The middle class Global Vice Chairin Asia alone currently numbers some Strategic Growth Markets525 million people, greater than the Ernst & Youngpopulation of the entire European Union.Between now and 2030, an additional threebillion people globally will enter this incomebracket. Over the longer term, this explosionof spending power has the potential to makea significant contribution to a sustained globaleconomic recovery and unwind long-standingeconomic imbalances between West and East.The rise of the global middle class – and how to capitalize on it 1
  4. 4. Executive summaryThe rise of the globalmiddle class — and howto capitalize on itB etween now and 2030, the number of people in the global middle 1 class will grow from 1.8 billion to 4.9 billion. The vast majorityof these three billion new consumers, with daily expenditure of between In the past, developed-world companies would typically take premium products that sold well in their home market and either sell them unchanged in rapid-growth markets or strip them down to make themUS$10 and US$100, will live in Asia and other rapid-growth markets. more affordable. Neither approach was satisfactory. Premium productsAlthough the majority of these consumers will have expenditure at may have sold well to the elites in rapid-growth markets, but they werethe lower end of this spectrum and therefore will not be considered often irrelevant for the vast proportion of the population on lowermiddle class by the standards of developed economies, this vast cohort incomes. And stripped-down products may have been more affordable,nevertheless has considerable spending power. Between 2009 and but they were not sufficiently tailored to meet the specific needs2030, demand from the global middle class could grow from US$21 of local customers.trillion to US$56 trillion.2 Reaching the next three billion will require companies to understandAgainst a backdrop of sluggish growth in developed markets, the unmet needs of the new middle-income customers and to createthis explosion of new purchasing power is good news for the global entirely new products and services to fulfill them. This will meaneconomy and the growth prospects of the world’s multinational thinking differently about every stage in the product developmentcompanies. A rise in private consumption among the middle class, process. Strong R&D capabilities will be important, but so too willparticularly in rapid-growth markets, will help to rebalance the global be innovative business models, deep customer insight, and a cultureeconomy and create a vital new revenue stream for companies across and a mindset that support innovation.a wide range of sectors. The aim of our report, which is based on a survey of 547 executivesYet capitalizing on demand from the next three billion will not be from around the world and in-depth interviews with some of the world’sstraightforward. Many companies will need to rethink their product leading entrepreneurs, senior executives and thinkers, is to examineand service offerings to ensure that these offerings are tailored to the the capabilities necessary to innovate for the next three billion. Weneeds of this vast customer base. explore the scale of the opportunity and look at the approaches that companies are taking to develop affordable products that meet the needs of customers on lower incomes. We conclude with a model we feel describes the necessary capabilities for companies seeking to target the next three billion consumers. Key findings of this research include the following:2 Growing Beyond Innovating for the next three billion
  5. 5. Innovating for the next three billion is a major opportunity, but Low-cost innovations are not just for rapid-growth markets.companies are realistic about the challenges. There is a widespread Companies that innovate for customers in rapid-growth markets shouldconsensus that innovation in rapid-growth markets represents an consider how they can take those ideas and apply them in developedimportant opportunity for growth. Slightly more than one-third of economies. As living standards between developed and rapid-growthrespondents to our survey say that they are already reaping rewards markets converge, and as companies seek new efficiencies in theirfrom a more “frugal” approach to innovation, while a further 40% plan operations and innovation processes, innovations designed with rapid-to do so. Companies with higher-than-average EBITDA growth are growth markets in mind will become increasingly valued globally asparticularly likely to be focusing on this opportunity. But respondents a source of competitive advantage.are also realistic about the challenges ahead. Many admit that it will Successful innovation in rapid-growth markets goes far beyondbe difficult to make these innovations profitable, while others are R&D. Creating products and services that are affordable for theconcerned about the extent of existing competition. next three billion requires companies to draw upon a broad rangeDeep customer insight and organizational agility are key to meeting of capabilities. R&D is important, but it is just one piece of thethe needs of the next three billion. An understanding of the needs innovation puzzle. To meet the requirements of quality, affordabilityof local customers is the most important contributor to successful and access, companies should be prepared to rethink their entireinnovation in rapid-growth markets. To solve the unmet needs of business and operating models. They should build new relationshipsthe next three billion, leading innovators spend time observing them with stakeholders across the supply chain, seek out new distributionto spot potential opportunities. They also give autonomy to local channels, and develop an intense focus on operational excellencemanagers to roll out new products and services, and ensure that to bring down costs and increase efficiency.a significant proportion of R&D takes place close to end customers. Local companies have the upper hand in serving lower-incomeCompanies must balance the need for local customization with customers, but multinationals are gaining ground. Companiesglobal scale. Economies of scale are vital to bringing down the cost headquartered in rapid-growth markets currently have the upper handof innovating for the next three billion and ensuring that it is profitable. in serving lower-income customers. They have deep local knowledgeGlobal innovation networks that enable resources and intellectual and insight into customer needs, and are accustomed to operatingproperty to be applied across regions can be a vital channel to share in an environment where constraints encourage creative problem-intellectual property with other markets. Some companies focus on solving. But companies from developed markets are keen to catchdeveloping global “platform technologies” that can be combined with up by applying their strengths of global resources and capabilities,local elements to make them relevant in each market. a process-oriented approach and strong brands. Footnotes 1. Homi Kharas, The emerging middle class in developing countries, Working Paper No. 285, OECD Development Centre, January 2010. 2. Ibid. The rise of the global middle class – and how to capitalize on it 3
  6. 6. AcknowledgementsWe conducted a series of interviews with some of the world’s leadingentrepreneurs, senior executives and thinkers to explore the differentapproaches to innovation in rapid-growth and developed markets. Dr BRA Mooryati Daniel Mendez Eloi D’Ávila de Soedibyo President of Sapore Oliveira Founder & Technical President of Flytour Advisor of PT Mustika Ratu, Tbk Josh Nash Linda Rottenberg Luiz Enrique Senior Strategist – Co-Founder and CEO Almeida National of Endeavor CEO of Regina Festas Competitiveness at Microsoft Corporation Mr. Sudhamek AWS Navi Radjou R. Gopalakrishnan CEO of GarudaFood Independent Director at Tata Sons Group innovation and Ltd. leadership consultant and a Fellow at Judge Business School, University of Cambridge4 Growing Beyond Innovating for the next three billion
  7. 7. About this reportThe findings for this report are drawn from two studies conducted in We surveyed developed market companies with rapid-growth marketSeptember 2011. An online survey of 547 C-suite executives, board operations and rapid-growth market companies in Brazil, Russia,directors and senior managers in rapid-growth markets was conducted India, China, Mexico, Turkey, Indonesia and South Korea. Half of theby the Economist Intelligence Unit and supported by a series of companies surveyed have more than US$1b in revenue, and 70% reportin-depth interviews with senior executives and leading thinkers. EBITDA growth in excess of 5% for the last year. Enrique Beltranena Ernesto Vidal Jeff Weedman CEO of Volaris Founder and CEO Vice President for of Ingenia Muebles Global Business Development at Procter & Gamble Maria T. Pinelli Maxim Nogotkov Dr. Meera Sampath Global Vice Chair President of Director of the Xerox for Strategic Svyaznoy Group Research Centre Growth Markets India at Ernst & Young Rain Newton-Smith Sam Fouad Prof. Vijay Head of Emerging Americas Emerging Govindarajan Markets at Oxford Markets Leader Professor of Economics at Ernst & Young International Business at the Tuck School of Business, Dartmouth College The rise of the global middle class – and how to capitalize on it 5
  8. 8. Section 1:An unparalleled opportunity6 Growing Beyond Innovating for the next three billion
  9. 9. O ver the next 20 years, global economic trends will completely transform thecustomer base for most industries. Rising The next three billion consumers are growing in confidence as well as purchasing power. In the Emerging Consumer Survey, whichper capita incomes, favorable demographics Credit Suisse published in January 2011, theyand continuing economic growth are creating found that 38% of consumers in the emergingmassive growth in the numbers of the global markets expected an improvement in their 4middle class. By 2030, there will be an personal finances over the next six months.additional three billion people joining this This will inevitably feed through into highercohort, and most of them will live in Asia. rates of consumption as populations save less and spend more. And as spending capacityThe numbers are staggering. In 2000, only grows, the share of expenditure consumed10% of spending by the global middle class by essential items, such as food and heating,took place in Asia. By 2030, this proportion will fall, while the population will spend morecould rise to 40% (see Chart 1). In 2009, the on higher-value items, such as householdmiddle class in Asia-Pacific spent just under appliances, cars and electronic goods. In 2004,US$5 trillion. By 2030, this figure could rise 3 for example, General Motors sold 1 car into almost US$33 trillion, according to the China for every 10 it sold in the United States.Organisation for Economic Co-operation and 5 By 2009, this ratio had reached one to one.Development (OECD).Chart 1: Shares of global middle class consumption, 2000–50%100 Others90 EU80 United States70 Japan60 Other Asia50 India40 China3020 Source: Homi Kharas, The emerging middle class in developing10 countries, Working Paper No. 285, OECD Development Centre, 0 January 2010 00 03 06 09 12 15 18 21 24 27 30 33 36 39 42 45 482020202020202020202020202020202020“There is tremendous potential for rapid-growth economies to increase their level ofconsumption,” says Rain Newton-Smith, Headof Emerging Markets at Oxford Economics.“We can see this already happening throughchanging trade patterns, with a flow of higher-end consumer goods to the region. But we Footnotesexpect this trend to deepen as wages increase,as the financial services sector becomes more 3. Homi Kharas, The emerging middle class insophisticated and as a higher proportion developing countries, Working Paper No. 285, OECD Development Centre, January 2010.of the population moves to urban areas.” 4. Emerging Consumer Survey 2011, Credit Suisse Research Institute, January 2011. 5. Homi Kharas, The emerging middle class in developing countries, Working Paper No. 285, OECD Development Centre, January 2010.The rise of the global middle class – and how to capitalize on it 7
  10. 10. “The new consumer does not have to adjust to the market. If you want to sell, you have to adjust.” Daniel Mendez, President of SaporeA mismatch in the offering Chart 2: How businesses approach pricing in rapid-growth markets How do you typically price your products or services in relationYet many companies have been slow to to competitors in your main rapid-growth markets?capitalize on this emerging demographic. %Although rapid-growth markets account for 100 Premium: Top end of market80% of the global population and 50% of global 90 Mid-marketGDP at purchasing power parity, the average 80 46 54 40 Value: Bottom end of marketS&P 500 company earns just 10% of its 70 6 60revenues from these economies. 50 40There are various reasons for this mismatch. 30 46 40 51One is that some rapid-growth markets 20remain difficult places to do business, serving 10 8 6 9 0up tough regulations or heavy bureaucracy. Total Developed market Rapid-growth companies with market companiesBut a bigger issue is often a misalignment rapid-growthbetween the product and service offerings market operationsof developed-world multinationals and thespending power and practices of customersin rapid-growth markets. In our survey, 54% This pattern of allocation is very differentof companies from developed economies from the reality of income distributionsfocus on the premium end of the market in most rapid-growth markets. In China,in their main high-growth markets. And even for example, just 0.3% of households earnamong rapid-growth market companies, the more than US$50,000 a year, and onlyproportion that focuses on this slice is as high 17.5% earn more than US$10,000 annually.7as 40%. By contrast, just 6% of developed- In India, these figures are 0.2% and 13.2%,market companies — and only 9% of rapid- respectively. In other words, many companies,growth market firms — target the bottom end regardless of market, are missing a significantof the market (see Chart 2). and increasingly important opportunity in developing economies. To bring products and services in line with the income distribution in rapid-growth markets requires a fundamental rethinking of innovation and go-to-market strategies. Rather than focus exclusively on the admittedly lucrative premium end of the market, companies need to create products and services that meet the unmet needs of the next three billion consumers. Footnotes 6. www.innosight.com/innovation_resources/ article.html?id=895. 7. Economist Intelligence Unit’s Data Tool.8 Growing Beyond Innovating for the next three billion
  11. 11. “Increased private consumption in many rapid- growth markets will play an important role in rebalancing the economy and creating a strong, sustainable recovery around the world.” John Murphy, Global Markets Leader at Ernst & Young Stripping out features from existing products • The Chinese company BYD has developed will not work, because, by definition, the a very low-cost method for producing products have not been designed with the lithium-ion batteries. The company has target audience in mind. Instead, companies reduced the cost of a battery from US$40 must identify challenges and create innovative to less than US$5. solutions that are both affordable and relevant • China’s Zhongxing Medical has developed to the local market and environmental an X-ray machine that can produce digital conditions. “You have to understand the images directly. It costs just one-tenth of local market needs and develop products the price Western multinationals charge that are not only going to help consumers for their specialized digital X-ray machines. to improve their lives but that also fall within their purchasing capability,” says Jeff • GE, the US industrial giant, has produced Weedman, Vice President for Global Business a handheld electrocardiogram machine that Development at Procter & Gamble. costs a fraction of traditional EKGs. This innovative device has brought down the cost of testing a patient to just US$1. A new generation • The Indian industrial group Godrej & Boyce of frugal innovators has developed a US$69 fridge that runs on batteries, called the ChotuKool. Recent years have seen a number of high- profile innovations that target middle- and • India’s Tata Chemicals has developed lower-income customers in rapid-growth a water purifier that uses a combination markets. Launched in 2009, the low-cost of rice husks and silver nanotechnology Tata Nano car is probably the best-known to filter out bacteria. The Tata Swach costs example. Tata’s goal was to create a car just US$20. that would sell for INR100,000, or around US$2,500, which is much cheaper than any • Bharti Airtel, an Indian telecom company, other production car in the world. To bring has turned itself into one of the world’s down costs, Tata reengineered parts to save most cost-efficient mobile service provider weight, reconfigured assembly methods and by creating innovative partnerships developed a complex network of third-party with suppliers and by sharing the costs suppliers to increase efficiency. Although of infrastructure with competitors. there have been teething problems with the • The Finnish telecom company Nokia has Nano since it was launched, there is no doubt produced a handset that costs less than that this was a breakthrough innovation. US$20. Its features include a dust-resistant Other examples of innovation for middle- and case and a contacts book that can be used lower-income customers include the following: by up to five users, because many low- income customers share a phone. The rise of the global middle class – and how to capitalize on it 9
  12. 12. “The emerging middle class is the number one driver of innovation among multinationals in rapid-growth markets. To succeed, companies will need to think about how to fulfill unmet needs and create entirely new business models as well as product innovations.” Andrea Vogel, EMEIA Strategic Growth Markets Area Leader at Ernst & YoungChart 3: Which multinationals are best placed for generating frugal innovation?In general, which of the following categories of company do you think hasthe advantage in generating frugal innovations?%80 Total 73 Developed market companies with 67 rapid-growth market operations60 58 Rapid-growth market companies40 42 33 2720 0 Multinationals based Multinationals based in in developed economy rapid-growth marketAs this list demonstrates, many of the Ernesto Vidal, CEO of Ingenia Muebles, acompanies that are leading the way with low-cost furniture chain based in Mexico, citesinnovation in rapid-growth markets are rapid decision-making and a quick response toheadquartered in rapid-growth markets. customer demands as important advantages.This is no coincidence. Among our survey “We listen to the customer and react quickly torespondents, two-thirds think that, in general, any new opportunities or problems,” he says.multinationals based in rapid-growth markets A willingness to improvise in the face ofhave an advantage in generating frugal constraints can also be a powerful advantage.innovations (see Chart 3). Companies in rapid-growth markets haveEloi D’Ávila de Oliveira, President of Flytour, long operated in a business environmenta Brazilian travel agency, thinks that rapid- where they face a shortage of resources, poorgrowth market companies benefit from infrastructure and a volatile macroeconomicbeing more agile. “They have strong local environment. These constraints have forcedrelationships and, unlike multinationals from them to be highly creative in their approachdeveloped markets, they do not have a board to problem-solving and accustomed toof directors thousands of miles away to whom developing ingenious workarounds tothey are accountable,” he says. “That means overcome obstacles. “Running a businessthat they can respond with the speed that the during years of volatility has given us themarket requires.” ability to adapt and come up with a new plan quickly,” says Mr. Oliveira.10 Growing Beyond Innovating for the next three billion
  13. 13. “Running a business during years of volatility has given us the ability to adapt and come up with a new plan quickly.” Eloi D’Ávila de Oliveira, President of Flytour Companies from rapid-growth economies may currently dominate local innovation, but developed-market multinationals are keen to make up lost ground. Overall, more than three-quarters of our respondents think that adopting frugal innovation to create products and services is a major opportunity (see Chart 4). And the number of developed- market companies that see this as an opportunity is almost identical to the number from rapid-growth markets. Chart 4: Finding opportunity in frugal innovation Please complete the following sentence based on the statement that best describes your company’s view on the opportunities for frugal innovation in rapid-growth markets. “Adopting frugal innovation to create products and services is...” % 60 Total Developed market companies with 40 rapid-growth market 40 41 40 36 37 operations 34 Rapid-growth market companies 20 22 20 18 6 4 2 0 A major opportunity A major opportunity A major opportunity Not something that we and we are already and we intend to take for some companies consider to be a major taking advantage of it advantage of it but not one that we opportunity see as a major priority The rise of the global middle class – and how to capitalize on it 11
  14. 14. It is also striking that companies in the surveywith higher-than-average EBITDA growthseem more likely to recognize the scale ofthe opportunity. Overall, 81% of the highperformers think frugal innovation is a majoropportunity, compared with 68% of those withlower EBITDA growth (see Chart 5).Chart 5: Companies finding opportunity in frugal innovationPlease complete the following sentence based on the statement thatbest describes your company’s view on the opportunities for frugalinnovation in rapid-growth markets. “Adopting frugal innovationto create products and services is ...”EBITDA growth: high vs low performance%60 High performers Low performers 4440 37 38 30 2720 15 4 5 0 A major opportunity A major opportunity A major opportunity Not something that we and we are already and we intend to take for some companies consider to be a major taking advantage of it advantage of it but not one that we opportunity see as a major priority12 Growing Beyond Innovating for the next three billion
  15. 15. Reaching a new customer baseat Tata ChemicalsW hen India’s Tata Group launched the Swach water purifier in 2009, it waspraised as a textbook example of innovating But in 2006, the project got a boost when R. Gopalakrishnan, Director of Tata Sons, suggested that Tata Chemicals would befor lower-income customers. Although there better placed to move the concept forward.have been water purifiers on the market for “With its in-depth experience in chemicalmany years, take-up of these devices has been processing technologies, product developmentvery low. In India, for example, penetration for a global market and consumer productof water purifiers in rural areas, where the businesses, Tata Chemicals was the idealrisks of waterborne disease are greatest, partner to take the project to the next stage,”is less than 1%. The main barrier to adoption he explains.has been price — ultraviolet water purifiers can The original device used rice husk ash as thecost more than INR5,000 (US$102), which is active ingredient in the water purificationfar beyond the means of most rural dwellers. process. But while effective, this did not meetMany devices also require running water international standards. So Tata Chemicalsand electricity, which may not be available improved the purification performance byeverywhere. impregnating the ash with nano silver particles.At a price of less than INR1,000 (US$20), A further breakthrough came from anotherthe Tata Swach was introduced as a highly part of the Tata Group, Titan Watches.cost-effective alternative to existing purifiers. The engineers at Tata Chemicals discoveredUnlike many other devices, it needs no that the precision engineering used inrunning water or electricity to operate, which watchmaking could also be applied in themeans it can be used in the most remote rural manufacture of the Swach. “We suddenlylocations. Its replaceable filters are capable had a product that came from the internalof purifying about 3,000 liters of water, innovation skills across several different partsor enough for a family of five over a period of the business,” says Mr. Gopalakrishnan.of 6 to 8 months. “Titan earns revenues by selling moreAlthough the Swach is manufactured and and more machines, while Tata Chemicalssold by Tata Chemicals, several companies markets the product and undertakes the riskfrom across the Tata Group took part in its and reward.”development. The software company TataConsultancy Services (TCS) developed theoriginal version of the Swach as a corporatesocial responsibility initiative. In the wakeof the Gujarat earthquake of 2001, TCSdistributed 50,000 filters to villages affectedby the disaster. The rise of the global middle class – and how to capitalize on it 13
  16. 16. Section 2:The four capabilitiesof innovation14 Growing Beyond Innovating for the next three billion
  17. 17. Innovating for the next three billion will require companies to develop a set of keycapabilities. Our research has identified four Companies must build these capabilities at both a local and a global level. In the rest of this report, we look at these four keythat are particularly important: capabilities in detail and explain the interaction between the local and global layers.1. Customer insight2. People and culture3. Research and development4. Operations and business modelThe rise of the global middle class – and how to capitalize on it 15
  18. 18. “Qualitative research is the most powerful way to gain genuine insight into your customers and understand what new products and services they might need.” Mr. Sudhamek AWS, Chief Executive Officer of GarudaFood Group 1. Customer insight: building a market-specific approach The development of any successful innovation Companies from rapid-growth markets requires companies to get close to their consider this capability to be especially customers and understand the problem that important, whereas those from developed needs to be solved. But in the case of the next markets tend to consider technology and three billion, this process will be particularly operational excellence to be more vital. important. Asked about the key enablers “Western companies tend to place greater of innovation, respondents point to an importance on process, while those that understanding of local customers as the most are based in a country like India tend to critical factor (see Chart 6). pay greater attention to culture,” says R. Gopalakrishnan, Director of Tata Sons. Chart 6: Most important enablers of innovation in rapid-growth markets Which of the following capabilities are most important to enable innovation in rapid-growth markets? % Total 52 Understanding of local customers 48 Developed market companies 55 with rapid-growth market 50 operations Operational excellence 56 Rapid-growth market companies 47 50 Technological excellence 57 45 26Ability to bring ideas to market quickly 22 26 23 Access to local talent 20 26 Support and appropriate 15 investment from senior 18 management 12 Ability to share resources and 15 15 knowledge across borders 15 16 Growing Beyond Innovating for the next three billion
  19. 19. “Global resources and capabilities are an important advantage for multinationals seeking to unlock the opportunities in rapid-growth markets. But these capabilities must also be combined with strong local knowledge and insight into customer needs.” James S. Turley, Chairman and CEO of Ernst & Young Traditional analytical tools can play a role Armed with this knowledge, the Godrej & Boyce in giving companies basic information about design team was able to rethink radically the customer demographics and opportunity, design for the appliance. It created a small, but many of those interviewed for this report portable device that consumes half the energy are skeptical about their value, particularly of a conventional fridge and, at US$69, costs in rapid-growth markets, where there may be considerably less to purchase. The ChotuKool a shortage of good-quality data. “Innovations also incorporates a battery that can be used to to me are not about data and analysis, they run the device in the event of a power outage. are more about having a vision for a new By spending time observing the customer product,” says Maxim Nogotkov, President base, Godrej engineers were able to identify of the Svyaznoy group of companies. their unmet needs and develop a product that was both more affordable and relevant than A common characteristic of the next three existing models. billion is that they are non-consumers of a company’s products — they have no history Other entrepreneurs emphasize the importance of buying something similar in the past. This of this approach. “Qualitative research is the makes analytical approaches to customer most powerful way to gain genuine insight research, such as focus groups, difficult to into your customers and understand what apply, because there is no existing product new products and services they might need,” to test. “The probability of successful frugal says Mr. Sudhamek, Chief Executive Officer innovation coming out of an analytical process of GarudaFood Group, an Indonesian food is very low because it is an unexpressed manufacturer. demand,” says Mr. Gopalakrishnan. R&D close to the customer The Indian company Godrej & Boyce The need for proximity to local customers has offers a good example of a more intuitive encouraged a growing number of companies approach. When it embarked on a project to locate R&D centers in countries such as to develop a low-cost refrigerator, called China and India. On average, respondents say the ChotuKool, its first step was to spend that 37% of their R&D currently takes place in time with the villagers who were likely to be rapid-growth markets. As companies feel more the product’s target market. Researchers confident about the rule of law and protection discovered that many rural families stored of intellectual property in these markets, just a few food items at a time, which meant they are likely to allocate an even greater that conventional fridges were far too large proportion in the future. for their needs. Another observation was that many villages had sporadic power supplies, which meant that food in traditional refrigerators was likely to spoil. The rise of the global middle class – and how to capitalize on it 17
  20. 20. “Western companies tend to place greater importance on process, while those that are based in a country like India tend to pay greater attention to culture.” R. Gopalakrishnan, Director of Tata SonsThe nature of this activity also seems to But local R&D is just one part of the solution.be changing. In the past, developed-market As well as developing products locally,companies in particular set up R&D labs companies need to give authority and profitin rapid-growth markets for cost arbitrage and loss (P&L) responsibility to business unitspurposes. But as skill levels have risen and on the ground so that they can make decisionsas these markets have become increasingly over which products and services to developimportant to overall growth prospects, this or scale. “You have to give local managersrationale is becoming less important. Although autonomy,” says Vijay Govindarajan,the ability to access low-cost skills is still the Earl C. Daum 1924 Professor of Internationalsecond most important reason for conducting Business at the Tuck School of Business,R&D in rapid-growth markets, it trails behind Dartmouth College. “If you need your localproximity to key growth markets as the leading people to come to the head office for approvalfactor (see Chart 7). for everything, then you will not move quickly enough to take advantage of opportunities.”Chart 7: Reasons for conducting R&D in rapid-growth marketsWhat might be the main reasons for conducting R&Din rapid-growth markets? % Total 44 Proximity to key growth markets 43 Developed market companies 45 with rapid-growth market 42 operations Ability to access low-cost skills 42 Rapid-growth market 43 companiesAbility to gain a better understanding 40 36 of local customer needs 43 Ability to operate in a low-cost 39 38 business environment 39Relevant expertise of local engineers 36 42 and scientists 31 Proximity to key inputs and 25 30 resources 21 Ability to transfer skills obtained to 19 21 compete in developed markets 17 Ability to partner with local 16 12 organizations 2018 Growing Beyond Innovating for the next three billion
  21. 21. “The main advantage for multinationals is that they have global resources and capabilities. But they must apply these efficiently and be willing to adapt their approach to the local customer.” Luiz Enrique Almeida, CEO of Regina Festas 2. People and culture: learning the new and unlearning the old Focusing innovation efforts on the middle Input from senior leadership is essential class in rapid-growth markets may make sense to overcoming these misgivings. The Tata as a concept, but there can be cultural barriers Group, for example, has created the Tata to product acceptance. Developed-market Group Innovation Forum (TGIF), a panel companies in particular are accustomed of 12 senior executives from across the to thinking of innovation as a means to add business, which aims to foster a culture sophistication and features to products rather of innovation across the Group. It has also than making them more streamlined and implemented an “InnoMeter” that measures affordable. Professor Govindarajan says that innovation capabilities and encourages companies from the developed world often interventions to create a more innovation- suffer from what he calls “the tyranny of the friendly culture. “Just like a thermometer, dominant logic.” He explains, “They grew up the InnoMeter enables us to understand how in a world where they were creating products departments are performing and gives us an for rich-world customers, and their view of the opportunity to nurture new ways of developing world is based on that foundation.” innovative ideas across the Group,” says Mr. Gopalakrishnan, who chairs the TGIF. Simply taking products from the developed world and hoping that customers in rapid- Cross-fertilization of talent from one R&D growth economies will buy them is unlikely center to another can also help to foster to be effective. Instead, companies need to a more unified innovation culture. At Xerox, adopt a culture and mindset that are willing for example, a program called “crossovers” to tailor products to customers’ needs. “The enables researchers to gain experience new consumer does not have to adjust to the in different labs around the world and acquire market,” says Daniel Mendez, President of insight into customer requirements. “This Sapore, a Brazilian corporate meals company. program helps our researchers to understand “If you want to sell, you have to adjust.” the local geography and customer, and, equally importantly, it helps the company Another common concern is that low-cost to strengthen the human fabric between innovations developed for rapid-growth the different research organizations and market customers will “cannibalize” the build a global innovation network,” says sales of more expensive premium products. Dr. Meera Sampath, Director of the Xerox But as Professor Govindarajan explains, Research Centre India. this fear is misplaced. “Although there is a cost associated with cannibalization, there is a much greater risk if you don’t innovate in these markets because your competitors will do it anyway,” he says. “Moreover, lower- cost innovation opportunities create new consumption and demand, so the slice of the pie is much bigger when you take into account the sales revenue from both the lower-priced products and the premium ones.” The rise of the global middle class – and how to capitalize on it 19
  22. 22. “Globally integrated R&D will be a crucial driver of successful innovation in rapid-growth markets. Companies need to ensure they can share resources, talent and intellectual property across different R&D centers so that local relevance can be combined with global scale.” Herb Engert, Americas Strategic Growth Markets Area Leader, Ernst & Young3. Research and development: conduct and share R&D internationallyInnovating for the next three billion will require Procter & Gamble adopts a similar approach.companies to gain insight into local customer Mr Weedman describes how the companyneeds and to develop products and services is developing a set of “platform technologies”that meet the needs of individual markets. that have global relevance and can beBut a purely local approach to innovation combined with local components or packagingis both inefficient and expensive. Companies to create customized offerings. For example,must therefore strike a careful balance between a broad need such as “odor control” can belocal relevance and global scale. applied globally, but combined with fragrances in cleaning products that suit local preferences.A global network of R&D centers enablescompanies to leverage global resources and In total, 45% of respondents say thatreapply innovation across multiple markets. innovation in their company takes place acrossAt Xerox, for example, a polycentric approach a global network of R&D centers. But thisto innovation means that the best aspects approach is considerably more widespreadof local and global are combined. The in companies headquartered in developedcompany’s researchers engage closely with markets (see Chart 8). In the longer term,local customers in a particular market, but companies from rapid-growth marketscollaborate with teams in other markets to see would be well advised to build this capabilityhow innovations developed with one set of to ensure that they can remain competitive.customers in mind can be reapplied elsewhere. “The main advantage for multinationals is that“We try to look at fundamental technologies they have global resources and capabilities,”that can apply across a broad range of says Luiz Enrique Almeida, CEO of Reginaproducts and services in different regions,” Festas, which sells party supplies. “But theysays Dr. Sampath. “I like to think that what must apply these efficiently and be willing towe do is create locally inspired but globally adapt their approach to the local customer.”relevant technology.”Chart 8: Location of innovationWhich of the following best describes where innovation generallytakes place in your company?%8060 64 5140 45 45 30 2720 24 9 18 17 5 5 17 16 3 3 3 3 2 14 0 Global network of R&D Network of R&D Network of R&D Single R&D center in a Single R&D center in a centers across both centers in developed centers in rapid- developed market rapid-growth market developed and rapid- markets only growth markets only growth markets Total Developed market companies with rapid-growth market operations Rapid-growth market companies operating internationally Rapid-growth market companies operating domestically20 Growing Beyond Innovating for the next three billion
  23. 23. “Big multinationals need to look at what has already been developed locally and then partner with entrepreneurs to scale up these innovations.” Navi Radjou, innovation and leadership consultant and a Fellow at Judge Business School, University of Cambridge 8 In the polycentric innovation model, new In a 2009 Harvard Business Review article, technologies and concepts can travel in all Professor Govindarajan coined the term directions. It is striking that almost one- “reverse innovation” to describe the process quarter of respondents from rapid-growth whereby GE took its portable, low-cost market companies that operate domestically electrocardiogram, which had been developed conduct all of their R&D at a single center for rural clinics in India, and found a new in a developed market. At the same time, a market in the US for the device among growing number of companies from developed emergency services at accident sites. As living markets are taking innovations developed standards in developed and rapid-growth in rapid-growth economies and finding new markets converge, and as companies invest markets for them in the developed world. more widely in rapid-growth market R&D, this trend is certain to accelerate. Among our survey respondents, 81% agree that frugal innovation is a concept that has as much relevance in developed markets as it does in rapid-growth ones (see Chart 9). Chart 9: Attitudes towards frugal innovation Total Developed market Do you agree with the following statements? companies with rapid-growth % market operations 100 Rapid-growth market companies 88 80 85 81 81 82 79 60 60 55 52 49 47 40 46 43 40 40 20 0 Innovation goes Frugal innovation is Frugal innovation is The opportunities of Frugal innovation is beyond R&D; it is a concept that has more about the social serving lower-income more relevant to social about business as much relevance in imperative (addressing customers in rapid- entrepreneurs and process, supply chain developed economies societal needs) than growth markets are non-governmental and connecting parts as it does in rapid- about making money exaggerated organizations of the organization growth markets than it is to major multinationals Footnotes 8. Jeffrey Immelt, Vijay Govindarajan and Chris Trimble, “How GE is Disrupting Itself,” Harvard Business Review, October 2009. The rise of the global middle class – and how to capitalize on it 21
  24. 24. The importance of an open approach Joint-venture partnerships betweenA more open approach to innovation, whereby multinationals and entrepreneurs in rapid-companies combine both internal and external growth markets can also make a powerfulpartners from around the world to generate contribution. “Big multinationals need to lookideas and solutions, will be a key component at what has already been developed locallyin successful innovation for the next three and then partner with entrepreneurs to scalebillion. By engaging the brainpower of local up these grassroots innovations,” says Naviresearch organizations and entrepreneurs and Radjou, a Fellow at Judge Business Schoolfeeding this into a global innovation model, and the co-author of Jugaad Innovation: Thinkcompanies have the opportunity to gain Frugal, Be Flexible, Generate Breakthroughaccess to local knowledge without sacrificing Growth (Jossey-Bass, 2012).global scale. “Open innovation allows us to Outright acquisition can be another route toimprove the success rate, shorten the time to gaining access to frugal innovation capability,market and reduce risk,” says Mr. Sudhamek. although in a number of rapid-growth markets,Procter & Gamble has become a leading this may not be possible because of regulatoryproponent of the open innovation model constraints. “Acquisition provides betterthrough its Connect + Develop program. access to the local market and, at theThrough Connect + Develop, P&G is able same time, financial muscle for Westernto tap into the innovative power of researchers multinationals to implement their localaround the globe. strategies,” says Dr. BRA Mooryati Soedibyo, founder of PT Mustika Ratu, a naturalAlthough the Connect + Develop program cosmetics and herb supplements companyis currently more advanced in developed based in Indonesia.markets than in rapid-growth ones, P&G seesit as a crucial tool for creating innovationsfor low-income customers. “We are constantlylooking to build networks so that technicalchallenges can be pushed out to relevantresearchers, whether they are governmentlabs, universities, private R&D firmsor suppliers,” says Mr Weedman.22 Growing Beyond Innovating for the next three billion
  25. 25. Microsoft:A platform for competitivenessT he dissemination of technology in rapid- growth markets has been a vital catalystof entrepreneurship and economic growth. Microsoft’s BizSpark program offers an example of this kind of collaboration. A global program that has to date helped 45,000But despite considerable progress in recent software startups succeed by giving themyears at bridging the digital divide, access access to Microsoft software developmentto technology in rapid-growth markets tools and connecting them with key industryremains well below levels in developed players, BizSpark is now available tomarkets. According to a 2007 report from entrepreneurs in a range of rapid-growthEuromonitor, lower-income countries markets, including India. “Rather than justaccount for just one-third of total broadband provide access to technology, programs like 9subscribers worldwide. BizSpark serve as a platform for innovation and economic growth,” says Mr. Nash. “It’sJosh Nash, a senior strategist at Microsoft, really about providing the tools for innovationhas seen an evolution in thinking on the digital that will enable a country to make the mostdivide in recent years. “A few years ago, the of its competitive differentiators.”hypothesis was that if you gave somebody acomputer, they would figure out how to turnthat into an opportunity which would lead toeconomic growth,” he says. “I think over thecourse of time we realized there needs to bemore to the equation than that.”Instead, companies like Microsoft increasinglysee their role as providing a more holisticset of tools that will enable innovation totake place. Hardware and software form partof this, but there are also important roles fora broader ecosystem, including government,software developers, partners andinnovators. And importantly, this networkneeds to be appropriate for the particularmarket. “Technology is not a silver bullet,”says Mr. Nash. “It is an enabler of a broader,more holistic solution that can really makea difference.” Footnotes 9. An Hodgson, “The Global Digital Divide,” Euromonitor International website, www.euromonitor.com/the-global-digital-divide/ article, accessed 12 October 2011. The rise of the global middle class – and how to capitalize on it 23
  26. 26. “Multinationals are just looking at the margins and not thinking about the business models and the way they are relating to customers.” Linda Rottenberg, co-founder and CEO of Endeavor4. Operations and business model: combining local relevance with global scaleRadical product innovations, such as the Tata Among our survey respondents, changesNano or ChotuKool, may hog the headlines to the pricing structure or business modelwhen it comes to innovation in rapid-growth are the most widely used approach to developmarkets, but they are just one small part products and services aimed at lower-incomeof the story. Just as important is the need for customers. More than half of companies saycompanies to think about the business model that they take this approach, while only 38%and ensure that it is appropriate for a lower- create entirely new products with lower-income customer base. income customers in mind (see Chart 10).Chart 10: Tailoring new product development to low-incomecustomers in rapid-growth marketsWhich of the following approaches do you currently taketo developing products and services aimed at lower-incomecustomers in rapid-growth markets?%60 Total 55 Developed market companies 52 50 with rapid-growth market40 42 operations 38 39 Rapid-growth market companies 37 36 35 28 26 2420 0 We change the pricing We create entirely new We simplify current We re-package structure or business products with lower- premium products products and services model of existing income customers aimed at higher- products to make in mind income customers them more affordable (e.g., in smaller sizes)24 Growing Beyond Innovating for the next three billion
  27. 27. “Creating low-cost but high-quality products and services for the middle class in rapid-growth markets will require companies to innovate across the entire value chain. They will need to strip out costs, increase efficiency and establish highly productive relationships with key suppliers and distributors to ensure that they can meet the price points that lower-income customers can afford.” Bill Delves, Asia-Pacific Strategic Growth Markets Area Leader, Ernst & Young Chart 11: High performance companies tailoring new product development to low-income customers in rapid-growth markets Which of the following approaches do you currently take to developing products and services aimed at lower-income customers in rapid-growth markets? EBITDA growth: high vs low performance % 60 High performers 55 Low performers 50 40 43 37 35 32 32 20 22 17 14 0 We change the pricing We create entirely We simplify current We re-package We do not currently structure or business new products premium products products and services target lower-income model of existing with lower-income aimed at higher- customers products to make customers in mind income customers them more affordable (e.g., in smaller sizes) Higher-performing companies (those with At the upper end of the market, some luxury higher-than-average EBITDA growth) are more goods companies have tweaked the business likely to take the more radical approach of model to increase sales to the aspirational creating entirely new products and services middle classes. Mr. Almeida of Regina Festas for lower-income customers. This suggests points out that, in Brazil, some luxury brands that they are more advanced in their ability allow customers to pay in installments — to target the next three billion effectively a concept that would be unthinkable on Bond (see Chart 11). Street or Rodeo Drive. At the most basic level, changes to the But these tweaks to pricing and payment business model may simply involve models only scratch the surface. The real reformatting the product or adjusting pricing. opportunity lies in thinking about the For many years, consumer goods companies underlying business model and ensuring have sold products such as shampoo in single- that it is tailored to the unique business use sachets that are affordable for customers environment in rapid-growth markets. “Pricing who are paid daily. “By making the cost can be solved, but a lot of multinationals are structure more variable, companies can give just looking at the margins and not thinking customers flexibility to buy according to their about the business models and the way needs but still deliver high-quality products they are relating to customers,” says Linda to them,” says Mr. Radjou. Rottenberg, co-founder and CEO of Endeavor. The rise of the global middle class – and how to capitalize on it 25
  28. 28. “Failure to scale will only give our competitors product development ideas. To ensure that companies achieve a successful innovation outcome, their planning must accommodate scalable capacity.” Dr. BRA Mooryati Soedibyo, Founder & Technical Advisor of PT Mustika Ratu, TbkEnrique Beltranena, CEO of Volaris, a Findings from our survey highlightlow-cost airline, believes that an important the difficulties that companies facecomponent of the business model should be in establishing appropriate business modelsthe ability to unbundle products or services for innovation in rapid-growth markets.so that different price points can be charged. Respondents point to profitability as the mostCustomers on the lowest incomes can pay important challenge (see Chart 12). Thefor the most basic, no-frills product, while simple fact is that many companies strugglethose with more disposable income can afford to see how they can sell a product or servicea number of add-ons. “Unbundling products at a price that is affordable to low-incomeand services enables companies to reduce customers and yet still turn a profit.their prices dramatically but also allows themto charge ancillary revenues,” he explains.Chart 12: Barriers preventing the development of new productsfor low-income customersWhat do you consider to be the main barriers for your companyto developing products and services that meet the needs of lowerincome customers in rapid-growth markets? % Total 54Profitability of products and services 56 Developed market companies 52 with rapid-growth market 43 operations Existing or future competition 50 Rapid-growth market companies 37 35Distribution of products and services 40 31 26Poor infrastructure in target markets 26 26 The market is currently too small 24 24 and fragmented 25 Lack of education and awareness 23 18 among customers 27Concerns that products and services 12 aimed at lower-income customers 11 will cannibalize premium offerings 1326 Growing Beyond Innovating for the next three billion
  29. 29. “Companies seeking to innovate in rapid-growth markets need to find ways to empower local managers to make decisions quickly. Local autonomy ensures rapid adaptation in these competitive new markets and increasingly provides innovations that can be used in other markets worldwide.” Sam Fouad, Americas Emerging Markets Leader at Ernst & Young Part of the challenge is one of mindset. But this focus on cost efficiency must not lead Companies in developed markets, in to other important qualities of the product or particular, have become used to high margins services being compromised. “You can always on premium products. In rapid-growth reduce costs, but if you sacrifice quality, then markets, margins may be much smaller, you won’t sell your product,” says Mr. Mendez. but the potential volumes are enormous. Respondents recognize that process efficiency The challenge is therefore one of shifting will be key to success. Asked about the the perception of managers in developed approaches they use for innovation in rapid- markets to a low-margin mindset, and then growth markets, they point to efficiency in ensuring continuous cost reduction and a laser the development process as the number one focus on efficiency across all aspects of the factor (see Chart 13). “The frugal product can value chain. only happen if you have a frugal supply chain and, more importantly, a frugal mindset,” says Mr. Radjou. Chart 13: Processes for driving innovation in rapid-growth markets Which of the following processes or approaches do you use for innovation in rapid-growth markets at your company? % Making the product and service 65 64 development process more efficient 66 55 A dedicated innovation team 60 50 Incentivizing employees for successful 42 40 innovation 44 Formalized measurement of return on 37 41 investment 34 Formalized testing, launch and review 36 40 process 34 Direct oversight by local market 36 30 management 40 Agreed process of financing for new 31 35 product launches 28 29 A formalized “go/no go” decision process 26 31 Relocating experts from developed 28 31 markets to rapid-growth market location 25 Partnerships with local entrepreneurs or 26 Total 25 organizations that specialize in innovation 26 Developed market companies with rapid-growth market Partnerships with non-governmental or 19 12 operations academic organizations 23 Rapid-growth market companies The rise of the global middle class – and how to capitalize on it 27

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