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Jelena Dukic_IBS1report


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Jelena Dukic_IBS1report

  1. 1. Doing Business at the Bottom of the Pyramid International Business Strategy 1 – Jelena Đukić
  2. 2. 2 Jelena Đukić Introduction ____ Over the past few years, business leaders and strategists around the world have increased the focus on the challenges of intense competition and slowing growth in high income markets. In order to remain competitive, multinational companies (MNCs) must adjust. Winston Churchill once said: “To improve is to change; to be perfect is to change often.” This process has led many of MNCs to reconsider the potential of emerging and low income markets. The concept of the Bottom of the Pyramid (BOP) consists of the market made up by 4 billion poorest people in the world that live on less than $2 a day. A lot of MNCs have already tried to enter emerging markets in BRICS countries that account for almost a quarter of the world’s GDP (Castellanos, Uglow & Kodama, 2013). However, the idea behind BOP suggests that the best way to meet the needs of the poor is through a profit driven market-based approach (Hart, Prahalad, 2002). Most companies have usually not considered people at the base of the economic pyramid due to the low individual income, but rather served customers from the “global tier”. However, the true opportunity for both the poor and MNCs actually lies at the bottom of the pyramid, also named the Tier 4 (Prahalad, Hart, 2002). Before getting into more details, it is crucial to understand which market is targeted in such a case. On the image on the right it can be seen that the top arrow represents the wealthiest countries and the bottom one the countries that are on the “Bottom of the Pyramid”. It is observant that in general, when going abroad, companies take with them their well worked out business strategies. However, even though this may work out when going to some high-income markets, when entering into an emerging market, their business models need to be modified. The BOP presents a whole new managerial challenge and in the further text, the advantages and disadvantages of doing so will be debated.
  3. 3. 3 Jelena Đukić Advantages ______________ There are more than 4 billion people living in Tier 4 originating from every continent, with the most affected regions being Africa, Latin America, Asia, Eastern Europe and the Caribbean (Prahalad, Hart, 2002). All together they make up 72% of world’s population and with the population growth rate increasing in developing countries, the number of people in the BOP could reach 6 billion in the next decades (Ashish Karamchandani, Mike Kubzansky, Nishant Lalwani, HBR, 2011). In previous years, MNCs mostly focused on serving the “global tier” customers first. Zilber and da Silva state that the MNCs were only paying attention to the easily spotted “iceberg”, yet the massive Tier 4 was largely kept under water. However, the real and numerous opportunities actually lay at the Bottom of the Pyramid. Some examples of these opportunities are: vast size, rapid growth, cost-savings, less competitive environment and opportunities for innovation. 1. Vast size As previously mentioned, the BOP constitutes the lower segment of the economic pyramid and it represents the purchasing power of all the consumers living on less than $2 a day or the equivalent of $3,000 per year. Moreover, even within the global BOP there are levels making it a pyramid itself. On the pyramid on the left the size of each layer represents the number of people in the different income segments. The aggregated income of the total BOP population makes up a $5,000 billion market. All these layers include around 4 billion consumers with a purchasing power of $5 trillion. Even so, companies should not expect high profit margins; however the unit sales could be extremely high due to a large number of potential customers. Therefore, it can be concluded that profits are not driven by high margins, but rather by the volume, which is in this case – the consumers. 2. Rapid growth As the developing markets included in the BOP are in their young stage of economic development, it is highly likely they may be hiding a huge growth potential which presumably could evolve very rapidly. Several African countries are experiencing growth rates of 5% and countries in Asia, Latin America and Eastern Europe are growing at an even faster pace. Another factor is the high birth rates that will increase the number of people in the BOP. In addition, the more people, the more customers,
  4. 4. 4 Jelena Đukić the higher profits (discussed below into more detail). Western cultures’ birth rates are declining, which also makes developing countries more desirable for MNCs. (Prahalad, Hammond, 2002) 3. Costs-savings In general, companies take their well worked out business strategies with them when going abroad. However, even though that may have worked with higher income countries, when entering the BOP, MNCs are facing obstacles when combing sustainability, good quality, low costs with being profitable all at the same time (Prahalad, Hart, 2002). Therefore, before emerging into the new markets MNCs must generate a completely new strategy - a great challenge, yet a great advantage for the future, since the brand new strategy will make the companies operate in a much more efficient way. When entering the BOP, Tier 4 customers’ needs must be taken into consideration; something that worked quite well in the past, may not work today, and thus change is inevitable. (Prahald, Hammond, 2002). According to Prahald and Hammond, change in the cost structure is imminent, as well, therefore stating to have high profits will not be an option anymore, but rather saying how efficient the capital is (Return on Capital Employed ROCE). Another factor beneficial to being cost efficient is that experience showed that cost structures tend to be lower in developing countries and producing locally can also lower the production costs considerably. 4. Less competitive environment Over past few decades, many MNCs tried to enter the BOP, however some of them failed to be successful due to the incapability to adapt their business strategies. Nonetheless, some companies succeeded to enter the developing countries and established themselves in the emerging markets. On the other hand, the intense competition has saturated the top of the pyramid, which was previously the main target of MNCs, thus they no longer represent the true competition due to decreasing growth and profits. Even though there are many opportunities and advantages for MNCs they have to bear in mind that they have to remain versatile and follow the steps of the previous companies and overlook the local companies’ strategies - “When in Rome, do as the Romans do.” (Khanna, Palepu, 2006) 5. Opportunities for innovation With underdeveloped infrastructure and technology, emerging markets are craving for innovation. Being unable to provide all the products that consumers from the BOP require in order to satisfy their basic human needs, this sector is great for innovation. All the innovative products and solutions MNCs had, yet could not present to developed countries due to high knowledge and unwillingness to participate can now be introduced to the BOP. With new and innovative products, many problems emerging markets had may disappear. After testing the products and conducting consumer reactions, MNCs can actually present these innovative products to developed countries that will result in satisfaction and be beneficial for both sides. (Khanna, Palepu, 2007)
  5. 5. 5 Jelena Đukić Disadvantages _________ In the text above, all advantages and opportunities of entering the BOP were mentioned. However, there are few challenges MNCs should prepare for in order to be successful in the emerging markets, and in this case, when entering the Tier 4. 1. Poverty The reason why the consumers at the bottom of the pyramid are so interesting to MNCs cannot be neglected. Even though being extremely numerous attracts the companies, the fact they are lacking the financial resources is most probably the greatest challenge when entering these types of markets. When looking at the figures, it is apparent that people from the BOP have a lot of money to spend, however that specific “a lot” is mostly spent on food and basic products. With the remaining money consumers purchase “luxury” goods provided by MNCs. MNCs need to understand that they are serving the market that lives slightly above the $1 a day which is somewhat above the poverty line (Karnani, 2007) and not to set their prices too high (Karamchandani, Kubzansky & Lalwani, 2011). Failing to do so appeared to be a fatal move for many companies that wanted to conquer these markets. 2. Geographic, economic and cultural difference Geographic, economic and cultural differences make a huge impact when creating a new strategy and setting up a business in the emerging country, even though it perhaps does not sound as important as it would be to create a well established costing strategy. Let’s take an example of a Dutch company wanting to enter Peru. First of all, there is an immense geographical distance that can disturb the business in several ways, such as climate, distribution channels, etc. Forces that influence economy in Western Europe may be completely different in Eastern Europe or Africa or in this Case, Latin America, thus it is important to be familiar with the know-hows in the business. Cultures differ from region to region, hence the pre-knowledge about the culture that the company will be facing in the future is an asset that is convenient to possess. All of these are most definitely just fractals of the business strategy when entering the BOP, yet the crucial factors to be taken into consideration. 3. Limited brand/product awareness In BOP markets some brands/products are widely available and recognizable whereas others are completely unknown, or it may be that consumers are unaware that they even need a certain product. That is where MNCs jump in and educate their potential consumers.
  6. 6. 6 Jelena Đukić Conclusion ____ When entering the BOP there are many challenges to be conquered, yet many advantages and opportunities that work in favor for the MNCs. As previously mentioned, a one size strategy is not applicable due to different needs of various populations, in addition to geographical, economical and cultural factors. Gaining previous and local knowledge is crucial and beneficial for MNCs and eases the process of adaptation. BOP markets are the markets of the tomorrow and MNCs must overcome all vicissitude situations, in order to capture the markets that will be of extreme value in the prospective future. Even if that means adapting the business strategy completely, ultimately every hardship must be overcome. In order for MNCs to be successful, consumers must be actively involved in the market, since they are another big aspect of the process. That way, consumers rise up from poverty and switch to a better and more prosperous life. Entering the BOP is most definitely not for every company, thus every MNC has to reason well and wage out whether entering the BOP is the right choice for them. Moreover, when carefully deciding, the willingness to modify the cost structure as well as the management of the company has to be taken into account. If most or all factors are favorable, MNCs should go for it. The risks are high, but the rewards are even higher.
  7. 7. 7 Jelena Đukić References _________ International Finance Corporation (IFC), World Bank Group (2014), “The Next 4 Billion: Market Size and Business Strategy at the Base of the Pyramid” Ashish Karamchandani, Mike Kubzansky, Nishant Lalwani (March 2011), “Is the Bottom of the Pyramid Really for You?” Paul Polak, Mal Warwick (April 2014), “Why Entrepreneurs Will Beat Multinationals to the Bottom of the Pyramid” Prahalad, C., & Hammond, A. (September, 2002) “Serving the World's Poor, Profitability” Confederation of Danish Industries (June 2007), “Working with the Bottom of the Pyramid” Khanna, T., & Palepu, K. (October, 2006). “Emerging Giants”