Challenges of SMEs innovationand entrepreneurial financing.docx

Challenges of SMEs innovation
and entrepreneurial financing
Jarunee Wonglimpiyarat
College of Innovation, Thammasat University, Bangkok,
Thailand
Abstract
Purpose – Today, the financing mechanisms to support small-
and medium-sized enterprises (SMEs)
development have been a subject of great interest and a
challenge to policy makers as SMEs are
regarded as an important sector contributing to economic
growth and stability. This paper is
concerned with the bank financing policies to support SME
development in China. The purpose of this
paper is to examine the governmental financing policies and the
innovation financing system of China.
The discussions are focused on the bank financing policies to
support SME development in China.
Design/methodology/approach – This study is a qualitative
research with the use of case study
methodology (Eisenhardt, 1989; Yin, 2003). The research is
focused on the policy perspectives of bank
financing to support SME development in the case of China, the
world’s fastest-growing economy.
To explore the role of financial institutions and banks in SME
financing in China, the research also
derives evidence from a collection of documentary
investigation. The research fieldwork and
interviews were undertaken in Beijing and Shanghai, major
financial centers in China, with the use of

semi-structured questionnaire. The analyses are undertaken to
answer the key questions of: What are
the Chinese government’s strategies to support the development
of SMEs? To what extent the
government policies in bank financing can support SMEs and
promote the development of an
innovative economy?
Findings – The empirical study has shown that despite the
introduction of the 12th Five-Year
National Economic and Social Development Plan to support
SMEs development, China still needs to
improve regulatory policies in support of innovative businesses
which would help its transition to an
innovation-driven economy. The study provides lessons and
policy guidelines to improve the
competitiveness of SMEs in China. The insights from this study
can also be applied to other developing
and emerging economies attempting to understand the role of
financing mechanisms in building an
innovative economy.
Originality/value – The study has addressed the policy
challenges to support SME development in
China, a major Asian emerging country and one of the fastest-
growing economies in the world
(with averaged growth rate of 10 percent per annum). The
empirical study of policy challenges was
undertaken in Beijing and Shanghai, major financial centers in
China. The study offers insights which
can be applied to other developing and emerging economies
attempting to understand the role of SME
financing policies and mechanisms in building an innovative
economy.
Keywords Sustainable development, SMEs
Paper type Research paper
1. Introduction

China is one of the fastest-growing economies in the world
(with averaged growth rate of
10 percent per annum). In 2014, China was placed in 23rd
position according to the
International Institute for Management Development world
competitiveness ranking and
28th position by the World Economic Forum. After joining
World Trade Organization
(WTO), China has adopted trade liberalization policies and
various government policies
to drive its economy. Small-and medium-sized enterprises
(SMEs) play a significant role
in the economy of China as they are the thrust sector that
account for 60 percent of total
World Journal of
Entrepreneurship, Management
and Sustainable Development
Vol. 11 No. 4, 2015
pp. 295-311
© Emerald Group Publishing Limited
2042-5961
DOI 10.1108/WJEMSD-04-2015-0019
Received 23 April 2015
Revised 9 June 2015
Accepted 16 June 2015
The current issue and full text archive of this journal is
available on Emerald Insight at:
www.emeraldinsight.com/2042-5961.htm

The author is thankful to Dr Pravit Khaemasunun, Yanathip
Techawiset, Professor Shufen Dai,
Kesrin Ariyaponges and China Thai Chamber of Commerce for
all research advice and support.
295
SMEs
innovation and
entrepreneurial
financing
industrial outputs and 80 percent of jobs created in China. The
Chinese government thus
realizes the importance of building an innovative economy
through enhancing SMEs’
capabilities. In building an innovative economy, the Chinese
government has introduced
the 12th Five-Year National Economic and Social Development
Plan to support SMEs
development. This paper attempts to understand the challenge of
financing innovative
economy through SME development in China.
The paper is organized as follows. Section 2 reviews the
theoretical framework on
the banks, financial institutions and their role in innovation. It
also reviews the
literature on venture capital (VC) financing to support SME
development. Section 3
describes the research design and methods. Section 4 discusses
the analyses of findings
with a focus on the bank financing policies to support SME

development in China.
Section 5 concludes the paper by drawing lessons and insights
that can be used as
policy guidelines to improve the competitiveness of SMEs.
2. Theoretical framework
SMEs are the economic sector making a significant contribution
to economic growth
and job creation. However, they often face significant
difficulties in accessing the kinds
of financing they need for growth (Pissarides, 1999; Hyytinen
and Toivanen, 2005).
Although the studies on traditional sources of finance for start-
up are already
voluminous (e.g. Moore, 1993; Gompers and Lerner, 1998,
1999, 2001; Mani, 2004), there
is a gap of research linking the study of entrepreneurial
financing to the aspect
of public policies in developing countries. Therefore, this study
attempts to fill a gap in
existing research by exploring the bank financing and VC
financing to support
entrepreneurial activities. Table I lists the types of financing
and sources of capital to
support SMEs.
In filling the research gap, this study will make a contribution
to the body of
knowledge in SMEs innovation and entrepreneurial financing.
Thus, the structure of the
theoretical framework section will be divided into two parts:
(1) Banks, financial institutions and their role in innovation.
(2) VC financing to support SME development.

2.1 Banks, financial institutions and their role in innovation
Banks and financial institutions play an important role in terms
of providing credits to
support the economic growth. Bank financing is critical to the
functioning of the
economy since it is an important source of funding to support
SMEs development.
Nevertheless, banks and financial institutions are reluctant to
provide credit lending to
Investor Goals
Family Success, payback
Friends Payback, friendship
Credit cards Payment
Suppliers Payment relationship
Business angels (private investors) Payback, returns, control
Venture capital Fast growth, multiple returns, ownership
Banks Payback, collateral
Source: The author’s design
Table I.
Types of financing
and sources
of capital
to support SMEs
296
WJEMSD
11,4
SME sector due to the riskiness of early stage ventures in terms
of insufficient assets,

having no proven track record and low capitalization (Berger
and Udell, 1998, 2006;
Black and Gilson, 1998; Wonglimpiyarat, 2007; Menkhoff et
al., 2012; Fredriksson and
Moro, 2014). As a result, they do not see this sector as a
profitable business. In other
words, they do not see worthwhile returns on SME investments
or whether such
investments would provide a potential pay-off.
Figure 1 portrays the valley of death (or the funding gap), the
difficulties
encountered by all SMEs in accessing the needed capital to
grow their businesses.
The valley of death refers to the period before a company can
generate revenues,
making it difficult to get the finance it needs to grow a business
in the start-up period
(Ehlers, 1998). Table II shows the target returns by investment
stages (Bygrave
et al., 1999). It can be seen that the high level of risks in early
stage investment requires
the highest return (internal rate of return over 50 percent) to
compensate the risks that
are higher than those in other stages.
Looking from an economic development perspective,
Schumpeter (1939, 1967)
argues that finance and financial institutions are the mainstream
of innovation
system as well as crucial determinants of the entrepreneurial
ability to develop
the new economy. The entrepreneurial firms are seen as playing
a crucial role to
the economy in terms of creating jobs contributing to economic
growth and stability.

Realizing the high risk nature of SMEs, many governments have
tried to bridge
the valley of death and improve SME capability. They see the
valley of death as
a challenging task in terms of introducing policies to manage
the financial risks that
Basic
Research;
Invention
The Valley of Death
Political picture
of the “gap”
“Valley of Death”
Applied
Research;
Innovation
Source: Ehlers (1998)
Figure 1.
The valley of death
faced by SMEs
Investee development phase
Expected return represented by internal rate of return (IRR) %
per annum
Early stage (Seed/Start-up) IRRW50
Expansion and growth 40WIRRW35
Maturity stage (Bridge, Management

buyout) IRRW30
Source: Bygrave et al. (1999)
Table II.
Target returns by
investment stages
297
SMEs
innovation and
entrepreneurial
financing
SMEs face with the aim to help SMEs cross the valley of death
(bridge the
financing gap). The establishment of specialized development
banks/SME banks
with special type of loan offerings for SMEs can be seen as part
of the government
policies to help alleviate SMEs’ financial constraints (Mani,
2004; Hyytinen and
Toivanen, 2005; de la Torre et al., 2010).
In recent years, the issue of SME financing has received an
increased attention as a
way towards building an innovative economy. Many economists
argue that despite
the heavy concentration of research and development (R&D)
expenditure in large
firms, it is the small firms that account for most of the
important inventions
and innovations (Freeman and Soete, 1997). Taking into account

the conventional
models of innovative economies, Schumpeter’s (1939) Mark 1
theory postulates that
small firms predominate in the process of innovation. Arguably,
the Mark 1 model
stresses the ability of the entrepreneurial small firms to
innovate (whereas the Mark 2
model is concerned with the technological innovation
developments by large firms).
It is argued that small firms play an important role in
innovation and industrial
development (Freeman and Soete, 1997; World Bank, 2010;
Krishnaswamy
et al., 2014). Realizing the trend of knowledge-based economy
(whereby the basis
of competition is increasingly built upon research knowledge
and innovation), many
governments have developed strategies/policies to support SME
financing with
the aim in building an innovative economy (Lerner, 1999, 2002;
Jeng and Wells, 2000;
Mani, 2004).
2.2 VC financing to support SME development
Figure 2 shows the funding requirement along the life cycle of
SME development.
Given the high uncertainties and risks in an early stage of
development, the source of
finance for new ventures is rather limited. The source of capital
to support early
stage venture is mainly from seed funds, business angels, VC
financing whereas
commercial banks and stock markets play a significant role in
providing finance in the
growth and mature stages (commercial banks providing finance
in the form of

Seed Start-up Growth Maturity
High
Low
Low
Time
Source of funds: seed
funds, business angels,
venture capital financing
Source of funds: commercial
banks, stock markets
R
a
te
o
f
g
ro
w
th
Risk profile
Source of funding
Source: Wonglimpiyarat (2007)
Figure 2.
Funding requirement

along the life cycle
of SME development
298
WJEMSD
11,4
loan capital or debt and stock markets providing finance in the
form of equity capital)
(Black and Gilson, 1998; Mani, 2004; Hyytinen and Toivanen,
2005; Giot and
Schwienbacher, 2007; Wonglimpiyarat, 2007).
Taking into account start-up financing, VC provides an
important source of
business finance to support SME development. By definition,
VC is a high risk,
potentially high-return investment to support business creation
and growth. It is a
source of funds that typically finances new and rapidly growing
companies through
equity participation (Bygrave and Timmons, 1992; Gompers and
Lerner, 1999, 2001).
VC has characteristics that set it apart from debt financing
alternatives and traditional
capital markets (Gompers and Lerner, 1999, 2001). It is a high-
risk financing investment
whereby venture capitalists generally expect high returns in the
form of capital gains
and dividends (Dixon, 1990; Pandey and Jang, 1996; European
Private Equity and
Venture Capital Association, 2005). The concept of modern VC
is defined by Megginson

(2004) as a professionally managed pool of money raised for the
purpose of making
equity investments in growing private companies with a well
defined exit strategy
(Giot and Schwienbacher, 2007).
SMEs assume a major influence in the economic development,
employment and
creation of new innovations (Birch, 1979; Gallagher and
Steward, 1986; Sahlman, 1990;
Massa and Testa, 2008). However, SMEs generally face
difficulties in getting access to
finance since investors do not prefer making investments in
SMEs due to their risky
nature of business operation. Since very small proportion of
monies seems to be
allocated to early stage ventures, therefore, the provision of risk
capital by VC firms
may be the most suitable form of external finance. This form of
investing brightens
SMEs’ prospects by relieving the capital constraints (Bygrave
and Timmons, 1992;
Gompers and Lerner, 1999, 2001; Wonglimpiyarat, 2007).
Currently, a number of developing countries have introduced
VC as an economic
development tool whereby the government of these countries
takes an operational
role in the development of VC industry (Lasserre and Schutte,
1995; Naqi and
Hettihewa, 2007; Tsai et al., 2009). The main focus of VC in
these countries is similar,
i.e., to provide seed capital and financing for technology and
innovation development.
Nevertheless, the structure of VC financing differs among
countries due to different set

of interacting institutions and structures of the national
innovation system (Lundvall,
1992, 1993, 1998, 1999, 2003).
3. Research methodology
This study attempts to fill a gap of existing research of SME
financing by linking
the aspect of public policies in developing countries to
entrepreneurial financing.
In particular, the research explores the challenges of SMEs
innovation and
entrepreneurial financing in the country case of China, the
world’s fastest-growing
economy. The research study uses the case study approach, a
qualitative research
(Eisenhardt, 1989; Yin, 2003), to analyze the impacts of the
12th Five-Year National
Economic and Social Development Plan on the bank financing
and VC financing for
supporting entrepreneurial activities.
In exploring the role of financial institutions and banks in SME
financing in China,
the research also derives evidence from a collection of
documentary investigation.
The research fieldwork and interviews were undertaken in
Beijing and Shanghai,
major financial centers in China, with the use of semi-structured
questionnaire. The
conduct of fieldwork interviews in the financial sector of China
was coordinated by the
Bank of Thailand, the Securities and Exchange Commission and
the Thai Chamber of
299

SMEs
innovation and
entrepreneurial
financing
Commerce in China. The interviews were conducted with banks,
financial institutions
and government agencies as shown in Table III.
In carrying out fieldwork research, the study aims to elicit
views on the government
policies and strategies to support SMEs and innovative
businesses, the backbone of the
Chinese economy that can lead to improved national innovative
capacity. The key
questions guiding the research are:
RQ1. What are the Chinese government’s strategies to support
the development of
SMEs?
RQ2. To what extent the government policies in bank financing
can support SMEs
and promote the development of an innovative economy?
In order to provide a cross-check on internal validity, interview
data are supported by
an examination of secondary data. The conduct and analysis of
the case study
have enabled the development of conclusions and
recommendations for the research.
The analyses provide lessons and insights which would be
useful for other emerging

economies to use the policy guidelines in supporting SME
development.
4. Analyses of findings
4.1 The economy of China and government strategies to support
SME development
China is the fastest-growing major economy in the world with
an average gross
domestic product (GDP) growth rate of 10 percent. The
overview of economic and
innovation performance of China is shown in Table IV.
Currently, the Chinese
government mainly uses the open door policy in attempts to
remodel itself from an
agriculture-based economy towards an innovation-driven
economy. Taking into
account the policies to support SME development, the Chinese
government has
launched various innovation policies to catch up with leading-
edge countries after it
joined the WTO in 2001. Specifically, the 12th Five-Year
National Economic and Social
Development Plan is a major government policy that places a
specific emphasis on
Name of institutions Characteristics of institutions
1. Bank of Beijing Bank owned by the local government
2. Huaxia Bank Bank owned by the central government
3. China Citic Bank Bank owned by the central government
4. United Overseas Bank or UOB Foreign bank
5. Bank of China Bank owned by the central government and
one of the Big Five
6. Bank of Shanghai Bank owned by the local government
7. Bangkok Bank China Co., Ltd. Foreign bank
8. Siam Commercial Bank Public

Company Limited
The bank is currently planning to open a representative office in
China
9. Thai Chamber of Commerce in
China
An agency promoting economic relationships between Thailand
and China
10. Bank of Thailand Bank of Thailand – the Department
dealing with investment and
trade relations with China
11. The Securities and Exchange
Commission
The Securities and Exchange Commission in Thailand with
specific research department providing advice on China’s
financial and monetary policy
Source: The author’s design
Table III.
List of institutions
providing research
interviews
300
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11,4

supporting SMEs in terms of creating an environment conducive
to entrepreneurship
and innovation for SMEs.
In China, SMEs are defined as follows according to the 12th
Five-Year National
Economic and Social Development Plan 2011-2015 by the
Ministry of Industry and
Information Technology:
(1) Small-sized enterprises: companies that employ fewer than
300 people and earn
less than 20 million RMB Yuan in annual sales revenue.
(2) Medium-sized enterprises: companies that employ 300-1,000
people and have
annual sales revenue of 20-400 million RMB Yuan.
In 2010, the number of registered SMEs in China is
approximately 11 million, contributing
to employment creation of more than 44 million people.
Therefore, SMEs are important in
driving China’s economic growth that the government cannot
afford to overlook. Table V
gives an overview of indicators to support entrepreneurship in
SMEs according to the
Global Entrepreneurship Monitor Report 2013, a global report
which provides an annual
survey of entrepreneurial activities worldwide. The first column
lists the indicators that
influence entrepreneurial activities in various dimensions. The
highlighted box shows the
performance of China compared to the average performance of
Asia Pacific and South
Asian countries which include China. It can be seen that the
performance of China in

supporting entrepreneurship in SMEs is likely the same as the
average performance in
North America and the Asia Pacific and South Asia (except that
China is relatively weak
in entrepreneurship education with the score of 1.6 but performs
better than other
countries in terms of physical infrastructure with the score of
4.0). These scores reflect the
government attempts to support entrepreneurial development in
China. They also reflect
the importance of entrepreneurship in building China’s
innovative economy.
Realizing the importance of SMEs in economic development as
they constitute more
than 90 percent of all firms in China, the Chinese government
has placed importance on
SME development to drive the national economy. Figure 3
depicts major institutions and
players providing support to SMEs as well as high-growth
innovative SMEs in China.
Indicators Year Important figures
Population (million) 2014 1,393
Gross domestic product (GDP) (USD billion) 2014 1,253
GDP growth (%) 2014 7.4
IMD world competitiveness ranking 2014 23
WEF competitiveness ranking 2014 28
Knowledge Economy Index (KEI) Ranking 2012 84
KEI Index 2012 4.37
% of R&D expenditure to GDP (approximate) 2014 1.95
No. of patent applications
Residents 2012 535,313
Non-residents 2012 117,464

Amount of venture capital (VC) investments (USD billion) 2013
3.5
Sources: The author’s design, based on the World
Competitiveness Scoreboard (various years) by
International Institute for Management Development (IMD),
World Economic Forum (WEF) Global
Competitiveness Report, World Bank, United Nations
Conference on Trade and Development
(UNCTAD), OECD Main Science and Technology Indicators
and Dow Jones Venture Source 2013
Table IV.
Overview
of economic and
innovation
performance
of China
301
SMEs
innovation and
entrepreneurial
financing
The government plays an important role in developing policies
and strategies to support
the transition to an innovation-driven economy. For example,
the Decision on Developing
High-Tech and Realizing Industrialization (CCCP) sets forth the
tenth plan (2001-2005) to

promote innovation commercialization. The Guideline for
Developing National
University Science Parks provides a plan to promote the
development of university
science parks. The government policy in encouraging R&D can
be seen a result of
adopting Deng Xiaoping’s open door policy to encourage
foreign investments and attract
new technologies. The major policy of the Ministry of Science
and Technology includes
the guidelines on national medium-and long-term program for
science and technology
development during the period of 2006-2020.
China’s Ministry of Science and Technology plays a significant
role in the design
and implementation of national innovation policies. The special
economic zones
and science parks were established to foster new technology
development.
In particular, the Torch program was developed to support the
creation of industrial
clusters. The national Science and Technology Industrial Parks
(STIPs) were
established to support high-technology enterprises. Up to now,
there are 54 national
STIPs established by the Torch program to promote the
development of innovation
clusters and advance upgrades in high technologies.
Currently, the government policy has placed a greater emphasis
on strengthening
clusters of special economics and high-technology zones as the
government
realizes their important role in offering infrastructure for
implementing the

innovation strategies. The government has also reduced the
corporate income tax
rate and value-added tax to promote high-technology
enterprises. Recently, the
Rating scores based on a five-point Likert scale
Indicators of entrepreneurship
North
America
(Average)
Europe
(EU)
(Average)
Asia Pacific and South Asia
including China (Average) China
Entrepreneurial finance 2.4 2.6 3.0 2.5
Government policy to support
entrepreneurship 2.7 2.6 2.8 2.7
Government policy to support
new SMEs 2.0 2.4 2.6 2.6
Government programs to support
entrepreneurship 2.6 2.8 2.7 2.6
Entrepreneurship education at
basic school 2.0 2.1 2.2 1.6
Entrepreneurship education at
post-secondary levels 2.9 2.8 2.9 2.7
R&D transfer 2.3 2.5 2.6 2.5
Commercial and legal
Infrastructure to support SMEs 3.1 3.2 3.1 2.6
Regulations related to market
dynamics 3.1 3.1 3.6 3.9

Regulations related to market
openness 2.6 2.6 2.7 2.6
Physical infrastructure 3.8 4.0 3.8 4.0
Cultural and social norms that
encourage business activities 3.2 2.6 3.2 3.0
Source: The author’s design, based on the Global
Entrepreneurship Monitor (GEM) Report 2013
Table V.
Entrepreneurship
overview of China in
various indicators
302
WJEMSD
11,4
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Major institutions
and players to
support SMEs and
high-growth
innovative SMEs
in China
303

SMEs
innovation and
entrepreneurial
financing
Ministry of Science and Technology has proposed State Council
of 2009 to strengthen
the science, technology and innovation system.
Interestingly, innovation is one of the policy aspects (the
Chinese dream) that
President Xi Jinping emphasizes: patriotism (aiguo); innovation
(chuangxin);
inclusiveness (baorong) and; morality (houde). The financial
policies under the
political leadership of President Xi Jinping can be seen as a
continuation of using an
open door policy to improve financing mechanisms and provide
financial funds to
support SMEs. The Chinese government provides grants, loans
and other incentives
(such as tax incentives for R&D, low income tax rates for high-
technology enterprises)
to drive innovation and growth. The SME financing policies can
be seen as a result of
government intervention in the financial market to fill SME
financing gap.
4.2 Challenge of the government policies in bank financing to
support SMEs
Financing constraints of SMEs are one of the major difficulties
faced by entrepreneurs

in China. The central government attempts to improve SME
access to finance by
introducing the 12th Five-Year National Economic and Social
Development Plan.
In China, the Big Five banks providing a major source of credit
for SMEs in China
are Industrial and Commercial Bank of China, Agricultural
Bank of China, China
Construction Bank, Bank of China and Bank of
Communications. Table VI shows the
performance of the Big Five accounting for 47.3 percent of total
market share.
As a result of the 12th Five-Year National Economic and Social
Development Plan,
the Beijing Municipal Government supports Chinese financial
institutions in setting up
SME credit departments. The policies of Beijing municipal
government put greater
emphasis in upgrading small scale financial institutions into
commercial banks so as
to facilitate SME access to finance. Table VII shows the granted
credits in China. As a
2008 2009 2010 2011
Credits granted to USD % USD % USD % USD %
Small enterprises 0.71 21 0.93 22 1.20 24 1.74 24.7
Medium enterprises 1.12 32 1.40 33 1.66 33 1.79 25.3
Large enterprises 1.61 47 1.90 45 2.16 43 3.53 50
Total 3.44 100 4.23 100 5.02 100 7.06 100
Source: China Monetary Policy Report
Table VII.
Credits granted in
China (units in

USD billion)
Total assets
Operating
income Total loans
Growth
rate per
annum
Bank 2010 2011 2010 2011 2010 2011 2010 2011
Industrial and Commercial
Bank of China 2,195,534 2,524,775 62,124 76,770 1,107,750
1,270,619 22.68 23.32
Agricultural Bank of China 1,686,363 1,904,988 47,676 61,950
781,078 880,728 22.23 20.26
China Construction Bank 2,003,562 1,763,510 52,771 64,778
901,472 1,031,842 22.45 22.36
Bank of China 1,706,340 1,929,864 45,158 53,534 903,387
1,011,931 18.68 18.10
Bank of Communications 644,632 752,231 17,004 20,711
364,915 417,904 20.08 20.49
Source: China Securities Regulatory Commission
Table VI.
Performance of the
Big Five
(USD million)
304
WJEMSD
11,4

result of the implementation of this credit policy, it can be seen
that the total loan
amounts granted to SMEs account for approximately USD3.53
billion (from total
credits granted of USD7.06 billion in 2011). It is argued that
the 12th Five-Year National
Economic and Social Development Plan reflects the efforts of
the Chinese government
to help SMEs cross the valley of death (according to the study
by Ehlers, 1998). Clearly,
the SME financing policies play an important role in helping
alleviate SMEs’ financial
constraints (in line with the studies by Mani, 2004; Hyytinen
and Toivanen, 2005; de la
Torre et al., 2010).
In China, the majority of the banking sector is owned by the
central government.
The credit granting system of each bank therefore has to follow
the prescription policy
from the central government. In credit granting, most of the
banks prefer to grant loans
to large enterprises since granting credits to SME is more risky.
Understanding
the problems of SMEs, the Chinese government, through the
People’s Bank of China and
the China Banking Regulatory Commission (CBRC), has
encouraged banks to increase
access to credits and supports to SMEs. The government would
assess the performance
of policy implementation or the effectiveness of banks’ credit
granting system from the
non-performing loans (NPLs) rate. It is interesting to note that
the proportion of NPLs to
GDP in 2010 is 2 percent compared to 25 percent in 2000. The

reduction in loan losses is a
result of the government’ s policy in taking steps to control
NPLs, an attempt to build
solid economic footing in China’s banking system (World Bank,
2012).
Table VIII summarizes reflections from the interviews with
regard to the government
policy on SME financing and the extent of bank financing to
support SMEs. Most banks
state a consistent view that the introduction of the 12th Five-
Year National Economic and
Social Development Plan does have influence on the banks’
lending policy in terms of
increasing SME loans as the banks are under control by the
government (via the CBRC).
They view that the 12th Five-Year National Economic and
Social Development Plan is an
overarching strategic plan defined by the government. However,
in practice the policy
implementation differs across the banks depending on the
policies of each bank and the
extent of credit risks that each bank can bear (risk exposure).
At present, most SMEs depend on informal loans outside the
banking system which
bear relatively high interest rates (charging the high interest
rates of 18-20 percent)
and thus constrain the SMEs’ ability to grow. Therefore, the
Chinese government
attempts to terminate this informal lending system so as to help
SMEs. Interviewees
stated that the introduction of the 12th Five-Year National
Economic and Social
Development Plan has not only increased SME lending but also
placed emphasis on

capital market financing to build an innovative economy since
the 12th Five-Year
Plan encourages the opening up of the capital markets for
technology-based firms to
improve the capability of the economy to innovate. The
interviewees expressed their
views that the introduction of the 12th Five-Year Plan has
changed banks’ credit
direction from lending to heavy industries to new industries like
information
technology, renewable energy, biotechnology and other high-
tech sectors.
According to the interviews with banks in China, one of the
banks stated that: “[…]
the 12th Five-Year Plan can be seen as the government’s
command that we have
to follow by setting up SME special unit to provide SME
financing. Although the policy
is not mandatory, in practice we must comply with these
directives. Otherwise,
the future of our business relations with the government will be
not easy […]”. Most of
the interviewees stated that as the 12th Five-Year Plan denotes
the policy signals that
policy makers attempt to favor SMEs, the banks have to comply
with the policy.
Nonetheless, by complying with the 12th Five-Year Plan, the
banks expressed concerns
305
SMEs
innovation and
entrepreneurial

financing
Policies/strategies of
SME financing
Enabling
policies/
strategies Description
1. Government policies/
strategies to support
SMEs
x The policies from the central government not only
influence the small banks having a high proportion of
SME clients but also the Big Five commercial banks. The
Big Five need to comply with the government policy by
increasing SME lending portfolio despite their reluctance
to lend to SMEs
The government provides incentives for banks to
increase SME financing. If the banks follow the
government policy guidelines on SME lending, they
would receive positive consideration and support in
terms of getting approval on opening more branches
Despite the government policies to support SMEs, they
still face difficulties in accessing finance. Most SMEs
turn to informal lending outside the banking system
(most SMEs still rely on black market lending)
2. Bank credit policies x Even though most banks view that the
intellectual
property (IP) assets such as patents, copyright,
trademarks, trade secrets should play an increasing role
as lending criteria for innovative businesses, this is not

the case in practice. Almost all banks argue that the
lending decisions still depend on the collateral value and
the borrower’s credit worthiness
Foreign banks in China are constrained by the limit that
they can give out credit loans. Consequently, foreign
banks operating in China tend to focus on providing
financial services to serve their own customers doing
businesses in China (rather than serving the Chinese
businesses)
Due to the difficulties in valuing IP assets, they are not
the preferred collateral (loan security) for banks. The
valuation of these types of assets requires IP valuation
experts to assess their actual economic value
3. Bank financing
programs to support
SMEs
x Banks assist SMEs to save on bank charges by waiving
fees or charges related to SME transactions. Banks also
help SME businesses in terms of lowering upfront fees,
commitment fees to reduce SME financing costs
Banks see that the policy from the central government
has greatly influenced their decisions in setting up the
SME Special Unit to provide SME financing, for
example, HuaXia Bank’s Dragon Boat Program to
provide small business financing
Banks are still conservative in providing loans or
credits to SMEs to maintain lower loan to deposit ratios
(75% loan to deposit ratio limit for all commercial banks
according to China’s Commercial Bank Law), for
example, China Citic Bank, one of the banks established
during China’ reform said that the bank could allow SME
loan losses by only 2-5%
(continued)

Table VIII.
Summary of
interview results on
the government
policies of bank
financing to support
SME development
in China
306
WJEMSD
11,4
about the high credit risks of SME financing which would result
in high incidents
of NPLs. Many banks have emphasized the importance of credit
risk management in
terms of laying the procedures to limit loan losses to 2-5
percent of the SME lending
portfolio. The banks stated that, they try to limit loan losses not
to exceed 2 percent of
the SME portfolio in the actual practice. Otherwise, they would
be under scrutiny over
their policies on SME lending/bank lending standards. The
banks also stated that the
introduction of the 12th Five-Year Plan seems problematic since
the government
expects that there should be no loan losses from SME lending.
Taking into account of VC financing, another important
mechanism to support
innovative SMEs, the VC industry in China is not well

developed and limited in scale
due to regulatory restrictions of fund-raising. The China
Venture Capital Association
was established in 2002 to promote government policies
conducive to the development
of VC industry. The Government-financed Venture Capital
Funds was established in
1993 in Guangdong, Jiangsu, Zhejiang and Shanghai together
with the formation of
University-backed Venture Capital Funds to provide university
incubating services
and encourage the process of technology commercialization. At
present, the VC
industry is dominated by international VC funds. The
international VCs have helped
build the high-tech industries of internet, networking as can be
seen from the successful
enterprises like Lenovo and Huawei Technologies.
Figure 4 presents comparative VC investments in China and
other countries
during 2006-2012. It has shown that China’s VC industry is not
fully developed. The
major obstacle to VC development in China is a lack of policies
to induce VC
investments, a lack of credibility and transparency in China’s
capital markets and
legal system. Moreover, the industry also suffers from a lack of
skilled professionals
Policies/strategies of
SME financing
Enabling
policies/
strategies Description

4. Policy aspects to support
innovation
x Although most banks implement the 12th Five-Year
Plan to support SMEs by setting up specific units to
increase the supply of SME financing, most of them do
not operate VC investment units to support high-tech
SMEs. At present, China’s VC industry is not fully
developed and still needs incentive programs to foster
the VC industry
Concerning credit lending, if the borrowers are
technology-based firms in Beijing’s Zhongguanchun
Science Park, they would get financial support from the
government in the form of fee refund.
China has the formal business angel market but its
business angel community is still small
The government has launched the national strategy to
promote Shanghai Free Trade Zone by providing tax
incentives to encourage investments and trade. In
promoting an innovative economy, the government also
gives tax breaks as an incentive to importers and
exporters in this zone
Note: x, category of policies/strategies as enabling
policies/strategies
Source: The author’s design (summarized from interview
results) Table VIII.
307
SMEs
innovation and
entrepreneurial
financing

with experiences in VC management. The government has
increasingly recognized such
difficulties and tried to improve regulatory policies so as to
support the growth of VC
investments in China. For example, at present, China’s Ministry
of Commerce has issued
regulations allowing foreign-invested VC firms to invest in
China. The Ministry of
Finance has also eased the regulations regarding the capital
requirements of
international VC firms – lowering the capital requirement by
USD10 million as well as
easing stringent regulations of foreign VC structure.
Nevertheless, the venture capitalists
still have difficulties in exiting their investments in the VC
market. Currently, the
development of VC industry in China is still at the initial
development stage. In
transitioning to an innovative economy, the country needs the
policy supports in terms of
VC financing, private equity funds, capital markets for
technology-based firms.
Most of the VC investments are in the sectors of internet, clean
technology, electronics
and optoelectronic equipment, telecom and value-added
services. The centers of VC
industry are Beijing, Shanghai, Chengdu and Shenzhen. In the
growing VC industry,
Zero2IPO Capital is the major VC corporation among others
(such as Accel Partners-
Beijing, Redpoint Ventures-China, Sequoia Capital-Beijing,
GSR Ventures-Beijing-China,

Eastern Bell Venture Capital, Walden International-Shanghai-
China, Warburg Pincus-
Beijing-China, VantagePoint Venture Partners-Beijing-China,
Vivo Ventures-Chengdu-
China) targeting investments in high-potential an high-growth
companies.
5. Conclusions
This paper explores the challenges of SMEs innovation and
entrepreneurial financing
in China. The empirical research is focused on the impacts of
the 12th Five-Year
National Economic and Social Development Plan, the main
policy function
after China joined the WTO, on SMEs development and
entrepreneurial activities.
The findings have shed light on the impacts of the 12th Five-
Year Plan over the bank
financing sector – its influence over the banks’ policy in terms
of increasing SME
lending. In adopting the 12th Five-Year Plan, the results of this
study have shown
that banks tend to focus only on SME financing (bank loans) but
not VC financing.
However, the extent of credit lending differs among banks
depending on each bank’s
credit policy.
0
5
10
15

20
25
30
35
40
2006 2007 2008 2009 2010 2011 2012
USA Europe Israel China India
Source: Dow Jones Venture Source 2013
Figure 4.
VC investments in
China compared to
other countries (units
in USD million)
308
WJEMSD
11,4
At present, the government has emphasized the aspect of
innovation strategy
according to President Xi Jinping statement on the Chinese
dream (focusing on
patriotism, innovation, inclusiveness, morality). However, the
VC policies, the financing
mechanism that can contribute to the build-up of national

innovative capacity, are still
weak. The study has shown that the Chinese economy is driven
by the government
intervention policies. The analysis also points out the challenge
of the Chinese
government in improving regulatory policies to support
innovative businesses. It is
argued that building national innovative capacity is highly
regarded as an important
factor to strengthen China’s position in the global competitive
landscape. Thus, the VC
financing should play an increasing role in supporting high-tech
and innovative SMEs
in the future since China’s VC industry is not yet fully
developed at present. For the
long term policy perspective to increase and sustain national
competitiveness, it is
necessary that the government policies should encourage the
private sector to provide
more VC and business angel investments to support high-tech
business start-ups and
SMEs. Arguably, effective financing mechanisms would
increasingly open up new
investment opportunities to support the rise of China in the
world economy.
The findings in this paper suggest important implications for
practice in that for
the developing countries with scarce resources and budgetary
constraints, it is the
government (not the private sector) that should play a major
role in encouraging the
provision of SME financing. However, the government
financing should not crowd out
private investments. The present study offers interesting avenue
for future research in

exploring the effectiveness of the government’s policies to
support SMEs’ growth.
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[email protected]
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Conventional wisdom has long held that innovation
is the strength of the West and that what gets developed
in the West is modifi ed and transferred to “the Rest.” But
the reality of recent years does not support this assump-
tion. In point of fact, we’re seeing a rise in the number
of innovations coming from emerging markets, and
we’re seeing even more in the way of infl uence from
emerging markets in the way that innovation is con-
ceived of, executed, and delivered.
Innovation happens where need meets opportunity. In
emerging markets, these needs are often very basic, par-
ticularly for those at the bottom of the economic pyra-
mid ( Prahalad 2004 ). As creative ideas for meeting those
basic needs are translated into compelling innovations,
emerging markets are becoming hotbeds of innovation
in areas ranging from healthcare to water to transporta-
tion. And innovation activities in emerging markets are
having profound impacts on the West; indeed, products
created in and for emerging markets are now fi nding
Irene J. Petrick is a faculty member at Penn State Uni-
versity as well as an innovation and strategic roadmap-
ping consultant. She has been a Welliver Fellow at
Boeing (summer 2005), a faculty intern on site at CSC
India (summer 2008), and an Intel innovation roadmap-
per (summer 2010 and 2011). She earned her PhD in
engineering science and technology management at
Penn State University. [email protected]
Suwan Juntiwasarakij is completing his PhD in social
media and innovation at Penn State University. He is
a Royal Thai Government Science and Technology
Scholar. [email protected]
SPECIAL ISSUE: INNOVATION IN EMERGING
MARKETS

Irene J. Petrick and Suwan Juntiwasarakij
THE RISE OF THE REST: HOTBEDS OF
INNOVATION IN EMERGING MARKETS
The rise of emerging markets will force Western companies to
recognize new
competitors and rethink their own innovation approaches.
DOI: 10.5437/08956308X5404009
eager buyers in developed nations. Once called reverse
innovation ( Immelt, Govindarajan, and Trimble 2009 ),
and now also known as frugal or constraint-based in-
novation ( Economist 2010 ), this reversal of the tradi-
tional fl ow of innovation is both reshaping consumer
Figure 1 .— Hotbeds of Innovation
Research • Technology Management24
0895-6308/11/$5.00 © 2011 Industrial Research Institute, Inc.
demands and forcing Western companies to rethink their
ideas about innovation and how it happens.
“Emerging markets” have often been associated with the
BRIC countries—Brazil, Russia, India, and China—but
companies seeking to better understand emerging markets
and frugal innovation must now look much further afi eld,
as regions around the world emerge as incubators of inno-
vation. This article highlights some recent developments in
emerging markets and provides some insight into how the

innovation model driving these emerging markets differs
from the model invoked by their Western counterparts.
Innovation Hotbeds
What does a desalinization project in Israel or the United
Arab Emirates have in common with mobile banking in
Kenya or the Tata Nano car in India? At fi rst blush, very
little. But these places, and these products, are emblem-
atic of the innovation power that has been fermenting in
the rest of the world and that is now poised to take full
advantage of globalization. Bloomberg BusinessWeek ’s
2010 ranking of the 50 most innovative companies in-
cluded 15 Asian companies; more than one fi fth of the
entrants on the list were anchored in emerging econo-
mies ( Arndt and Einhorn 2010 ).
Many of those markets are evolving specializations in
areas that are particularly important for their home econ-
omies ( Figure 1 ). We’ ve chosen to emphasize four areas:
mobile banking, microfi nance, and social media; trans-
portation; energy and natural resources; and healthcare.
In calling out innovation hotbeds, we’re not attempting
to be all-inclusive, but rather to highlight the confl uence
of factors that is now driving the emergence of truly in-
novative products and services from unexpected corners
of the world.
Mobile Banking, Microfi nance, and Social Media
Want to be at the center of mobile banking and the mo-
bile wallet? Go to Kenya. The M-PESA program, a joint
venture between Vodaphone and Safaricom, has revolu-
tionized the way that local farmers and small business
owners manage their money. These entrepreneurs and
farmers go to market with goods and keep track of pur-

chases and expenditures using their cell phones. Cell
phones replace the bricks-and-mortar bank, providing
the unbanked access to credit, an easy way of paying
bills, and seamless tracking of their expenditures and in-
cremental wealth accumulations—all via text messages.
The underlying enablers of this mobile banking revolu-
tion lie not only in a rethinking of the way fi nancial
July—August 2011 25
institutions work, but also in innovations in cell phones
to accommodate the habits of emerging-market users,
such as phones that can store multiple contact lists to al-
low multiple users to share a phone.
An Indian entrepreneur has taken the mobile bank one
step further by combining smartphone technology with
a biometric fi ngerprint scanner, creating an ATM on
wheels—bicycle wheels, that is. In Mexico, it’s motorcy-
cle wheels, which Grupo Elektra loan offi cers use to visit
potential customers in their homes and, using handheld
devices, communicate with the central offi ce to determine
on the spot whether or not a potential customer possesses
the wherewithal to borrow for a big-ticket purchase.
Mobile technology also supports microfi nance, which is
transforming the bottom of the pyramid by fi nancing tiny
businesses with very small loans, one entrepreneur at a
time. Microfi nance, pioneered in Bangladesh by the Gra-
meen Bank, has become a well-established mechanism
for funding innovation at the very bottom of the pyramid.
Microfi nance lenders and borrowers track the use of these
funds and their repayment via mobile technology. The
Grameen Foundation now has a footprint in 36 nations.

Transportation
The Nano automobile is probably one of the best and most
well-known examples of emerging-market infl uence in
innovation. The Nano, which is designed and produced by
Indian fi rm Tata Motors, was priced at a lowly $2,500
when it was introduced. Little more than an enlarged mo-
torbike with a fi xed weather shield, the Nano was just
what the Indian market needed—a car designed to fi t eas-
ily on the streets of the most crowded cities, with a modu-
lar design that allows it to be shipped in kits and assembled
on site by third parties if needed. The Nano is a complete
departure from the Western automobile. But it’s a perfect
fi t for the Indian reality, made possible by several key fac-
tors: the rise of a growing middle class in India that wants
and can now afford transportation solutions; the large
amount of time Indian workers spend commuting and the
premium on parking, which is very limited; and Indian
consumers’ lower expectations with regard to standard
features compared to their Western counterparts. The
lower maximum speed allowed on Indian roads and an
absence of government mandates regarding safety fea-
tures also enabled the barebones Tata design.
Energy and Natural Resources
Emerging markets are often rich in natural resources, and
their ability to extract, refi ne, and produce products from
these resources is gaining in both effi ciency and effec-
tiveness. Brazil, for instance, is supplementing its ample
oil supplies with a world-class biofuels industry based
on sugarcane and ethanol production. But to really take
advantage of innovations related to natural resources
requires both the presence of the natural resources and

the entrepreneurial spirit and insight to translate those re-
sources into compelling, innovative solutions. In coming
years, Russia, a major miner of platinum group metals
(PGM), may have that golden combination. The country
is poised to become an up-and-coming innovative force
as new agreements between Russia and Finland will
marry resources and entrepreneurial know-how. Five
years from now, we expect that this combined force may
well propel Russia to hotbed status.
Water, the new oil, is becoming a critical resource all
over the world, but especially in emerging markets; both
production of potable water and water conservation are
driving innovation. The United Arab Emirates (UAE) is
the world’s highest per capita consumer of water. In ad-
dition to its existing excellence in desalinization, the
UAE is expected to achieve innovation in areas related
to water conservation and packaging as it seeks to re-
duce its consumption by half in the next fi ve years. Is-
rael, another leader in desalinization, has developed new
fi ltering systems and pioneered effi cient within-plant
systems to optimize individual units and reduce the
plants’ energy footprint. Additional innovations are ex-
pected in the coming years through the use of nontradi-
tional energy sources, primarily solar.
Healthcare
Perhaps surprisingly to some, given their lack of infra-
structure, some emerging markets are leading innova-
tors in healthcare. But emerging-market healthcare
innovations are driven by the same factors that drive
innovation in other sectors: the need for basic, good-
enough solutions to improve the lives of bottom-of-the-
pyramid consumers. GE has become a leader in this area,
actively innovating in and for emerging markets. GE de-

veloped an inexpensive, portable EKG machine, the
MAC 400, for the Indian market and has produced ultra-
sound machines for the China market. GE’s philosophy
is to reduce the products to their essence, emphasizing
the features that are core to the device. All other features,
such as printers, can be modularized and less expensive
solutions can be provided. The philosophy has brought
unanticipated dividends in Western markets, where
healthcare costs have risen to staggering levels. In a sec-
tor that once could take up every expensive innovation
introduced into the market, cost-conscious consumers,
medical administrators, insurers, and even the govern-
ment are seeking less-expensive solutions. GE has been
able to leverage its developments in medical devices for
emerging markets to grow sales in Western markets.
Emerging-market innovators in countries such as Ghana,
South Africa, and Mexico also are leveraging the ubi-
quity of cell phones and the power of mobile technology
to improve access to healthcare. For example, Mexico’s
Medicall uses a subscription model to offer over 1
million people access to professional healthcare advice
for a fi xed fee of $5 per month, far below the cost of
a physician’s offi ce visit. And short message service
(SMS) technology is being used in Mali to provide more
accurate malnutrition diagnoses; healthcare profession-
als predict the likelihood of malnutrition based on SMS
reporting of body weight and other physical factors.
SMS is also being used to reduce the risk of counter-
feit medications through Ghana’s mPedigree program,
which allows a patient receiving drugs from a pharma-

cist to text a code on the medication label to a central-
ized clearinghouse for authentication.
Emerging markets are also becoming healthcare pro-
viders for Western patients in search of good care at a
lower price, feeding a relatively new market in medical
tourism. India, with the emphasis on understanding ac-
tivities and reducing them to repeatable processes that
served it so well in business-process outsourcing, is
emerging as a leader in this fi eld. Devi Shetty an Indian
heart surgeon, has pioneered the use of mass-production
techniques applied to surgical procedures. At their Ban-
galore facility, the 1,000-bed Narayana Hrudayalaya
Hospital, Shetti and his team of cardiologists perform
over 600 operations per week. This brings the cost down
to almost $2,000 per open-heart procedure while main-
taining the same quality standards and success rates of
a world-class U.S. hospital—where similar operations
cost more than ten times that. Thailand, another popular
medical tourist destination in Asia, serves tourists from
more than 190 countries worldwide.
What Drives Emerging Markets?
“Innovation and new product development do not work
the same way in emerging markets as in the U.S. or
other developed markets — the needs of the consumer
and professional customer are different. For example,
in the U.S. we see many companies focused on mobile
health or web-based applications. Yet in India, the ma-
jority of people don’ t have laptops or smart phones. So,
simpler technologies are required. In addition, in rural
markets just getting access to basic care is a bigger is-
sue than in urban areas. So, the types of products that
can help are different than those typically used in a hos-
pital or physician’ s offi ce.”

Kevin Ruffe, Vice President
IT Innovation, Johnson & Johnson
So what makes emerging markets so compelling as a
source of new ideas and innovations? There are actually
two factors driving the migration of ideas and innova-
tions from Rest to West. On the one hand, the emerging
markets have a very fast-growing consumer base. More-
over, these consumers are earning more and the burgeon-
ing middle class—particularly in India and China—has
increased spending power and a pent-up demand for con-
sumer goods. And even at the bottom of the economic
pyramid, spending is rising ( Economist 2010 ).
On the other hand, both consumers and companies in
these emerging markets are familiar with doing more
with less, a concept Indians embrace as jugaad . This
means that companies compete based not only on prod-
uct or service features, but also on the value of these
features for consumers. Value, in emerging markets,
means reducing products and services to their essence.
Products have to meet the needs of the consumer and
work reliably in challenging environments.
Fred Davis, managing director of Invetech Australia, a
product design and development company, describes the
challenges of designing for the various segments of the
economic pyramid in emerging markets. “At the top
are a small number of wealthy and sophisticated users,”
he says. “Closer to the bottom are people earning less
than $2 a day, many in remote rural locations struggling
with basic needs such as clean water and adequate
sanitation.” His company’s experience working with the
bottom of the pyramid suggests that (1) minimum price

dominates, (2) durability and reliability in adverse con-
ditions are very important, and (3) repairability must
match local skills. Considering these three aspects, the
feature sets that might be compelling to Western consum-
ers have completely different prioritization in emerging
markets. For example, the Western consumer preference
for replacing products when they break is completely
foreign to many emerging-market consumers, who place
a high priority on the longevity of the product and its
repairability. In this context, a design that uses widely
available parts or a modular construction that makes re-
placing components easy is far preferable to one with a
full range of features.
“If you are selecting between alternative product
concepts and design solutions for people further
down the pyramid, then minimum price dominates.
Low-cost adequate is better than higher-cost supe-
rior . Think lean, really lean.”
Fred Davis, Managing Director, Invetech Australia
Finding the Path
Designing and innovating products and services for
emerging markets requires a different development path
than Western methods usually call for. In the West, we
are often tempted to design for higher-end consumers
who are price insensitive and then, through increasingly
larger volumes, gradually lower the price to appeal to
more cost-sensitive segments of the market. Instead,
companies wishing to compete in emerging markets need
to consider two distinct paths to market—one local and
one global. This combination specifi cally acknowledges
July—August 2011 27

the extreme market-pull infl uences of the local emerging
markets. At the early stages, a funnel model still applies
in which market and technology forces act in concert to
infl uence the development of proven product or service
concepts ( Figure 2 ). Here we mean “proven” in the sense
that these concepts could be reduced to practice and oth-
erwise manufactured and distributed. At the point at
which the proven concept is evident, the path to market
may follow one of two paths. On the one hand, when the
product or service offers technology developments that
exceed currently available solutions (creating a techno-
economic affordance), innovations can be launched di-
rectly to the markets where these products and services
are sold—which may be global. Some high-technology
examples exist in which emerging-market fi rms are pro-
ducing feature-rich products for the global market
through technology and process enhancements. This
techno-economic affordance results in highly valued
products and services that are not defi ned by local condi-
tions. A good example of this is the medical tourism that
we discussed earlier.
The second path to market is locally focused and often
defi ned by socioeconomic necessity. Here, products and
services are reduced to their essence, resulting in lean-
featured offerings that capture essential functionality.
Often, however, these local innovations are so success-
fully conceived that they appeal to other geographic re-
gions. Both of GE’s emerging-market focused medical
imaging products—the Indian-market electrocardio-
gram and the China-focused ultrasound machine—are
fi nding markets in rural areas of the West, where reduc-
ing cost per patient is a very strong motivator for buying

decisions and where portability is critical. The differ-
ence between this model and existing models for West-
ern innovators is the focus and starting point. The more
common Western approach is to consider high-end con-
sumer needs and then slowly introduce lower-cost ver-
sions of the product over time, as market share and the
technology develop. While this approach does have
value, in emerging markets, it completely misses the
larger opportunity offered by lean-featured products for
the large volume of consumers at the bottom of the pyra-
mid. Finding what works for these consumers offers the
chance to springboard successful local innovations to
the larger global stage.
Tapping the Talent Pool in Emerging Markets
“ One of the biggest challenges we have in innovation
is fi nding the right people that can bring a new and
fresh perspective to solving our customer problems.
One of the most effective ways in addressing this is to
reach into our global organization to people outside
of our core markets. They often bring the kind of in-
sight that, quite frankly, would never have occurred
from people so close to the problem and from the
same culture. It’s not just the economics of low cost
labor arbitrage; it’s about accessing that talent and
creativity.”
R. Lemuel Lasher, President,
Global Business
Solution

s Group
Chief Innovation Offi cer, CSC Corporation
Emerging markets have more to offer Western fi rms than a
new approach to innovation and a massive consumer base.
They also possess a growing talent pool that is in tune with
the realities of their locale, a rich resource that companies
from GE to IBM to Boeing are tapping to their competi-
tive advantage. GE has one of its largest R&D facilities
in Bangalore and Boeing’ s Bill Lyons, general manager of
research and technology, Australia, notes that tapping
technology leadership worldwide is a differentiator in the
marketplace. “Even with one of the most diverse, edu-
cated, and talented workforces anywhere,” he told us, “we
know we can’t corner the market on innovative ideas or
technical skills. Working with technology leaders through-
out the world helps Boeing assimilate new ideas and in-
novative processes into our products and program.”
Figure 2 .— Innovation Paths for Emerging Markets

And real success will demand something beyond simply
working with technology leaders; it will require a com-
mitted local presence. Honeywell’s Paul McLaughlin,
director of HPS architecture, has been spending the last
couple of years managing global work that links their
Philadelphia, Pennsylvania, offi ces with engineers and
designers in India and China. After extensive travel and
hands-on product development management, his obser-
vations suggest that regardless of the specifi c industry,
multinational business success will come not only with
the participation of global team members but with a
local presence. “It is Honeywell’s belief that the most
effective method to achieve sustainable growth in a spe-
cifi c region or country is to have a core infrastructure in
that region or country. This not only includes the requi-
site sales, marketing, and after-sales support, but in ad-
dition, engineers and innovators that can defi ne and
develop fi t-for-purpose products and solutions tailored
for the local market, a supply chain for sourcing locally
provided materials, local manufacturing, local distribu-
tion, and fi eld service engineering.”
Conclusion

Ultimately, regardless of their location, successful com-
panies of the future will
• balance the feature-rich expectations of the traditional
Western consumer with the “good-enough” approach
emerging-market consumers expect;
• leverage the growing pool of talent in emerging mar-
kets in situ to tap into both the talent and their knowl-
edge of local needs and practices; and
• morph traditional management processes to incorpo-
rate emerging-market practices that emphasize per-
sonal relationships, rapidly reconfi gurable supply
networks, and unorthodox delivery methods.
Madhavan Satagopan, chief technologist, manufacturing
and technology, for Wipro sums it up best. “While there
is a lot of talk of reverse innovation, the key to innovating
in and for emerging markets is to address the market and
consumption rhythm and patterns, to understand the im-
portance of scale, and to cater to engrained preferences
where utility is valued above cutting-edge effi ciency.”
The innovation landscape is shifting. Companies seeking
sustained growth through innovation need to rethink their

strategies for engaging in and with emerging markets.
Special thanks to those who provided background on
this piece and agreed to be quoted on their companies’
beliefs and experiences with innovating in and for
emerging markets.
References
Arndt , M. , and Einhorn , B. 2010 . The 50
most innovative companies .
Bloomberg BusinessWeek , April 15.
http://www.businessweek.
com/magazine/content/10_17/b4175034779697.htm (accessed
May 3, 2010) .
Immelt , J. , Govindarajan , V. , and Trimble ,
C. 2009 . How GE is
disrupting itself . Harvard Business Review , October.
http://hbr.
org/2009/10/how-ge-is-disrupting-itself/ar/1 (accessed May 3,
2011) .
The Economist . 2010 . The world turned upside down: A
special

report on innovation in emerging markets . Special issue ,
April 15.
http://www.economist.com/node/15879369?story_id=15879369
(accessed May 3, 2011) .
Prahalad , C. K. 2004 . Fortune at the Bottom of the
Pyramid:
Eradicating Poverty Through Profi ts . Upper Saddle River,
NJ :
Wharton School Publishing .
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