21 Jun 2010  Research & Ideas

Strategy and Execution for Emerging Markets

How can multinationals, entrepreneurs, and investors identify and respond to new challenges and opportunities around the world? In this Q&A, HBS professors and strategy experts Tarun Khanna and Krishna G. Palepu offer a practical framework for succeeding in emerging markets. Plus: Book excerpt with action items. Key concepts include:

  • The ambition level of large, fast-growing emerging markets around the world rivals that of companies in the United States in the late 19th and early 20th centuries.
  • Khanna and Palepu outline how to identify and respond to institutional voids in product, labor, and capital markets.
  • Investors and entrepreneurs can respond to niches in institutional infrastructure in the private sector, such as the need for information analyzers and advisors, aggregators and distributors, transaction facilitators, and more.
  • A useful starting point for managers is to construct an institutional map to identify institutional voids—which may themselves present business opportunities.
  • Western multinational companies as well as local entrepreneurs are innovating products to attract the emerging middle class. Such innovations could potentially benefit consumers living in mature markets.

 

Emerging markets such as the BRIC countries—Brazil, Russia, India, and China—entice and intimidate. When managers are asked what is special about emerging markets, they typically point to rapid economic growth, potential competitors, and vexing problems including but not limited to corruption, financial crises, and weak intellectual property rights.

HBS professors Tarun Khanna and Krishna G. Palepu, authors of the new book Winning in Emerging Markets: A Road Map for Strategy and Execution (Harvard Business Press), offer an actionable framework to help potential entrants answer the following key questions:

  • In this particular market, which market institutions are working, and which institutions are missing?
  • Which parts of our business model can be adversely affected by these institutional voids?
  • How can we build competitive advantage based on our ability to navigate institutional voids?
  • How can we profit from the structural reality of emerging markets by identifying opportunities to fill voids, serving as market intermediaries?

For Khanna and Palepu, an emerging market is anyplace where buyers and sellers cannot easily and efficiently do business with each other. The scholars therefore focus their research worldwide, not just on the BRICs.

"Often the main prize today is the emerging middle class, which aspires to consume world class products at lower price points." -Krishna G. Palepu

"We have been studying emerging markets for about 15 years," explains Palepu in our interview. "We've wanted to learn about the challenges of the process and the challenges of companies in those markets trying to compete on a global platform. We are also curious how international companies have been able to intimate themselves into the conditions of those markets."

Palepu, whose current research and teaching activities focus on strategy and governance, is the Ross Graham Walker Professor of Business Administration and Senior Associate Dean for International Development. Khanna, the Jorge Paulo Lemann Professor at Harvard Business School, has studied and worked with multinational and indigenous companies and investors in emerging markets worldwide.

Palepu and Khanna joined forces for our Q&A.

Martha Lagace: Why study emerging markets?

Krishna G. Palepu: Emerging markets are the growth engine for most Western companies today. They also present a great opportunity for entrepreneurs in these countries to build the future. And from an intellectual perspective, emerging markets provide a lab for scholars because everything we know about management needs to be reexamined in a new context: Are ideas about management still robust when you change the institutional context? If not, how should we modify ideas about management in general?

While the work that Tarun and I have done focuses on strategy, the same set of challenges exists in other parts of management thinking, too, such as organizational behavior, marketing, finance, and so on.

Tarun Khanna: Everyone agrees that firms should create value wherever they are. But when we ask what kind of value and for whom, who are the relevant stakeholders, how is work actually going to be implemented on the ground, there are different answers in different circumstances. That's the intellectual puzzle we have been trying to wrestle with for 15 years.

There's also the sheer energy in emerging markets, the excitement and enthusiasm that people there and now thankfully people everywhere feel about emerging markets. This too makes it possible to take a long view.

Q: Which emerging markets are most exciting?

Palepu: Each set of countries has its own fascination. That's why we prefer to think about a cross section of countries and understand what is similar and different. We focus on many different emerging markets to develop a theory that spans all emerging markets as opposed to a particular geography. In particular, we study Brazil, India, China, Turkey, Indonesia, and Mexico. They—and others—fascinate us because their ambition level is reminiscent of ambition in late 19th- and early 20th-century United States. Their companies and entrepreneurs are literally trying to build future great companies while dealing with the challenges of scaling up as well as huge opportunities in managing rapid growth. These countries also provide an innovation platform to justify tailoring and inventing products and services just for them.

Khanna: Think about Chile. Chile is not by anyone's reckoning a large market, but it is a very interesting laboratory. Free market principles were introduced initially under the authoritarian regime. Compared with other emerging markets anyway, Chile has since become a paragon of reasonably good governance. Its process of change is ultimately an economic process that is nonetheless embedded in societal norms and political realities.

Palepu: Yes, Chile—just like Israel, South Africa, and South Korea—is crossing over from an emerging market to a more mature market. Learning about Chile helps us predict the future of other markets. We are interested as well in the Middle East, Malaysia, and African countries. Eastern European countries have their own set of challenges, potentially benefiting from the EU yet not large enough and therefore getting crowded out.

Q: What are "institutional voids," and how should managers around the world think about institutional voids as problems as well as opportunities?

Khanna: Here's an example. Let's think about the sourcing of talent. A business school in some sense is an institution that, in addition to training and teaching people to think about their role in society, serves a variety of functions from the standpoint of a potential employer. It helps screen talent and certifies that it is of high quality. In the United States there is a rich ecosystem of similar business schools that compete and, through the process of competition, need to remain honest. Executive search firms also complement this process.

By institutional void, we refer to the situation in most emerging markets when specialist institutions and intermediaries—such as executive search firms and business schools—are either completely absent or not functioning as well as they might. So, in this example, buyers of talent can't get together as easily as they might, with sellers of talent (such as graduates of business schools). For managers, if their business growth is predicated on hiring appropriate amounts of talent—as it invariably is—what do they do to compensate for the absence of support services that they might take for granted in the United States or in other more mature markets?

In the book we discuss at length how companies adapt to these missing institutions. We also describe different kinds of institutional voids and give many examples of companies trying to adapt.

"A useful starting point for managers is to construct an institutional map and see what the institutional voids are." -Tarun Khanna

A useful starting point for managers is to construct an institutional map and see what the institutional voids are. It's important to have the right kinds of conversations and identify the problems that need to be resolved over and above the core function in a business of making anything from widgets to washing machines to life-saving drugs. McDonald's sells burgers worldwide, but the way it does so has to change from location to location, adapting to the institutional voids in each location.

Palepu: The organization Li & Fung fills a void by making the market between, on the one hand, thousands of producers of goods and services and on the other, big-box retailers and many others in the United States that want to source from emerging markets. Li & Fung took advantage of the need for intermediaries and created a big business out of it. It is fair to say that without Li & Fung, the sourcing function for most major retailers in the U.S. would come to a grinding halt.

Our framework for institutional voids captures what is common to all emerging markets and explains the distinction between emerging markets and more mature markets. It could help managers audit any given emerging market and its different institutional voids. Managers can then tailor-make their strategy to a particular market, given that different elements are missing in different places and economies.

Here's another example. Vizio is a U.S. company created within the last five years that produces the number one flat-panel TV brand in the U.S., beating Sony, Samsung, and Panasonic. It created a brand and financed itself to grow fast despite a limited number of staff—because of the institutional infrastructure in the United States. Vizio relies on Costco as a distributional partner, which adds credibility as well as helps to the brand without overspending on advertising. A logistics system allows Vizio to import televisions from a manufacturer in China in just-in-time fashion and deliver them to Costco without much capital. But if the founder wants to take that model and replicate it in Brazil, for example, he needs logistics and financing infrastructure. Even if the demand for flat-panel TVs exists, he can't just go and do the same thing.

The Vizio example highlights the power of institutions to support entrepreneurship, but also shows how nontransferable certain business ideas are when you take them to contexts without key institutions. In fact, part of Vizio's global strategy is to only go to those markets where Costco is going. In our taxonomy, Costco is an important institution because it facilitates business between producers and customers in an efficient manner.

Q: How can intermediaries grow as businesses in their own right?

Khanna: Emerging markets can't mandate intermediaries into existence. Entrepreneurs must first recognize an institutional void and deem it in the best interest to create a business model and compete.

Palepu: When we say that emerging markets have institutional voids, it almost sounds as if they are backward and not good enough. Actually there is a flip side. The more institutional voids there are, the more niches there are for entrepreneurs to fill. That is why growth in these economies is so high. There are all kinds of opportunities for entrepreneurs to develop markets in the private sector. According to some estimates, about half of U.S. GDP is due to business done by intermediaries in the private sector.

Government institutions are necessary in terms of the rule of law, regulatory framework, and adjudication capability; but in the private sector there is also the need for a tremendous number of institutions and intermediaries such as information analyzers and advisors, transaction facilitators, adjudicators, credibility enhancers, aggregators and distributors, and so on. Managers can understand how to think about the list of institutions and a framework of enumerating them.

Q: You describe "emerging giants" as "a small but growing set of companies that have built world-class capabilities to challenge global rivals in their home countries and even in developed markets." What is an example of an emerging giant?

Palepu: The Tata Group in India is probably well on its way to becoming a giant. When markets in India opened, the Tata Group had been in existence for more than a hundred years. Yet as a sprawling, diversified business group spanning 80 or 90 businesses, each of which was not performing up to its full potential, it was uncompetitive.

The chairman of the group, Ratan Tata, creatively reorganized the business to make it survive in the new open global economy, and then challenged his group of companies to innovate. They designed the Tata Nano, a vehicle at the $2,500 price level to address the needs of the emerging middle class in India. At the same time, Ratan Tata has challenged his companies to think globally. They have done a large number of acquisitions around the world, the most notable being Corus steel, as well as Jaguar and Land Rover and many others.

The Tata Group is a great example of a company that transformed itself from a successful company in a closed, local environment to a fairly aggressive player that has fostered innovation and globalization in almost a trendsetting manner in a completely different, globalized environment of rapid growth and extreme competition.

Khanna: In our book we also discuss Haier Group in China, which has a major presence in the U.S.; Garanti Bank of Turkey, one of the most efficient banks anywhere; Cosan, in the sugar business in Brazil; and many others. We discuss in depth some strategies that have worked and some that haven't.

Q: How does the business of multinationals change in emerging markets?

Palepu: Often the main prize today is the emerging middle class, which aspires to consume world-class products at lower price points. Multinationals may stumble when they enter emerging markets while addressing a very limited group of people who can afford global quality at global price points.

The emerging middle class wants goods and services at global quality with local price points. It's a big challenge. If multinationals want to compete in emerging markets, they need to innovate to provide global quality, which is their forte using their resources and innovation capacity, but at a local price point. And often customers equate lower price points with lower quality. How can you actually produce global quality while charging price points at 50 percent lower than global prices? Only if you understand local customers and strip away unnecessary features of the product.

It is also a challenge for local companies because local companies usually reduce price by reducing quality. For local companies the challenge is to upgrade quality, while for global companies the challenge is to understand local customer needs and produce localized products.

In our book we discuss companies including GE, which has been innovating in the medical sector, and cellphone companies such as Nokia that reach large groups of customers by producing phones comparable to better phones but at lower price points.

Q: What products from emerging markets could cross over to the West?

Palepu: With the economy in the West coming under more financial stress—incomes stagnating, entitlement costs rising, governments facing deficits, and people more value conscious—high-quality products at reasonable prices are in demand. One example: In health care, GE is producing a computerized tomography (CT) scan machine that is functional without a lot of bells and whistles. It was designed originally for the Chinese market where patients without insurance pay for CT scans themselves. In the U.S., given the increased focus on containing health care costs, perhaps those machines could supplement more advanced equipment used for initial screenings or at community hospitals. There is great possibility for similar innovations wherever there is a need.

Book excerpt from Winning in Emerging Markets: A Road Map for Strategy and Execution

By Tarun Khanna and Krishna G. Palepu

Winning in Emerging Markets: A Road Map for Strategy and Execution

Emerging Market Action Items: The frameworks and examples in this book point to several key action items for companies operating in and out of emerging markets.

Experiment to Fit Business Models to Emerging Markets: Institutional voids can frustrate, stifle, and undermine the business models and operations of any company doing business in emerging markets. In light of these contextual challenges, some companies choose to exit or avoid emerging markets. Those companies that decide that the opportunities in emerging markets are too great to pass up or delay need to appreciate and respond to the challenges posed by institutional voids.

Emerging markets are so tough to crack that companies are highly unlikely to get their strategies right the first time out. Companies of all stripes need to experiment to fit their strategies to the unique contexts of emerging markets—and instill in their organizations an organizational openness to experiments. Zain's One Network and Microsoft's FonePlus are only two examples of successful emerging market experiments.

Position Your Business as a Partner in Progress: Foreign as well as domestic companies have found success in emerging markets by positioning themselves as partners in progress—building businesses that also advance market development. Initiatives along these lines can take a number of forms—from advancing traditional corporate social responsibility to filling institutional voids—in service of businesses or as stand-alone projects.

Microsoft's investments in the development of China's software industry facilitated the development of its own business in the country. The job creation and tax revenue produced by Zain's business in African countries facilitated its government relations and operations. Similarly, the employment Tata Consultancy Services brought to Uruguay enabled the company to receive fast-tracked visas for employees traveling from India. At home, Tata Group filled voids in social services for employees in Tata Steel's company town Jamshedpur. Metro Cash & Carry's primary business filled voids in the food supply chains in emerging markets, reducing waste and bringing more transactions into the tax net, although this argument could not overcome entrenched opposition in Bangalore. Nonetheless, working to be—and to be seen as—a partner in progress can help companies in emerging markets, particularly multinationals coming in from more developed markets.

Balance Ambition with Humility in Emerging Markets: Multinationals based in developed countries as well as emerging market -based companies face a tension between ambition and humility. Multinationals want to exploit the tremendous opportunities in emerging markets, but they need to carefully evaluate the extent to which they have the local knowledge and capacity to fully exploit those opportunities. Segmenting these markets and carefully aligning ambitions and capabilities can help multinationals avoid costly mistakes. Multinationals need the humility not only to gauge their own capabilities in relation to the institutional context of emerging markets but also in terms of their position in emerging markets. As one multinational executive explained, "Most emerging markets are highly sensitive. They're emerging because for years they've been colonized. That has left its own suspicions, distrust, et cetera of foreigners. It's certainly true in China. It's certainly true in India. It's probably true in many other places. So people want the benefits of globalization and development, but they want to know that they're not being exploited." 1

Emerging market -based companies also need to weigh their ambitions with their capabilities, particularly as they consider approaches to globalization. Teva Pharmaceutical's "billion-dollar theory" exemplifies emerging giant audacity. As one company executive explained, "Many companies pass the same way in Israel. The difference is really not personal. The difference is in the recognition that going the path that history wrote for us, we will remain a small Israeli company that will not have any influence on anything. If you want to do something, try to do something very different. What we did was something that, at that time, was very different." 2

India's Tata Group, among the most audacious emerging market -based globalizers, has faced organizational strains in its globalization, as one company executive described:

    [B]ecause we are starting fresh, we don't have the collective memory of mistakes. [B]ecause India is booming, because our balance sheet is strong, people don't see risk in the same way they would do if they were working in [a multinational company] where growth rates are high at 10 percent. That balance of risk versus ambition: How fast can we go? What's our capability? How far can you test people who've never done it? We've got lots of smart people whose experience is very limited in international business. So that's the balance between throwing people in versus holding people back because you don't have the bench strength to do it. 3

Just as any company operating in an emerging market needs to audit its institutional context in relation to its own capabilities, multinationals and emerging market -based companies need to audit their management capabilities and bandwidth as they weigh how far they can go in emerging markets and, in the case of emerging giants, how ambitious they can be in their globalization. As the example of TCL shows, audacious moves into new market contexts and attempts to integrate widely different corporate cultures through acquisitions can be particularly challenging.

Appreciate the Inherent Risks of Emerging Markets: To many observers, the emerging market story is largely one of growth and opportunity. This euphoria can quickly end when companies are burned by corruption, abrogation of contracts, wanton expropriation, or other risks in these markets. These risks are inherent in emerging markets, but in light of them, what should firms do? Companies can exit these markets, limit their ambition so as not to encounter them squarely, limit their exposure by operating through an agent or other party, or build in mechanisms, such as audits and internal vigilance, to deal with corruption.

Infosys and Tata Group set high standards for their organizations in light of corruption in India. As illustrated by the experience of Siemens—which agreed to pay $1.36 billion to U.S. and German authorities in 2008 to settle corruption charges—not maintaining such high standards can impact not only a multinational's business in an emerging market but also its wider business. 4 In mid-2009, it was reported that more than 120 companies were under investigation by the U.S. Department of Justice for potential violations of the Foreign Corrupt Practices Act. 5 Specialized antibribery compliance firms—credibility enhancers, in our taxonomy of market intermediaries—have sprouted up to help firms manage these issues. 6

The chief executive of one emerging giant active in many emerging markets described how his firm has managed the corruption issue:

"How do we survive? It's like many of the great companies who survive corruption in their own countries. For us, the challenge is how to conduct our business in the most ethical way and according to the highest standards, moral standards. That is something we will not give up. And that's a choice because we have the whole world to go after. We have more than 220 countries worldwide. Therefore we have a choice. If we go to a country where we are asked to do something which is corrupt, we will just withdraw. We just don't do business there. And that happened a number of times, so we accept only to work in areas where we will not be forced in any degree of corruption, whether directly or indirectly." 7

About the author

Martha Lagace is the senior editor of HBS Working Knowledge.

Footnotes

1. Ravi Venkatesan, "Ravi Venkatesan, Chairman, Microsoft India," video, product number 9-708-804 (Boston: Harvard Business School Publishing, 2007).
2. Eli Hurvitz, chairman, Teva Pharmaceutical Industries, "Teva Pharmaceutical Industries, Ltd.," video, product number 9-708-806 (Boston: Harvard Business School Publishing, 2007).
3. Alan Rosling, executive director, Tata Sons, interview with authors, April 2007.
4. Daniel Schäfer, "Siemens to Pay €1bn Fines in Effort to Close Bribery Scandal," Financial Times, December 16, 2008, 17.
5. Dionne Searcey, "U.S. Cracks Down on Corporate Bribes," Wall Street Journal, May 26, 2009, A1.
6. Ibid.
7. Saad Al-Barrak, "Zain (MTC) Pre-Class," video, product number 9-709-803 (Boston: Harvard Business Publishing, 2008).

Book details

Excerpt reprinted by permission of Harvard Business Press. From Winning in Emerging Markets: A Road Map for Strategy and Execution. Copyright 2010 Tarun Khanna and Krishna G. Palepu. All rights reserved.

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