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It’s often being said that innovation is the mother of competitiveness. That’s true, but only to a limited extent. The fact is that innovation is only a means, and not an end. So what’s the end then? Adaptation. Only those companies, which adapt to a changing environment will withstand the test of time. From a Western perspective, the notion of innovation as the key source of competitive advantage held true for most of the 20th century, as companies in developed markets could rely on global business models and reap benefits from cost differentials and arbitrage opportunities across geographic regions. However, as globalization keeps its momentum, the traditional paradigm of inventing in developed markets and producing in developing markets is becoming increasingly obsolete.

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Re-Innovating Innovation: The Case for Emerging Markets

- Dr. Martin Lockstrom

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A World in FluxGlobalization is the key driver behind the need for a new innovation paradigm. The reasons are two-fold. First, globalization is a self-nurturing process, which requires companies to globalize, which in turn drives globalization further. Historically, companies started down this path by sourcing from low-cost countries, followed by localizing production, and so forth. This was a model of global production, in which products were mainly developed by Westerners, in Western countries, for Western consumers – if products were in demand in other markets, it was a bonus. In today’s marketplace, however, things look radically different.

Developing economies are generally growing very fast, often at twice the rate of developed economies. As a result, they are increasing their share of world economic output. For instance, over the last decade, China has overtaken both Germany and Japan, to become the second largest economy in the world, and is estimated to overtake the U.S in less than a couple of decades if current forecasts hold true. India is also catching up, albeit at a slower rate, and is today among the top ten global economies. It’s the same story for other emerging economies throughout South and South-East Asia, as well as Latin America and parts of Africa and the Middle East. Meanwhile, in the wake of the financial crisis, developed economies in Europe and North America are struggling to stay competitive and revive slumping consumer demand.

So in order to adapt to this brave new world, it is imperative that companies reap benefits not only on the supply side by securing critical factor inputs such as raw materials, but more importantly, adapt to the needs of local consumers in emerging markets, to offset the declining demand in mature ones. Put simply, in order to remain competitive in the future, companies are required to re-innovate innovation. On an ongoing basis.

Learning from the LocalsIt’s often been claimed by pundits that inventiveness and innovativeness is virtually non-existent in emerging markets, and particularly in China. However, this cannot be further from the truth. The problem here is that we’re talking semantics – what is perceived as innovativeness in emerging markets is not necessarily perceived so in developed ones, and vice versa. This is a dangerous fallacy, as it prevents companies from thinking about innovation in new and necessary ways that are required to succeed in novel markets. Whereas people in the West tend to think about innovation as a highly linear, structured, long-term process with the aim of creating radical or disruptive innovations, innovation in emerging markets is often the opposite – unstructured, chaotic and opportunistic.

Why is this the case? For starters, besides cultural aspects, the innovation approach in emerging markets is simply a result of environmental factors. First, the economies are growing fast, and rising middle-class consumers have not yet developed the same level of brand loyalty that we see in mature markets. Therefore, agility is essential in order to exploit opportunities, which could be perceived as short-term opportunistic behavior by those from the Western world.

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Second, the purchasing power is often orders of magnitude lower in emerging markets whereas the savings rate is higher. This limits the ability of local consumers to absorb the cost of breakthrough R&D. As a consequence, innovation in emerging markets is often more focused on reducing rather increasing product/service sophistication – a concept usually referred to as frugal innovation. Whereas Western companies often try to serve niche premium market segments with limited volumes and high profit margins, companies in emerging markets are doing the opposite. A good example here is Bharti Airtel, which redesigned its entire value chain in order to be able to serve the mass market with rock-bottom prices. Another excellent example is Aravind Eye Care Hospital, which so far has provided inexpensive or even free eye surgeries to more than 32 million patients during its 36 years of existence. Both cases are manifestations of jugaad (Hindi for “improvised arrangement” or “work-around”), where novel approaches have to be deployed in order to overcome institutional voids and a lack of resources.

Third, consumers in emerging markets often have special needs, and hence any product/service features that are added are usually idiosyncratic, often low-cost, and almost always highly impactful. An excellent instance of such innovation is the Chinese phenomenon of Shanzhai (Chinese for “mountain stronghold”), which is a term used to denote inexpensive, often inferior-quality imitations or knock-offs of Western products with a local twist – nevertheless the innovativeness and speed-to-market is truly impressive. Examples include mini iPhone knock-offs with two SIM card slots or cell phones resembling cigarette cases (sometimes even combining the two) among many others.

Impact on Western CompaniesThe traditional Western approach to innovation has been based on increasing product sophistication with functions and features; increasing product customization; and shortening product lifecycles, all with the objective of increasing margins, even at the cost of volumes. This has set off a vicious cycle of organizational complexity, rising overheads and in turn the need to recover that with a higher price premium.

This approach has worked very well in B2B businesses where quality and performance requirements are high, and reasonably well with luxury consumer goods and certain proximity-dependent services such as upscale hairdressing or fine dining. For most other industries however, premium prices are harder to command and makes them vulnerable to emerging market competitors. The reason for this, as explained earlier, is that emerging market players are often adept at reducing complexity, producing in large volumes, and keeping overhead costs low enough to survive on razor-thin margins. Once these competitors get access to crucial technology, they penetrate premium markets with lower prices to turn them into volume markets.

There are numerous examples of these - particularly from China - such as battery manufacturer BYD (also a carmaker), and microwave oven manufacturer Galanz who now command impressive market shares. These companies are among those who won big deals from foreign customers; received training and technology transfer through supplier development activities; and by staying cheap and flexible by using inexpensive labor instead of automation, ultimately turned into global juggernauts.

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New Strategic Imperative for InnovationSo, two things are clear: First, companies can no longer rely on pure global innovation, developed in one place and sold in another. Second, companies that rely heavily on generating revenues from premium markets are inherently at risk. The following sections elaborate three key drivers of innovation advantage.

Building Growth Momentum

As mentioned earlier, the organization governing innovation in emerging markets needs to be reshaped in order to be effective. This is due to the fact that the environment in emerging markets, with its institutional voids, is often radically different compared to the West. Overcoming these is pivotal for getting a market foothold and generating growth; this is also where local players have competitive advantage. Hence merely replicating existing innovation processes in emerging markets is doomed to failure.

Institutional voids exist in many shapes. An overview is given below:

• Political/Legal: Different/weak legal systems, frequently changing regulations, frequent changes in the political landscape, opaque political processes, trade barriers, lack of Government support,

• Social/Cultural: Different customs and religions, heterogeneity/homogeneity of ethnic/religious groups

• Technological/Infrastructural: Poor availability/access to technologies, weak IP protection, lack of physical infrastructure (e.g. railroads, highways, sea ports, airports etc.)

• Economic: Size and growth of economy, economic inequality among different regions and social strata

Reaping Benefits from Innovation Hubs

It is clear that these voids cannot be overcome from a remote overseas location; in virtually all cases, this means having local teams with sufficient on-the-ground resources who can make necessary changes to products, services and processes, but more importantly, build solid relationships with local institutions in order to get access to timely information and fair treatment. Companies like GE for instance, have set up global R&D centers in key locations across the globe (e.g. Bangalore and Shanghai) in order to tap into the local talent base.

By doing so, companies are able to pursue what is commonly referred to as reverse innovation, wherein products are developed and tested in emerging markets, before being launched elsewhere in the world. Because they have to counter institutional voids, they are forced to rethink everything from products to processes to even business models, which actually opens up new market opportunities.

This is opposite to the traditional innovation paradigm in which products are developed in mature markets and launched elsewhere in downgraded versions.

Another important aspect of reverse innovation is the identification of new consumer needs, or more properly, consumer needs that were previously unknown. Companies have taken different measures to accomplish this. For instance, Unilever has set up a Concept Center in downtown Shanghai where consumers can try out new products. P&G lets new hires spend time with peasants in the Chinese countryside to study their behaviors.

This type of ethnographic market research can reveal interesting insights; for instance, repairmen of the Chinese home appliances manufacturer Haier discovered that rural people used washing

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machines for cleaning vegetables. This information was fed back to the R&D department, which subsequently designed larger outlets to avoid clogging. Another example is Mexican cement maker Cemex, which discovered that local consumers preferred buying cement in bags rather than pre-mixed cement from trucks, and consequently packaged and sold their retail products like powdered soap.

Smart Sourcing of Key Resources

Proactive companies today are not relying solely on their in-house R&D departments for innovative ideas. More and more are opening up their boundaries through open innovation networks (OINs) over which ideas can flow both in and out. One of the pioneers in this area

is P&G, which launched its Connect and Develop concept in 2000, which let external innovators sign up and submit ideas that were screened and further refined in a co-creation effort.

This not only called for technology, but also required significant changes to processes, and more importantly to corporate culture, by changing the existing paradigm from “not invented here” to “proudly invented elsewhere”. By doing so, the company could tap into a potential pool of 1.5mn external researchers. The results were remarkable: After five years, the share of innovations with external origins increased from 15 to 35 percent, while reducing the share of R&D expenses from 4.8 to 3.5 percent of total cost.

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ConclusionMany multinational companies have for long relied on a Western-centric innovation model where products have been designed in the West, for the Western market, and at a very late stage launched in emerging markets in a downscaled version. As a result of the shift in center of gravity in global markets towards emerging markets, companies have to pursue innovation the other way around by innovating in emerging markets and subsequently adapting products and services for developed markets. This may sound easy in theory, but changing the mindset of senior managers and the overall corporate culture is indeed a daunting challenge. A clearly articulated innovation vision and a rigorous corporate innovation strategy is definitely a good start.

What is more, Western companies have traditionally had profitability, not profit, as the key financial metric. This in turn has incentivized companies to primarily target high-margin market segments around which they have erected entry barriers to competition by increasing product/service sophistication. However, as technology diffusion has increased tremendously through a combination of outsourcing and the advent of the IT over the last decades, many proprietary technologies have been easily absorbed by aspiring competitors, with rapid commoditization as a result.

To sum up: Market players that have learnt to compete on volume despite low margins in a tough environment have also developed a lethal capability to explode premium market barriers in mature markets. Western incumbents will only be able to win this race as long as they can compete and excel not only at home, but more importantly, in the rough-and-tumble of emerging markets.

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About the Author

Dr. Martin Lockstrom Principal Consultant, Building Tomorrow’s Enterprise, Infosys Labs

Martin is a specialist in Supply Chain and Operations Strategy, Outsourcing/Offshoring and International Management. During a six-year stint in China, he established the research and education activities at the SCM, Sustainability and Automotive academic centers at China Europe International Business School, Shanghai.

He established the first endowed chair for Purchasing and SCM in China at Tongji University, Shanghai, and was also responsible for setting up Supply Chain Management Institute China, an international network of SCM research and education hubs.

Martin co-founded Procuris Solutions, an IT company specializing in SCM-related solutions, offering consulting services to companies like Accenture, Ariba, BMW, Clariant, Dell, Dow, Ernst & Young and Intel, among others.

He has a Ph.D. in Supply Chain Management from European Business School, Germany, a bachelor’s and master’s degree in Industrial Engineering and Management, from Chalmers University of Technology, Sweden. He speaks Swedish, English, German and Chinese, has published over 50 articles and papers and presented at more than 60 conferences.

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