Friday 19 April 2013

The Frugal Business

How developing countries will "develop" mature economies


For decades, innovation seemed to be the core competence of the so-called developed world, the industrialized countries that are on the brink of turning into knowledge societies. But this business model, and subsequently, the economic and social "software" of the rich part of the world is under pressure from the phenomenon of frugal business.

When the Indian appliance manufacture Godrej & Boyce decided to improve its penetration of the local refrigeration market, it discovered, to its surprise, that the vast majority of Indian households did not want a refrigerator to store a large supply of perishable goods, but rather only to cool drinks and store a few fresh items. The manufacturers had to give this some thought. The result was the ChotuKool, a small top-loading unit without a freezing compartment that does not require a coolant or compressor, runs on a thermoelectric chip and a 12-volt power supply, and costs only $69. The ChotuKool is lightweight, energy-efficient and highly portable. It is easy to imagine a similar product doing well in Western niche markets.

This example sheds light on a development that is about to transform the Western economies and the way business has been run for decades: A shift from sophistication to just-enough-to-fit-the-needs, from over-engineering to practicality, from brand premium to efficiency. I call this the trend toward frugal business.

While Western companies expect 70% of their future growth to come from emerging markets, they imagined that this would be in the form of selling sophisticated products and services that would appeal to the more affluent consumers in those markets and that are adored by the rest of the world.

It thus came as a shock to Europe when they found out that, China – often seen as the workbench rather than the R&D laboratory of the world – is by now a net exporter of innovation to the continent, with a positive balance of over 500 million euros in 2012 alone.

The reason for this success is not limited to China. Emerging markets and their consumers have distinct characteristics, in terms of spending power, buying habits, and market conditions that lack the kind of Western-style infrastructure.

A new paradigm has thus been created: there is a need that is satisfied by products and services that serve a narrow and clearly defined purpose and that are easy to use and efficient. These frugal offers have become attractive to the rising middle class around the world, and now including those in developed countries, too.

Frugal business encourages companies to redesign their business models as a requirement of success. The strategies of simply exporting products originally designed with Western consumers in mind, in the practice known as "glocalizing" or taking a global product with slightly different or slimmed-down features to local markets, were commonly taken by many companies – with the notion that, doesn't everyone like to use French perfume, wear American clothes, or drive a German car?

Creating mega-markets out of micro-consumers

And yet, even the people at the bottom of the income pyramid, once considered as "too poor to serve", are turning into a vast and powerful consumer force. While they may have only a few dollars to use on products and services, their collective spending has amounted to $5 trillion. The "aspiring poor" many of whom are joining the market economy for the first time, are making the crucial difference to businesses.

Companies that fail to adapt their Western-oriented business models to the low-income environment in which they now have to operate find themselves stuck in a narrow and low-growth niche, with their products appealing only to the few urban rich. Meanwhile, emerging-market companies have gotten adept at devising ways to turn large volumes of small transactions into profits, essentially creating mega-markets out of these micro-consumers.

Low-cost engineering may have gotten a bad rep in the West, due to the association with cheap copies of inferior quality, or cars that fall apart and do not meet standards of comfort and safety. Yet it would be a fundamental mistake to underestimate how innovative and revolutionary many low-cost products actually are. The Indian automaker Tata now old 34 patents on technology it has developed specifically for the Nano, which costs $2,500. Drug companies in India have slashed the cost of medicines, not by taking shortcuts, but through relentless process innovation and global sourcing. Shantha Biotechnics brought down the cost of the Hepatitis B vaccine from over $20 per dose in the 1980s to less than $1 today. It has since been acquired by Sanofi-Aventis. Other Indian companies have also reinvented the production of diabetes medication.

Frugal innovation requires complete product and process redesign from the ground up. It is intensely market-driven, letting end-users decide which features are necessary and how much they are willing to spend on it. The result is not a product with 80% of the features of a Western model at 70% of the price, but rather more likely to be a 50% solution at 15% of the cost. With the rapid pace of technological advancements, this 50% performance can quickly develop into 80% to 90%, at which point, it could compete in more affluent markets.

The list of radically reengineered products that are flowing from the emerging markets to the West grows longer. This is in the opposite direction of what conventional business would suggest. Low-cost netbook computers were first developed by Asus in Taiwan and by other Asian companies as the answer to a need for entry-level computers for emerging market consumers, who could not afford regular laptops or personal computers. Previous attempts by rich-world companies to popularize mini-computers failed by remaining too expensive and out of the reach of many consumers.

India's Mahindra & Mahindra, the world's largest maker of farm equipment, now sells an ultra low-cost tractor developed for Indian farmers to gardeners and hobby-farmers in the Unites States, cutting into the home market share of John Deere.

India’s Mahindra & Mahindra, the world’s largest maker of farm equipment, now sells an ultra-low-cost tractor developed for Indian farmers to gardeners and hobby farmers in the United States, cutting into John Deere’s home market share. Meanwhile, some of the low-cost pharmaceutical products developed by Shantha Biotechnics have been certified for distribution by foreign health agencies, such as the FDA in the US.

Emerging market innovation can no longer be ignored by managers and policy-makers. The key is to tap into the tremendous amount of innovation that is now flowing from emerging markets into the developed world. In the age of frugal business, agility and nimbleness could spell success or failure.

Roland Berger Strategy Consultants has closely studied economic trends and opportunities in emerging markets. To learn more, get the latest issue of think:act CONTENT on "Hot Markets", which focuses on how emerging markets are the new laboratories of innovation.

Yours,
Torsten Oltmanns

Follow Torsten Oltmanns on Twitter: @torstenoltmanns

Image credit: Raghu Rai

Tuesday 9 April 2013

Come on Europe - get over it and focus on the future


 


It was one of those nights in Davos. Everyone was rushing to one party and deciding to miss out on two others. Amid the electrifying frenzy, in a small wine cellar of the main hotel gathered some of the leaders of Germany's biggest and most prominent industries. As the cellar grew packed and warm, two seasoned transatlantic leaders and a German minister gave informal speeches on US-European relations. The US is an important ally in a world of declining growth and rising conflicts, they said. It was a relevant message—if only there were Americans in the room to hear it. The absence of our friends from across the pond was clearly felt in this gathering of some of the world's high and mighty, and in some ways is reflective of the situation in which Europe finds itself.


In 2012, as Europeans wrestled with their crises, heads of state, finance ministers and CEOs from China, India and the US came together to press for a solution. In 2013, in the World Economic Forum in Davos and in other examples, as the Europeans continued to direct the discussion towards challenges closer to home, they seemed to stay away.


Consumed by Faustian pondering
Wherever you meet European politicians, policy-makers, academics, journalists and other thought-leaders these days, there is much talk about changing the fundamentals of the European Union—whether it's the banking sector, the social services, the education system, the energy supply, the share of industry of our economies. The conversation always goes back to "structural reform".


While there is a definite need to solve some real and major problems, there is a perspective that needs to be taken: This crisis is already on its fifth year. It might well take another five years for needed reforms to show their effects. Structural changes often require a full decade or longer to unveil their potential. This is admittedly too long a wait for those in southern Europe who are now suffering from unemployment and bleak prospects. And it is similarly too long for those in northern Europe who see themselves as the ones who will foot the bill in the end.


Welcome to the VUCA world
Those who expected the world after the crisis to be the same world they knew before it must be sorely let down by reality. We are on a journey towards the "new normal", which we are only beginning to understand. Some patterns have begun to show:

  • Renationalization. At the industry level, in the banking sector, there is no longer any real "European" bank. At the state level, German chancellor Angela Merkel officially declared that the era of multilateral agreements has ended and now is the time for bilateral solutions, such as in trade.
  • US rebound. Low energy prices, a well-educated and young workforce and wages that are surprisingly only 10% higher than in China are making re-sourcing industrial production to the US a truly sensible idea. Over 100 international companies now plan to re-source to the US, while many European firms are starting to consider the same.
  • China upswing. The ruling party is renewing its pact of growth versus allegiance. Rural areas have been given fresh development plans, including relying on cooperative regional banks to spur business (not unlike the German Sparkasse example). The economy is clearly on its way towards higher values and higher prices. It may come as a surprise to Europe to learn that China is a major exporter of innovation to Europe, with a positive balance of 600 million euros in 2012.
  • The unknown growth driver. What will drive growth next is harder to identify. The unification dividend after the fall of the Iron Curtain, the rise of the information technology industry and the financial services boom all provided us in the past a signal where to allocate investments. Today the signals are less clear and less certain. Europe might be in for a slow decade, but neither businesses nor society are equipped to deal with the challenges.  

In the early part of this millennium, military forces were faced with a new reality of conflicts, characterized by volatility, uncertainty, complexity and ambiguity. It is evident that the concept of VUCA has its applications and relevance in the business world as well.

Europe needs to urgently adapt to the new challenges. While it is important to kick-start structural reforms and clean up the mess of the past, that is the job of experts and administrators. But developing and focusing on the right strategies to succeed in a VUCA world—that is the job of leaders.

On the issue also view Roland Berger's Bernd Brunke giving an interview to BBC http://www.bbc.co.uk/news/business-22194191

Follow Torsten Oltmanns on Twitter: @torstenoltmanns

Image credit: Nicu Buculei on Flickr