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