Harvard Business Review Exclusive: The new frontiers

In 1893, American historian Frederick Jackson Turner declared that a frontier isn’t just a place; it’s also the process of adaptation and change that shifting borders force on people and institutions. The young Wisconsin professor was describing the role that the frontier had played for three centuries in creating the American nation, but the Turner thesis applies to modern business, too.

Over the past three decades, the borders of the corporate world have constantly shifted as developing countries opened their economies to foreign businesses. As a consequence, multinational companies have had to cope with runaway growth, intense competition, greater complexity— and constant change.

Even so, little they have learned has prepared Western companies for the impact of today’s great recession on globalisation. Not only is the worldwide slowdown hurting developed economies more than emerging economies, but it’s affecting the latter differently and substantively altering their role in the global economy. By the time the slowdown ends, the frontier will have shifted again in unexpected ways.

Today’s great crisis is forcing change at three levels. First, the developing countries are becoming relatively bigger markets. Defying the odds, they seem likely to expand by 1.6 per cent overall in 2009, with the International Monetary Fund (IMF) projecting in April 2009 that China’s economy would grow by 6.5 per cent, India’s by 4.5 per cent, and the West Asia’s’s by 2.5 per cent. The pace is much slower than the spanking 6.1 per cent at which the emerging markets grew collectively in 2008, but it’s remarkable considering the IMF’s forecast that the developed economies will shrink by 3.8 per cent this year.

Second, governments are reshaping the contours of economic development even as they stoke growth through monetary and fiscal policy measures. No government is doing that more than China’s, which is using the $586 billion stimulus package it announced in November 2008 to influence demand and supply in 10 industries that together account for 50 per cent of the country’s GDP. “The government calls it a stimulus, but it’s really redesigning industries,” says David Michael, the Greater China head of the consulting firm BCG. “The ‘new normal’ in many rapidly developing economies will be different after the recession.”

Third, competition in developing countries has become more intense. With exports shrinking, companies in those countries are concentrating more on growing their sales at home. The rivalry is particularly heated in markets for commodities, such as steel, cement, and aluminium, and for upmarket and middle-market consumer segments. With multinational companies trying to squeeze more revenues out of developing countries, too, only the fittest businesses seem likely to survive the slowdown.

Smart companies in emerging markets have started responding to the challenges these changes pose. In fact, a few of them saw the downturn coming and modified their strategies quickly. Companies in these countries already have an edge because they’re the world’s cheapest manufacturers and don’t need to develop low-cost business models. But before the downturn began, rising resource costs and appreciating currencies had eaten away at their profit margins. Many businesses are using the recession as a pretext to do some spring cleaning and reduce costs. They’re restructuring portfolios, halting iffy diversification plans, and consolidating operations.

Some businesses are using the cash they’ve freed up to develop value-for-money products and services, particularly for rural consumers and those in the lower middle class. Several Chinese manufacturers are using the slackening of demand as an opportunity to develop advanced products of their own, so that they won’t always have to serve as subcontractors. In India, Tata Motors’ March 2009 launch of the world’s most inexpensive car, the $2,000 Nano, has made low-cost innovation a priority for companies and entrepreneurs. There’s even a name for the trend: the Nano Effect. And in China, BYD Auto’s December 2008 launch of the world’s first massproduced plug-in electric car, the F3DM, which sells for $22,000, has created a similar BYD Effect.

Most Western companies are preoccupied with the crisis in their home markets, but they need to start focussing on the next phase of global growth. If they want to avoid being blindsided tomorrow, they must track five tectonic shifts that are emanating from the developing world.

SHIFT 1
A Growing Divide

Many executives are convinced that the manner in which the recession unfolded across the globe last year underscores the close connections between developed and developing economies. Since the 1990s, countries have become tightly interlinked, primarily by trade and financial flows.

A contraction of the developed economies will set off shock waves in emerging markets and send stock markets all over the world tumbling—as has happened in the past year. In this view, it’s unlikely that the emerging markets can continue their rise when the advanced economies are falling.

Yet, more and more evidence shows that today’s recession will make decoupling a reality.

Because demand and investments from OECD nations have fallen at an unprecedented rate, governments of several developing countries—including Brazil, China, India, and South Africa—are trying to reduce their economies’ dependence on international trade.

Their governments are investing in infrastructure and reducing taxes, particularly on products for low-income consumers. If they succeed in increasing consumption at home—a big if during a global crisis when consumer confidence is low—they will be able to sustain growth even when demand from the OECD nations falls.

Don’t forget, the developing nations have also discovered one another. Trade between emerging markets accounted for 40 per cent of their exports and imports in 2007—double the level two decades ago. In fact, half of China’s exports went to other developing countries. The longer the recession lingers in the developed world, curtailing demand for natural resources and manufacturing, the more the trade between the developing countries is likely to grow.

Emerging markets and the United States may part ways in another fundamental manner after this recession. Politicians and policy makers have traditionally believed that the United States boasts the best model of a market economy. But American-style capitalism is under fire because of the financial crisis, and the U.S. government bailout has changed the system so much that it’s scarcely recognisable.

As a result, policy makers in the developing world are likely to slow down the pace of deregulation and consider creating European-style welfare states. For a long time, “capitalism with local characteristics” has been the buzz phrase in China; it soon may become one in the rest of the developing world.

SHIFT 2
The Return of Family-style Leaders

Out of crisis springs opportunity; out of adversity, new leadership paradigms. In developing nations, the new paradigm will come from family businesses and state-owned enterprises.

Many emerging giants are run by families, especially in Brazil, India, Mexico, and Turkey; in China, the state is a surrogate for the family. Succession often becomes an issue in such businesses, so bringing in “professional” management has traditionally been a priority for stakeholders.

The established wisdom is that families should list their companies on stock exchanges, hand the reins to corporate executives, and have founders play only supervisory or ceremonial roles. Family conflicts have bedeviled business groups, particularly in India and Latin America, and family-managed companies have been terrible about governance, as the recent Satyam Computer accounting scandal in India shows, so bringing in the pros has appeared to be the best practice.

However, the crisis is stirring up fresh debate about leadership styles and bringing a new breed of quasi-family, quasi-professional leader into the limelight. In emerging markets, the notion that family members and the bureaucrats who run state-owned companies can provide good leadership, particularly in an uncertain environment, is earning greater acceptance.

In Asia and South America, the heads of family-owned businesses wield a great deal of power, which enables them to make decisions and modify strategies quickly—just as entrepreneurs can. Their influence allows them to deal deftly with policy makers, cut through red tape, and use social networks for their companies’ benefit. The leaders of government-run enterprises are equally powerful. For instance, Chinese oil companies have often won deals by promising to open the spigots of government aid to African nations.

Enterprises managed by families or governments also find it easy to adopt a long-term perspective. Driven by personal pride or national interest, they don’t dance to the tune of the stock market. They pursue long-term strategies even when economic growth collapses, especially because their controlling equity stakes insulate them from takeovers. CEOs like Kumar Birla of the Aditya Birla Group, Pat Davies of Sasol, and Naguib Sawiris of Orascom have stuck to their ambitions during this recession, reassuring stakeholders that they are in it for the long run.

SHIFT 3
A Reversal in M&A

Many emerging giants are in a rush to become global industry leaders, so the moment the liquidity crunch eases, they will hit the takeover trail in developed economies. With Wall Street almost halving companies’ values, those predators will be vying to acquire commodity producers, old brands in sunset industries, and state-of-the-art technologies in sunrise industries.

The next reverse M&A wave will differ from the previous one in three ways. One, Indian companies set the pace for cross-border deals in 2007, but companies from China, Brazil, and even Russia will take the lead in the future. Those companies are cash-rich and less leveraged than Indian companies, which borrowed heavily from banks before the recession to complete several major deals— such as Tata’s purchase of Jaguar Land Rover and Corus, and Hindalco’s purchase of Novelis.

Two, Chinese and Latin American companies will use M&A to internationalise rather than globalise. They will try to buy several businesses in the same country or in neighbouring countries instead of hankering after one company with worldwide operations. The number of cross-border Latin American deals done by Brazilian companies, for instance, jumped significantly in the past few years, going from just two in 2005 to 11 in 2006 to a record 25 in 2007, according to the Zephyr database. In 2008, Brazilian companies acquired 23 more enterprises to create pan-Latin American leaders, or multi-Latinas.

Three, companies will acquire more small and midsize businesses overseas instead of acquiring giants. Indian companies may not have much of a choice; they’re busy digesting the big companies they took over before the financial crisis erupted and so will focus on small and strategic acquisitions. The shift has also become perceptible in China since global acquisitions left both TCL and Lenovo with hangovers.

Emerging giants will also experiment with new ways to strike up partnerships overseas, particularly to secure raw materials in other developing countries. For instance, China’s banks have been buying stakes in or extending loans to foreign companies. China Development Bank recently lent $10 billion to Brazil’s Petrobras in exchange for a long-term supply of oil.

SHIFT 4
Higher Stakes in Sustainability

Money is often colourful in emerging markets, but it is turning green everywhere. Many enterprises recognise that if they don’t develop eco-friendly products, packaging, and manufacturing processes by the time the recession ends, they may be shut out of premium segments by multinational rivals.

The drive into non-urban markets in China and India is reinforcing the message with a twist: Sustainable solutions are essential to people who don’t have access to water, electricity, or clean air. For these rural customers, companies need to develop products that can work with small quantities of water or electricity or that use alternative sources of energy such as solar power. NGOs, labour organisations, and governments are also compelling companies to develop more sustainable products; their environmental standards have become business norms in export markets.

Many emerging giants think they can leapfrog rivals in developed countries, which are just starting to get serious about eco-friendly products. That creates a level playing field —for the first time. For instance, BYD was able to launch its plug-in hybrid two years before GM, which will launch the Volt in 2010, and a year ahead of Toyota, whose plug-in hybrid is due in late 2009.

Stung by Western criticism, governments of some developing countries are tackling environmental problems and pressuring local companies to go green. Take China, where automobiles are responsible for as much as one-fifth of carbon emissions. The Chinese government has recently imposed tougher emission guidelines and created a carbon-based taxation system. Its goal is to have 10,000 hybrid, electric, and fuel-cell vehicles in 10 cities by 2010.

The State Grid Corporation of China is setting up charging stations for the cars in Beijing, Shanghai, and Tianjin initially. With demand for hybrid, electric, and fuel-cell vehicles in China likely to reach 100,000 a year by 2012, the Chinese automobile company Chery has already followed in BYD’s footsteps and launched a plug-in hybrid car in February, and its rival Geely plans to unveil its plug-in hybrid later in 2009.

SHIFT 5
The Call of Africa

Africa is bound to beckon when emerging giants hunt for growth again. The developed nations will return to health slowly, and emerging markets are tough to crack, so the lure of the world’s second-largest continent will be inescapable. The IMF forecasts that Africa’s economy will grow by 2 per cent in 2009. Although that’s below its 2008 growth rate of 5.2 per cent, the decrease is due mostly to a fall in the prices of commodities that Africa exports.

Africa isn’t integrated with much of the developed world, but it does have trading relationships with developing countries in Asia, so it will probably recover in tandem with those markets. In later years it may start catching up with them: According to a Goldman Sachs report, South Africa’s per capita GDP will surpass the per capita GDPs of Brazil, Russia, India, and China by 2050, even though the South African economy will be smaller than any of the four BRIC economies.

Africa is a market of around 1 billion people, just shy of India’s 1.1 billion. Cynics will say it isn’t a country but a continent. They’re right, but then people say the same thing about China and about India, whose regions differ as much as African nations do. Those differences haven’t prevented companies there from learning to adapt to local conditions.

Many multinational companies, such as Coca-Cola, Unilever, and Novartis, already do business in Africa. Several Chinese and Indian companies have also found it easy to operate there; they’re accustomed to dealing with regional variations and can adapt the business models they use at home. India-Africa trade was an estimated $20 billion in 2006. China’s trade with Africa shot up from $10 billion in 2000 to $32 billion in 2006. While India had invested some $2 billion in Africa, China had committed more than $8 billion by 2008.

According to Vijay Mahajan, a University of Texas, Austin, marketing professor who wrote the book Africa Rising in 2008, the continent’s premium segment, which he calls Africa One, consists of about 50 million to 150 million people, and the bottom-of-the-pyramid segment, Africa Three, consists of about 500 million to 600 million. Both segments are tough to crack, he says. Companies should target Africa Two, the middle-class segment, which, at somewhere between 350 million and 500 million people, is bigger than India’s middle class.

In recent weeks, economists have been wondering what shape a recovery might take in developing countries. Will it be a V—a sharp rebound? Will it be a U—a gradual recovery? Or will it be a W, as economies rise and fall before rising again? Whichever it might prove to be, the recovery will spell “threat” with a capital T because many emerging giants will come out of the recession lean, mean—and green.

Anand P. Raman [araman(at)harvardbusiness(dot)org] is a Senior Editor at Harvard Business Review based in Boston, who tracks trends and companies in emerging markets. He was the Editor of Business Todaybetween 1992 and 2000. This is the abridged version of an article published in Harvard Business Review, July-August 2009. Copyright @ 2009 Harvard Business School Publishing Corporation. All rights reserved. To subscribe to Harvard Business Review, please email hbrcare@intoday.com