An interesting article on the extraordinarily rapid progress that firms from emerging companies have made in challenging traditional industry leaders from the West appeared recently in The Economist. The article cited the findings of the latest annual report published by the Boston Consulting Group (“BCG”) on the “rising stars of the developing world” that the number and size of cross-border acquisitions by firms in emerging economies had surged in 2010. The BCG report also included an analysis of 100 leading firms from emerging economies, over 70 of which came from one of the BRICs (13 companies from Brazil, six from Russia, 20 from India (six of which are part of the Tata empire) and 33 from China), and noted that the revenues for the group had grown at an average annual rate of 18% over the last decade (three times faster than non-financial firms in the Standard & Poors 500) while also achieving profit margins of 18% (6% high than non-financial firms in the Standard & Poors 500). BCG attributed the success of these firms to several factors including their ability “to resolve three trade-offs that are usually associated with corporate growth: of volume against margin; rapid expansion against low leverage (debt); and growth against dividends.” However, while recognizing the impressive performance described by the BCG report, the Economist sounded a cautionary note and detailed the following challenges that the firms it referred to as the “tiger cubs” will need to overcome in the years ahead to really catch up with their entrenched rivals from the US, Europe and other parts of the developed world:
- The recent growth in China and other emerging markets—as well as much of the continuing growth that is projected for the future—is tied to heavy investment on infrastructure that inures to the benefit of low-cost construction and heavy-equipment companies in those countries. Obviously, roads and bridges are being built at record pace in China, India and other emerging markets and Chinese firms are even winning large contracts in the US; however, if capital for these projects becomes scarce or too expensive the gold rush may come tumbling down.
- Firms based in emerging markets tend to rely on the conglomerate model as their preferred form of organizational structure and while this has been successful up until now many question whether the model is sustainable from an efficiency perspective. If Chinese and Indian firms wish to continue using this model they will likely need to borrow and implement new technology and management techniques that have been deployed by “old multinationals” in the West such as General Electric. A related challenge for these growing challengers will be coping with more and more operations taking place far away from their headquarters office.
- It remains to be seen whether firms from emerging markets, which have often relied on the acquisition of established brands from the developed world (e.g., Lenovo/IBM PCs), can build their own global brands that will be accepted and valued by consumers in the US and Europe. Simply put, firms based in Brazil, China or India probably have their work cut out for them in exporting products that are favorites in their local markets to Western countries and their success in doing so will determine just how well they will do in terms of revenue growth and associated profit margins.
- There are certain industries and market sectors where firms from emerging markets have been content to follow a rapid revenue growth strategy while sacrificing margins in order to achieve market share. For example, low-margin generic drugs are common offerings of pharmaceutical firms from the developing world and the same holds true with respect to consumer goods in many instances as firms from emerging markets lead with low-cost products. The result so far is that established global brands continue to dominate in niche markets with higher profit margins.
- As they push to build a larger presence in Western markets firms in emerging markets must also cover their “rear guard” and fend off the advances of global multinationals from the West into emerging markets. For example, the Economist noted that the Times of India had reported that IBM has become the second largest private-sector employer in India.