For years, the BRICS (Brazil, Russia, India, China, and South Africa) were synonymous with broad-based, rapid growth. Not anymore. Data for 2015 from Oxford Economics shows China’s GDP growth slowing to 6.5%, South Africa eking out a percentage point or two, Brazil flat, and Russia actually contracting. Growth in other emerging markets, especially those with commodity-dependent economies, has slowed as well.
The economics of emerging markets are also becoming more challenging. China is losing its cost competitiveness in exports thanks to rising labor costs, as well as higher energy costs than those in countries such as the U.S. and Mexico. China has plenty of company: the cost advantages of Brazil, Russia, Poland, and other countries are also diminishing.
Despite the slowdown, this is certainly not the time for MNCs to retreat; if anything, it may be a good opportunity for reengagement, as we have observed before. (See “Time to Reengage with, Not Retreat from, Emerging Markets,” BCG Perspectives, May 2014.) Some 300 million additional households will enter the consuming class in emerging markets during this decade. The populations of less developed countries are still growing four times faster than those of their developed counterparts: by 2020, 6.4 billion people (out of 7.5 billion worldwide) will be living in emerging markets. These economies will add more than 600 million urban dwellers between now and 2020. An increasing number of free-trade agreements will help contribute to sustainable economic growth. Still, these markets present big challenges for MNCs—the biggest having to do with competition, costs, and shifting relationships with key stakeholders such as employees and governments.
Competition. Most MNCs now face a fast-rising number of agile and aggressive local competitors that are winning share in many industries. The number of companies in Asia with more than $1 billion in annual revenues jumped sixfold to 1,015 between 2003 and 2013 and doubled in Latin America, Africa, and the Middle East to a total of almost 700. And these are not only companies making simple low-cost products or commodity components; many are in sophisticated segments of the engineering and manufacturing sectors. For example, emerging-market-based companies now control between 30% and 80% of the global markets for rolling stock, onshore wind-power equipment, coal power-generation equipment, wireless telecommunications equipment, and photovoltaic equipment. Their competitive prowess is typically rooted in three factors: a significant cost advantage owing to small overheads, lower wages, and lower R&D costs; a deep understanding of local markets and strong relationships with local stakeholders, including both customers and suppliers; and a nimble and aggressive corporate culture, which enables quick decision-making and significant risk-taking.
As the search for growth pushes many MNCs into middle markets in emerging economies—where they seek new middle-class consumers in B2C businesses and small-business customers in B2B—these companies run head-on into local competitors. Middle markets are tough, and in our experience most MNCs have struggled to make money in them. Prices are often only 50% to 70% of those in “high end” markets, where MNCs have traditionally focused. In mobile handsets in Asia, for example, local (mostly Chinese) competitors have erased profits in the lower price segments. In banking, new local operating models based on digital or mobile technologies are constantly pushing down price points. And in many infrastructure projects in emerging markets, competition from local companies has made it much harder for global players to bid successfully.
Costs. MNCs also face profitability pressures owing to flattening revenues and rising factor costs. Data from the European Union Chamber of Commerce in China shows 40% of European MNCs reporting flat or declining revenues in China in 2013, 2014, and 2015. EBIT margins have contracted over the same period, compared with the companies’ worldwide averages. Only 28% of European MNCs are optimistic about their profitability prospects in the next two years, compared with 36% in 2012. Almost one-quarter of companies are actually pessimistic about profitability.
On the manufacturing side, many emerging markets, such as China and Brazil, are no longer the labor bargains they once were, thanks primarily to rising wages. Productivity-adjusted manufacturing wages in China almost tripled from $4.35 to $12.87 per hour between 2004 and 2014; they are now higher than those of Asian neighbors such as Vietnam and India—and roughly on a par with those in Mexico. Manufacturing costs in Brazil jumped 25% over the same period. Workers with the engineering and technical skills that many MNCs need are still few in number, making finding, hiring, training, and retaining them expensive. In addition, their productivity significantly trails the productivity of skilled workers in developed markets.
Relationships with Stakeholders. Adding to these challenges, MNCs are losing their allure for local employees precisely at a time when they need skilled managers and staff on whom they can place added responsibility. And once-welcoming governments are becoming less accommodating as economies mature. Governments feel more confident in their ability to regulate and influence markets, and local companies have become more numerous, more competitive, and more deliberate in lobbying for their benefits. Governments in many emerging markets are less hesitant to flex their muscles, and their actions or interventions usually favor local players. Unpredictability in the regulatory arena, including tariffs, import duties, licenses, and local content requirements, for example, are another source of frequent frustration for MNCs. Governments’ actions are often beyond MNCs’ control, of course, but they underscore the need to improve performance.