Unlocking Growth in the Middle

Unlocking Growth in the Middle

          
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Unlocking Growth in the Middle

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  • Four Steps to Business Model Innovation

    Multinationals that have cracked middle markets think systematically about the opportunities and threats. We have distilled their varied experiences into four steps that can guide executives as they launch their own endeavors.

    Uncover opportunities through customer discovery. Business model innovation starts by developing a capability in each local market to understand customer needs, buying habits, and price points, and to determine the potential size of the opportunity. Two avenues of discovery can be fruitful here: an analysis of megatrends that will encourage new types of demand and a narrow, deep examination of the hypothesized unmet needs of the middle-market customer. In parallel, the corporate center should identify “overlaps”—situations where middle-market opportunities might span multiple products or markets across the organization.

    About five years ago, for example, senior management at conglomerate Philips recognized that the rise of the middle class in emerging markets could greatly benefit several of its businesses. Increasingly affordable health care would spur demand for medical equipment; construction of new and better housing would raise demand for lighting; and greater wealth would spur demand for home health products and domestic appliances. That led Philips to develop a dedicated strategy and business model for the emerging markets, starting with China, India, and Brazil. Philips realized that to capture new opportunities in the middle, it needed to expand its portfolio with a new set of products relevant to local middle-class households. The company also gave greater power to the organizations in Brazil, India, and China through shared accountability.

    The second type of customer discovery, narrow and deep analysis, was undertaken by Indian conglomerate Godrej, which designed and marketed a new kind of refrigerator to middle-income consumers in India. Godrej had looked in detail at how Indians were trying to cool food items in the absence of a dedicated device. Godrej worked with many village women to modify its ChotuKool prototype, then built the lightweight refrigerator using solid-state technology instead of a compressor and priced it between $65 and $75. The challenge for Godrej was not to improve an existing product but rather to design a new one tailored to a specific customer segment. Godrej also rejected the traditional channel of sales force plus distributors and dealers, and instead enlisted nongovernmental organizations and microfinance institutions to distribute the refrigerators throughout India. As an Indian conglomerate, the company might have had an inherent advantage, but multinationals can build a similar store of local-market knowledge by conducting rigorous customer-discovery efforts.

    Scoping out new customer segments within the middle should be done as precisely and quantitatively as possible—not just to determine the potential rewards of a new business model but also to make it clear to others in the organization that it’s worth pursuing. This will require understanding the priorities of the target segment in sufficient detail to tailor a winning offering. Learning as much as possible about potential middle-market customers is essential to unlocking potential demand.

    Convert opportunities into viable business models. Once the customers’ needs have been identified and the opportunity seized, a company can shape the new value proposition and align its operating model to win in the middle. Having identified the unmet needs and the priorities driving those needs, a company must create a business model suitable to meet them.

    Business model innovation touches all aspects of the business model framework we identified earlier. Changes to the value proposition, value chain, organization, or cost structure may be necessary to reach the middle in emerging markets, which almost surely will result in a departure from some aspects of the company’s traditional business model.

    Few developed-market customers of KFC, for example, would recognize KFC China’s restaurants. KFC China had to abandon the dominant logic that made Kentucky Fried Chicken a global brand: a limited menu, low prices, and an emphasis on takeout. Under new management in the early 1990s, the company stretched the brand so that KFC would better appeal to what middle-market Chinese consumers wanted: a wider variety of foods and traditional dishes than the standard fast-food outlet would offer. Managers enlarged the restaurants to about twice the size of those in the U.S. They needed bigger kitchens to prepare Chinese food and more floor space so customers could linger. KFC China thus positioned itself as a special-occasion restaurant within reach of the middle class.

    Configuring this new value proposition required operational changes. KFC had to reinvent its value chain and the manner in which it procured key resources for its restaurants. Because the network of distributors that KFC relies on in many countries does not exist in China, it built its own distribution arm—including warehouses, its own fleet of trucks, and a unit that monitors safety along the supply chain all the way back to animal feed companies.

    Like KFC, other multinationals are bound to face underdeveloped physical infrastructure and other distribution challenges in emerging markets. They will need to devise innovative solutions to acquire raw materials or to reach customers, sometimes involving the reinvention of their entire value chain.

    Companies may also have to adjust their cost structure in order to reach emerging-middle consumers through lower price points. Otherwise, they may find themselves funding growth with no clear path to profitability. Unilever, for its operations in India, for example, has lowered service levels in midsize and smaller Indian cities in order to manage its distribution costs. Instead of serving retail stores in these cities through just-in-time fulfilment by truck, employees stop in once every two days by bicycle or scooter. And rather than splitting sales, order collection, and delivery among specialist employees, Unilever combines the functions in a single employee.

    Opportunities to lower costs can come from unexpected places. Reebok has leveraged lower real-estate costs and lower-priced shoes and apparel to increase brand awareness and compete with multibrand retailers in India. The company realized that with lower rental costs in smaller but rapidly growing cities, it could open own-brand stores that offer outdated or off-season products at a discount. Reebok thus has been able to create demand for its new merchandise in large cities like Delhi and also penetrate new markets in smaller cities such as Karnal.

    Test, scale up, and iterate. Before committing valuable resources to new business projects in emerging markets, the corporate center should ensure that they are viable projects. At the same time, companies don’t want managers to be so risk averse that they avoid proposing new business models.

    The corporate center can play a useful role here by leading and moderating the discussion on how to manage experimentation with different models, how to mitigate the risks, and how to connect the dots among locally adapted business models. That means determining which platforms (in areas such as brand, manufacturing, and procurement) should be common across the enterprise and which will need to be modified for new markets. The center will need the right information, the ability to derive insights from that information, and the key execution capabilities—all of which can combine to produce smart tradeoff decisions.

    Business models can be tested cheaply to prove the main hypothesis and avoid ill-advised investments. For example, in developing its microentrepreneurship-distribution mechanism called Shakti, Unilever began with just a few microentrepreneurs. Only after it found that the concept was profitable did it continue with the new model.

    Once pilots have paid off, a company will have to scale up quickly and efficiently. Resources for such efforts are typically controlled at the center, so finding the right balance between local autonomy and central efficiency will require leaders at all levels to be more adaptive and collaborative.

    For KFC, rapid expansion has been a central feature of its China strategy as it embraces smaller cities. What helped KFC scale up quickly, to 700 cities so far, was another change to its traditional business model: switching from franchising to primarily company-owned outlets. Owning the restaurants makes it easier for KFC to expand geographically, closely control operations, and centralize purchases.

    One way to scale up quickly is to acquire a local producer. Philips used this method in the highly competitive market for health care supplies in emerging markets. Purchasing eight health-care companies in China, India, and Brazil offered a quick route to local expertise, cheaper manufacturing facilities, and closer relationships with hospitals and clinics outside the main cities. The aim was to produce customized, affordable products, such as a basic catheterization lab, yet with differentiating features that cost one-third of what the premium product would cost in Europe or the U.S. Philips opted for a “build, buy, and partner” approach to arrive at a successful model for the emerging markets; pursuing a new business model through acquisition, reinforced by organic investments and strategic alliances, was the fastest and most feasible way to reach scale.

    The alternative to going it alone or making a potentially risky acquisition is to gain scale through a joint venture with a local partner. That’s what Tesco, the U.K.-based grocery chain, did to increase its presence in Malaysia. Tesco joined with RHB Banking Group to offer simple banking products at 22 of its grocery stores. In 2010, just a year after the two companies launched cobranded credit and debit cards, they introduced a concept that was quite innovative for Malaysian retail banking. Branded “Easy by RHB @ Tesco,” the in-store branches offer hassle-free loans, instant cash, and other simple, standardized banking products. Instead of tellers and paperwork, Easy features just a few salespeople and self-service terminals for straight-through processing. For RHB, Easy has led to superior loan growth. For Tesco, it has provided a way to reach and retain more emerging-middle-class customers. And customers are motivated to use Easy because of the additional vouchers they can get for their Tesco grocery purchases.

    Manage emerging markets like a business model portfolio. Once they reach middle-class customers in several emerging markets, companies will soon find it necessary to manage multiple business models and multiple brands. Just as executives aggregate individual products into a portfolio that can be managed, they should do this for their business models. Taking a portfolio approach allows them to assess and gain a view of the payback, risk level, and launch timing for the entire enterprise, and to share lessons with other local units more readily.

    As part of any restructuring, it’s often advantageous to simplify decision making so that managers at the local level can take advantage of fast-moving opportunities. Serial business-model innovator General Electric, for example, has found that having local units report to someone high up in the organization keeps emerging markets on the senior-management agenda, enables reverse product or business-model innovation that flows back to developed markets, and ensures that local units get the support they need from the corporate center.

    More broadly, multinationals can use common platforms to support business model innovation in multiple markets, so that local units don’t have to start from scratch each time. Think “voice of the customer 101” or “distribution in a kit.” Some of these platforms can be housed in regional centers or shared-services centers. Regional offices cluster markets that have common consumer characteristics, competitor sets, geographic proximity, or channel development. They generate savings through best practices and automation. Shared-services models have traditionally been used for noncore activities such as call centers, computer support, or cash management, but they could also be applied to other activities that directly touch middle-market customers.

    Once a company has a portfolio of emerging-market businesses, power in the organization may have to shift to where the growth is in order to protect middle-market initiatives from short-term thinking or a lack of investment. Companies may also have to adjust their organizational structures to take advantage of the growth opportunities.

    Honeywell, a leading supplier of turbochargers for cars, recently changed its organizational structure to attack the growing car markets in China and India. Honeywell created a new position, reporting directly to the head of the automotive business, to oversee automotive operations in the two countries. That executive is now based in Shanghai, a move that reflects the importance of China in the company’s plans, the need to ensure that growth efforts receive significant attention, and the importance of developing tailored business models and products to serve Chinese consumers, including those in the middle.

    Management of the portfolio should include hard targets and metrics with which to evaluate each of the business models, as well as the whole. Just as a business model in mature markets may not transfer to the developing world, so too may performance metrics need to be altered to reflect new realities. Forward-looking metrics such as market share may be more relevant than financial metrics when entering or expanding in a developing nation.

    In 2009 at the conglomerate Siemens, CEO Peter Löscher made the conquest of middle markets the main priority for every business unit. Each unit was required to define a strategy for becoming number one in its midmarket, with 50 in-company consultants offered “free” to advance this effort. Siemens established rigorous tracking based on quarterly reviews, with targets set and road maps defined for adding value in each country. Siemens tracks its business units’ market share in middle markets, plus more detailed metrics such as the number of product managers and R&D employees in each country, the share of products sourced there, and the level of employee retention.

    Organizational challenges in a portfolio of emerging-market businesses will be different from those in mature markets. Efforts to penetrate middle-tier markets through innovative business models often resembles a startup operation, putting a premium on employees with an entrepreneurial mindset. Local teams should think like business builders, considering the entire equation of business economics—thinking that goes beyond a narrow sales focus on exceeding the next quarter’s quota. At the corporate center, meanwhile, leaders must be willing to consider alternatives to traditional business models, to free up resources accordingly, and to keep up a regular dialogue with multiple local teams.

    India’s New Retailers,” Outlook India, July 11, 2009.
    David E. Bell and Mary Shelman, “Yum! China,” Harvard Business School Case Study, December 16, 2010.
    “Yum! China.”