Frugal Innovation: Is the future of innovation in emerging markets? In recent years, the product development occurring in emerging markets such as India and China has been truly impressive. Goods, once thought great luxuries, ranging from cars to cell phones have proliferated among hundreds of millions of new consumers. Emerging markets are defined as new market structures arising from digitalization, deregulation, globalization, and open-standards that are shifting the balance of economic power from the sellers to the buyers. (Business Dictionary, 2012:1).
Bangladesh, Taiwan, South Korea and Singapore are also considered to be emerging markets; however, the seven largest emerging economies by nominal GDP are China, Brazil, Russia, India, Mexico, Indonesia, and Turkey. The ASEANChina Free Trade Area, launched on January 1, 2010, is the largest regional emerging market in the world. Innovative product development in these regions has been given many names; this essay will refer to it as frugal innovation. Frugal innovation is the process of reducing the complexity and cost of a good and its production. Usually this refers to removing nonessential features in order to sell at thin margins to large numbers of consumers. Designing such products may call for an increase in durability, and selling them may call for reliance on unconventional distribution channels.
The process allows companies to reach the vast consumer group at the base of the pyramid (the BOP), who can only afford to buy the most inexpensive products that are both functional and durable. These people are the 4 billion who earn annual per capita incomes below $1500, the minimum considered necessary to maintain a decent life. (Unite for Sight, 2011: 1) This essay will outline the strategies used by frugal innovators and the success stories that have surfaced from within emerging markets. It will then demonstrate the opportunities that frugal innovation presents to multi-national enterprises (MNEs) as well and how ignoring these operators in emerging markets might threaten their current market position.
This essay will touch on the challenges that MNEs will face when trying to compete with emerging market companies, while also exploring contrary evidence that it is unlikely these emerging market companies will ever pose a threat large enough for MNEs to make drastic plans. Product development in India, China, and other emerging markets has many challenges but also certain advantages and opportunities for growth. Many of these opportunities were unavailable to Western companies at their inception.
Companies in emerging economies are able to leapfrog by deploying state-of-the-art technology from the outset, rather than progressing through the generations of technology that have characterized industry evolution elsewhere (Arnold and Quelch, 1998: 16). Not only is leapfrogging possible technologically, but it is also possible culturally. Arnold and Quelch also state that customers in emerging markets with newly acquired disposable income may be less conservative than early consumers in developed markets, due to the rapid growth rate of emerging economies and easily acquired aspirations for higher standards of living.
There is also strong evidence that emerging markets have been attracting a large percentage of the worlds investments in research and development. Of the more than 1000 FDI projects in R & D worldwide for which information has been collected¦ the majority (739) were located in emerging economies or economies in transition. (Karabag, Tuncay-Celikel & Berggren, 2011:1347). While political instability, extreme poverty, lack of education, poor infrastructure and uncertain rule of law often hamper growth in emerging markets, companies in emerging markets may nonetheless enjoy a conducive environment to get started on innovative projects.
The work of Ray and Ray (2010, p 146) outlines three factors necessary for innovation in the BOP: entrepreneurial leadership and vision; modular designs to meet user demands of affordability , functionality and operability through architectural innovation; and the exploitation of the local knowledge base and the creation of local innovation clusters. An example of a company who used frugal innovation that displayed these three factors was an Indian government-owned telecom technology development centre called CDOT.
Satyen Pitroda, CDOTs founder, displayed this entrepreneurial vision. Leadership in this field required someone with both technological expertise and a close familiarity with the needs of the BOP. He grew up in one of the poorest rural villages in India and didnt have access to a telephone until he was 21 years old. For the innovator to have a close relationship with his environment as he did, allows products to be designed to suit their needs accordingly.
Someone in a different social sphere than the poor consumer base (such as a leader of an MNE in a developed country) would have trouble accomplishing the same things that Pitroda has. He recognised the need for products to eliminate the frills (Ray and Ray, 2010: 148) that tend to be typical of MNE products. Lastly, CDOT were able to utilise the massive amount of skilled labour located around them who were willing to work for very low wages. This enabled CDOT to meet the challenge of high technology switching at a fraction of the cost compared to MNEs. (Ray and Ray, 2010: 148)
Another successful emerging market company like CDOT is Grameen Telecom, which is an example of a company that decided to design their products specifically for the BOP. They are not-for-profit company located in Bangladesh. They saw opportunity in the fact that an astonishing 3 billion people around the world are without access to a reliable telecommunications service. It (Grameen Telecom) lent up to $175 to women in rural villages”independent entrepreneurs who became known as the wireless women of Grameen¦
Once equipped and trained, the entrepreneurs could then sell phone usage on a per-call basis at an affordable price to others in their villages. (Hart and Christensen, 2002: 55) Not only was this service extremely beneficial for the people of these villages”they no longer had to travel for miles just to send small pieces of information”it was also highly profitable for Grameen. The rural phones booked three times the revenue per phone¦ if extended to all of rural Bangladesh, the business could generate revenues in excess of 100 million per year. (Hart and Christensen, 2002: 55) By contrast, phone-company giants in developed countries have made some huge investments in 3G that are unlikely to ever produce satisfactory returns since customers already can use the Internet on their various other devices to do the same tasks. (Hart and Christenson, 2002: 56) This is clear evidence that there are times when it is far less risky to target the base of the pyramid first and then move your way up to a more sophisticated consumer base. Not only has Grameen developed a successful telecom company, but they have also started a microfinance bank.
This is another area where companies in developed nations have disregarded the lower end of market, as they did with telecom services. Grameen Bank makes extremely small loans, ones that are too small to be profitable for most large banks in more developed countries. This allows small businesses to start up in developing countries when it was never possible before. Since Grameens initiation it has lent over $9 billion dollars with a 98% recovery rate. Today, it has even gained foothold in a marginalised banking market in the US”poor neighbourhoods in New York City. (Trimble and Govindarajan, 2012: 10) This is proof that companies in emerging markets (such as Grameen) are using knowledge of their surroundings and applying it not only their own environment but also to the poor segments of societies in more developed countries.
Their ideas seem to be catching up to those of MNEs; they seem to be capturing more of the market than they ever have before. Lastly, not only has India become successful in microfinance banking and in telecommunications, it has also become the fastest growing auto market over the past 2 decades. Modi and Jhulka, 2012: 522) Indian conglomerate business Tata launched a car that they called the Nano, which became the worlds most affordable car. The Nano will make car ownership possible for 65% of middle class Indians. Business leaders at Tata noticed that a large amount of the population was in need of safer alternatives to motorbikes in large, heavily populated cities. By ignoring the lower end of the market again, automakers in developed countries have put themselves at risk. Tata motors now has plans to scale up the Nano platform and launch it in Europe and the US.
Given weak economic growth and high unemployment, Nano poses the risk of becoming a significant new competitor at the low end of the market in developed countries. A similar story occurred in China. Galanz produces microwave ovens that are a simple, energy efficient product at a price that was affordable by Chinas middle class and small enough to fit in their kitchen. (Hart and Christensen, 2002: 54) They created a business model that could earn high profits by selling high volumes of low cost products, enabling them to move upmarket towards developing larger machines.
By 2002, it began to compete fiercely with firms in developed countries; its global market share for low cost ovens was 35%. Multinational enterprises in developed countries should view the successes of these emerging market companies as motivation to consider taking advantage of the opportunities that frugal innovation has to offer. In fact, some believe that established players stand to lose something even more precious than opportunities forgone.
They stand to lose long held market positions (Trimble and Govindarajan, 2012: 2) This is particularly true in a stagnating macroeconomic environment with extensive austerity measures being deployed to address fiscal imbalances in the developed world. MNEs need to act quickly in order to avoid losing market share. There is risk of competition emerging from these markets because it is so much easier for local firms who are closer to the consumer base to carve a niche; some say that to really take advantage of the opportunities offered by the emerging world the only option is to go there and set up shop. (Wheatley, 2012: 2)
MNEs must seriously consider how much time they want to or need to spend on thinking about strategies to combat this new market competition. Local firms may provide a very serious competitive threat in the development of new business models. These firms will find new ways to combine low costs, locally sourced resources and unique market knowledge to develop ways of delivering value that Western firms will find difficult to match. (Enderwick, 2007: 78) Several journals have suggested strategies on how MNEs should tackle emerging markets.
When entering the market for the first time, MNEs should think critically about timing. In normal situations, there are usually benefits attached to being a first-mover. However, when trying to establish for the first time in emerging markets, no firm should attempt to pioneer. (Arnold and Quelch, 1998: 10) , Waiting too long however will allow local entrepreneurs to snatch up all the opportunities. Once the MNE has entered the market, it is important to implement a partner policy.
This policy describes the need for cooperation on strategic issues as well as on the execution-oriented tasks of the traditional distributors role. (Arnold and Quelch, 1998: 17) This means that when MNEs try and establish themselves in emerging markets, they must use people from the local area and let them perform more important roles than a usual distributor might. Typically, distributors stationed in developed economies would only attend to simple tasks; however, middle men in emerging markets will be expected to perform additional marketing tasks, such as selecting target markets and coming up with promotion strategies. This is made necessary by the companys lack of local marketing knowledge and operating capability. Arnold and Quelch, 1998: 17)
Not only is frugal innovation a potentially good business prospect for well-established MNEs, it is also a compelling business idea for younger firms as well. For young and start-up firms, EMs (emerging markets) represent a more attractive way of being born global, because of their high growth rates, less established brand preferences, more fragmented industry structures and less intense competition (Arnold and Quelch, 1998: 11) The most attractive part of this statement for MNEs is that emerging markets have less established brand preferences.
People in developed Western countries for the most part have chosen a brand that they know, love and trust and they tend to demonstrate tremendous, even irrational, loyalty as a result. For example, many British families wash their dishes with Fairy liquid, drink Twinings tea, and eat Heinz baked beans. For the most part, people who have been buying these brands since they were children will rarely buy any other brand. The opportunity for young firms is to establish themselves early in markets that have not yet chosen their staple brands and develop that same loyalty.
In addition, another benefit to starting off in a developing country may be the lack of regulatory systems there. Regulatory systems can also be needless barriers to innovation when they become labyrinthine, technologically obsolete, or captured by the vested interests that seek to sustain the status quo. Under such conditions, innovation in the developing world may enjoy the advantages of lower friction and faster progress. (Trimble and Govindarajan, 2012: 8) However, several factors cause MNEs to hesitate imitating frugal innovation in emerging markets.
Some think it could be a profitable idea if it worked, but it is just too risky: Establishing R&D is a long-term investment which entails considerable risks and uncertainties¦ there may be political and legal risks in otherwise promising countries; there may be intellectual property rights (IPR) issues and macro-economic risks concerning economic and financial stability. (Karabag, Tuncay-Celikel & Berggren, 2011: 1350) For many large companies in developed countries, the risks outweigh the benefits of starting new forms of innovation in unknown places.
Some believe that it is not only risky, but also a bad idea. The common fear among Western companies is that they will be destroying the market for expensive technology if they decide to begin backward innovation which is a narrow range of basic or stripped down products, which the corporation has value engineered for different conditions in emerging markets which are affordable, and easy to use (Arnold and Quelch, 1998: 15) .
The Economist notes MNEs are worried that consumers will eventually ask themselves why they would ever buy a device for 10,000 if the same firm makes a slightly simpler one for 1,000? (Asian Innovation, 2012: 2). Avoiding cannibalisation, or destructive innovation is, however, is often a strategy that backfires if your competitors are able to proceed with it nonetheless. Obstacles to frugal innovation may exist for MNEs because they are blinded by misconceptions. Some companies consider the concept, yet think about it in entirely the wrong way. Even the large conglomerates seem to have a one-dimensional view of the world when they invest overseas¦ one in particular decided whether to invest in Saudi Arabia based on the film The Kingdom (Wheatley, 2012: 4) The movie contained a scene where an American oil company was playing a softball game in a housing compound in Riyadh, Saudi Arabia, when al-Qaeda terrorists set off a bomb, killing many Americans in the process. Their reasoning was that if they sent their workers to a country abroad they would have a similar unfortunate experience.
Hesitation may equally reflect a belief that selling in these developing markets may be seen as unethical and exploitative. However, this may also be another misconception. The private sector may do more harm by ignoring poor consumers than by engaging them¦ If the poor cant participate in global markets, they cant benefit from them either (Prahalad and Hammond, 2004: 31). There is evidence that most of the open opportunities in the massive consumer base of the BOP will be snatched up by small entrepreneurs like Grameen, CDOT, Galanz or Tata, since they have so many advantages by being closer to the consumer base.
However, MNEs wont be missing an opportunity if the growth of these emerging economies begins to slow down. Some believe that East Asia will never pose a significant threat. Krugman (1994, p. 65) demonstrates this theory by analysing history and recognising that it was once claimed that a collectivist, authoritarian state was inherently better at achieving economic growth than free market democracies and projected that the Soviet economy might outstrip that of the United States by the early 1970s.
However, when this theory is analysed further, one notices that Soviet growth was based on rapid growth n inputs¦the rate of efficiency growth was not only unspectacular, it was well below rates achieved in Western economies¦ If the Soviet economy had strength, it was its ability to mobilise resources, not its ability to use them efficiently (Krugman, 1994: 70) Now, applying this to Asian growth in comparison, they are quite similar. Growth in East Asia also seems to be due to growth in inputs like labour and capital rather than improvements in efficiency. Growth in East Asia has been primarily input driven, and the capital piling up there will begin to yield diminishing returns.
In other words, if one looks at the developing countries production curves (the relationship between investment and gross domestic product) one will notice that they have moved along their production functions and have not shifted them. The outcome of this debate will hinge heavily on the ability of East Asian economies to stimulate domestic consumption among their newly urbanised labour force. In this regard, the Asian economies, even those under communist rule, already demonstrate considerably greater propensity towards consumerism than the soviet society of the 1970s.
In conclusion, there is evidence that frugal innovators may, at a minimum, pose a threat to the growth prospects of MNEs in emerging markets. For as long as emerging markets remain the predominant drivers of global economic growth, this represents a true opportunity cost. Worse still, to the extent that developed economies continue to stagnate, offer limited employment prospects and undertake austerity measures in order to restore fiscal balance, frugal innovators may well be able to evolve into serious competitors in traditional domestic markets.
Any MNE that fails to consider both the risk and the opportunity that this poses will likely find their market share eroding. from both sides demonstrating that the emerging markets may or may not pose a threat to multinational enterprises in developed countries in the near future. There has been strong evidence within the good performance of emerging markets companies that their market share is growing larger and larger and edging closer and closer to the territory of MNEs.
There have been many papers published that emphasise the need for MNEs to act upon the opportunities presented by frugal innovation. However, it may only be a temporary amount of time of growth before some of these emerging markets begin to slow down and impose less threat. However, in the meantime, it is important for well-established MNEs to start product development and planning for what they are going to do in the event of an imminent threat on their market share.