Leaders of multinational companies are by now well aware of the growth potential that emerging-market consumers represent, an opportunity that we estimate could exceed $20 trillion annually by the end of this decade.1 Many multinational players, however, don’t seem to be capturing that growth as well as their emerging-market counterparts are. That came to light last year as part of ongoing research that began more than five years ago and was the foundation for The Granularity of Growth.2 We examined the growth rates of companies headquartered in developed economies and compared them with those of companies domiciled in emerging markets, examining performance in both developed and emerging markets. One striking finding was that companies headquartered in emerging markets grew roughly twice as fast as those domiciled in developed economies—and two and a half times as fast when both were competing in emerging markets that represented “neutral” turf, where neither company was headquartered. We found this to be the case across industries.
One potential explanation was that the smaller size of emerging-market business segments would explain a large part of the outperformance. In essence, emerging-market businesses were growing faster from a smaller base. The smaller base point was true: the average revenue for business units of emerging-economy companies in our sample, at $3 billion, was less than half of the $8 billion size for units from developed-economy companies. We’ve recently done further research, however, to isolate the effects of size on the performance gap. Specifically, we compared the growth rates of $3 billion and $8 billion firms within the developed-market sample and found that $3 billion companies grew at 10.7 percent annually over the period we studied, while $8 billion companies grew by 7.3 percent. On this basis, the smaller size of emerging-market businesses, on average, accounts for 3.4 percentage points of the growth gap, or, at most, a quarter of the overall 13-percentage-point differential (Exhibit 1).
Companies in emerging markets grew faster than those based in developed economies—and size explained only a fraction of the differential.
It is impossible to definitively disaggregate the sources of the remaining growth differential. However, the following three factors appear to be materially different for these two classes of companies:
Higher reinvestment rates. Emerging-market companies paid dividends at a lower rate than developed-market companies, returning only 39 percent of earnings to shareholders, while developed-market companies returned close to 80 percent. They also reinvested excess cash to grow fixed assets at a higher rate: 12 percent annually versus 7 percent for developed-market companies (Exhibit 2). The company in our sample with the highest rate of growth in fixed assets—roughly 30 percent annually over the last decade—was South Africa’s Mobile Telephone Networks (MTN). For most of that period, rapid asset growth accompanied aggressive expansion in the company’s Internet and cellular services in Africa and the Middle East. More recently, the company has been moving into mobile-money services, especially in African countries that lack financial infrastructure. This, too, has required significant investment—for example, $784 million on recent network expansion in Ghana, and $1 billion on its Nigerian network.
Low dividend payouts and high fixed-asset growth suggest emerging-market companies were reinvesting more aggressively.
Agile asset reallocation. Additionally, we found that on average, emerging-market companies have been reallocating capital toward new business opportunities more dynamically than those headquartered in developed economies. Companies in India, for instance, consistently redeployed investments across business units at a higher rate than US companies.3 India’s Kesoram Industries is a notable example, shifting 80 percent of its capital across businesses units over the seven years we studied. Up until 2005, the company focused most of its capital expenditures on rayon and cement. Beginning in 2007, however, it moved the majority of new investments to the tire business to capture the double-digit growth in India’s automobile sector, which has been spurred by improving highway infrastructure. This type of strategic reallocation, our research has shown, is correlated with higher total returns to shareholders over time.4 Potentially contributing to agility was the fact that majority shareholders comprised a much more influential bloc among emerging-market companies than at developed-economy companies. Although we aren’t suggesting this is the ideal governance model under all circumstances, it does create conditions for more effective shareholder alignment and more rapid decisions.5
Growth-oriented business models. Emerging-market companies generally serve the needs of fast-growing emerging middle classes around the world with lower-cost products. Developed-economy companies tend to rely more on brand recognition while targeting higher-margin segments, which are relatively smaller and thus less likely to move the needle on the companies’ overall growth rates. We found that across a number of product segments—such as soft drinks, telecoms services, and mobile phones—emerging-market companies’ price points were 10 to 60 percent below those of developed-market counterparts. Even in business segments such as construction equipment, emerging-market players offered more products at lower prices.
Consistent with that growth model has been the focus of many emerging-market players on R&D investments aimed at lower-cost products that fit developing-market conditions (and sometimes fuel “reverse innovation,” which can make a dent in developed markets). That’s still the case, and in aggregate, emerging-market companies still file significantly fewer patents than their developed-market counterparts. But they are starting to catch up (Exhibit 3), and a few innovation leaders are emerging, such as Chinese manufacturer Huawei, which was among the world’s top five companies in terms of international patents filed from 2008 to 2010. Huawei had 51,000 R&D employees in 2010, representing a stunning 46 percent of its total headcount, and placed them in 20 research institutes in countries such as Germany, India, Russia, Sweden, and the United States. Efforts such as these could boost the intensity of global competition.
Developed-market companies have filed more patents, but emerging-market companies have been gaining ground rapidly.
As the locus of future growth continues to shift to emerging markets, companies across regions should be thinking systematically about strategies for pursuing it. For many companies, a clear understanding of where to place their bets will be key, and some will need to grapple with ways to overcome organizational inertia. Business unit leaders, for example, may resist cutting costs in home markets in order to invest more in emerging markets. Many companies, meantime, still find it difficult to convince senior executives to relocate to unfamiliar locations and they may be reluctant to move teams en masse to emerging areas. In the quest to direct resources to regions with the greatest growth potential, it might be time for global players to start thinking more like emerging-market companies.