The best performing emerging economies emphasize competition

The best emerging-market firms are more competitive than firms in advanced economies including the United States and the United Kingdom, write Jonathan Woetzel, Anu Madgavkar and James Manyika in Harvard Business Review.

Development economists over the ages have puzzled about why some emerging economies perform much better than others over the long term. We have been looking at the same issue in our latest research, and find one element that others haven’t tended to focus on: the often intense competitive dynamics that can be found in the best performing emerging economies—a competitive mindset that has spawned a new generation of productive and battle-hardened companies that aspire to be global champions.

That finding may seem counter-intuitive: don’t many emerging economies nurture and shield their national champions from competition? The short answer we find from our research is: No. In fact, by some measures, the best emerging-market firms are more competitive than firms in advanced economies including the United States and the United Kingdom.

For our research, we looked at 71 emerging economies and identified 18 that achieved rapid and consistent GDP growth over the past 50 and 20 years. They include the usual Asian suspects—China, South Korea, and Singapore—but also less obvious countries including Ethiopia and Vietnam.

When we examined their track record more closely, we found that these 18 “outperformer” countries had twice as many large firms with revenues exceeding $500 million as their peers, relative to the size of their economies. More large companies means the gains are distributed more broadly than would be the case with just a few—but that domestic competition can be ferocious. Indeed, it is much harder for this plethora of emerging-market firms in the outperforming countries to get to the top and then stay there. More than half that reached the top quintile in terms of economic profit generation between 2001 and 2005 had been knocked off their perch a decade later, in 2010-15. By comparison, 62% of incumbents in high-income economies on average remained in the top quintile for the same decade. In the United States, 68% stayed put, and in the United Kingdom it was as many as 76%.

A survey we conducted of companies in seven countries also brought its share of surprises. The top-performing emerging-market firms innovate more aggressively than their advanced economy rivals: 56% of their revenue comes from new products and services, compared with 48% for firms in advanced economies. These firms also invest almost twice as much as their advanced economy peers, measured as a ratio of capital spending to depreciation. And they are nimbler as they do so: on average, they make important investment decisions six to eight weeks faster, or in about 30-40% less time.

Moreover, when it comes to that metric beloved by stock market analysts and investors, total returns to shareholders, these firms also outperformed. Between 2014 and 2016, the top quartile of companies in the best-performing economies generated total return to shareholders of 23% on average, compared with 15% for top-quartile firms in high-income countries.

The ascendancy of emerging-market firms is evident in rankings such as the Fortune Global 500; more than 160 of these firms have joined the list since 2000. While emerging-market firms accounted for about 25% of total global corporate revenue and net income in 2016, they contributed a disproportionate 40% of the revenue and net income growth of all large public companies between 2005 and 2016.

There are some clear lessons here for all economies, not just emerging ones. Allowing and indeed encouraging domestic competition brings results not just for the firms that survive it, but also for the economy as a whole. The successful large firms in the outperforming economies act as catalysts for change, through investment and building capability among their suppliers. Many of these suppliers are small- and medium-sized companies that tend to be less productive than the larger firms, but are nonetheless critical for employment. By bringing them into their ecosystems, the larger competitive firms help instill management and operational best practices, and can accelerate and encourage technology adoption.

While our research found that firm-level innovation is high, we also note that policy plays an important role. In outperforming emerging economies, policy makers work with the private sector to define the development agenda, and they also rationalize regulations and barriers to growth. Yes, some governments do give financial and other support to young companies, with the goal of helping them grow. That has been the case in countries from South Korea to Singapore. However, where they have done so most successfully, the support is time-bound and targeted. The broader aim is to make companies, and the economy as a whole, more competitive.

We can see that clearly when looking at the productivity record of these countries. We decomposed total productivity growth in the economy from 1965 to 2012 across 35 sectors, including 15 manufacturing sectors and 20 service sectors. For most outperformers, we found that long-term growth was overwhelmingly driven by productivity growth within individual sectors rather than from the mix across sectors. In other words, success depends less on finding the right mix of sectors than on identifying sources of competitive advantage—and continuously driving productivity improvements within those sectors.

The finding is yet another sign that competitive dynamics are essential—and that countries that get them right prosper.

This article appeared first in Harvard Business Review.

About the author(s)

Jonathan Woetzel is a director at the McKinsey Global Institute, Anu Madgavkar is a partner with the McKinsey Global Institute (MGI), James Manyika is the San Francisco-based director of the McKinsey Global Institute (MGI), the business and economics research arm of McKinsey & Company.