In October 31, 1989 Mitsubishi Estate bought a controlling stake in the Rockefeller Group, owner of iconic buildings including Rockefeller Center and Radio Center Music Hall. The acquisition, for many, underscored the inevitable rise of Japan Inc. In the preceding decade, best-selling books like Clyde Prestowitz’ Trading Places: How we are Giving Our Future to Japan and How to Reclaim It and Ezra Vogel’s Japan as Number One confidently predicted that Japan Inc. would dominate wide swaths of the global economy by the 1990s. Instead, Japan lost a decade, and Japan Inc lost its luster.
In the past few years, firms from emerging markets have acquired high-profile firms. Mittal Steel bought Arcelor, while the Brazilian-Belgian brewer InBev acquired Anheuser Busch. Many North American and European managers reassure themselves that the rise of emerging market firms will repeat the Japan Inc story–initial success, followed by massive hype that ends in a fizzle. The analogy to Japan Inc is reassuring, but deeply flawed. This comparison ignores the underlying sources of advantage enjoyed by the best emerging market companies.
Some Western managers attribute the success of emerging market competitors to low labor costs. That may have been more true a decade ago, but today multinationals and even start-ups can tap the pool of lower-wage employees in India, China, and elsewhere through outsourcing, offshoring, joint-ventures, and their supply chain. Other managers site government support for the rise of emerging market champions. In fact, many emerging market leaders, including Mittal Steel and Brazilian jet-maker Embraer, rose to global leadership by freeing assets from the heavy hand of government ownership. Conventional wisdom notwithstanding, most Chinese firms have attempted to reduce government ownership through successive rounds of re-financing.
Finally, some critics accuse emerging market firms of using cheap capital to snap up Western assets. This may be true in specific deals, such as CNOOC’s bank-funded bid for UNOCAL, but these are the exception. Most companies in emerging markets have endured a cost of capital that is significantly higher than that engaged by firms in OECD countries. Brazilian leaders such as Vale and AmBev, for example, rose to prominence during a decade when real interest rates in Brazil often topped 20%. Access to even expensive capital can dry up when currency crises infect emerging markets. CEMEX bought a Spanish cement maker, in part, to tap capital markets outside Mexico.
If the conventional wisdom does not explain the rise of emerging market champions, what does? A process akin to Darwinian selection. The immense hardship inherent in doing business in emerging markets serves as a rigorous training ground that culls out the weak and leaves the strong.
The high cost of capital forces emerging market firms to do more with less. AmBev and Mittal have historically lead their industries in return on invested capital-a critical advantage in capital intensive sectors. The volatility of emerging markets is an excellent training ground in risk management. Mittal competes in many emerging markets, but manage their risk through a sophisticated geographic diversification strategies and ongoing monitoring.
Consumers in emerging markets are discriminating buyers despite their low disposable income. To succeed in serving these customers, firms must relentlessly innovate to offer desirable products at low prices. The best of the emerging market companies excel at fighting a two front war-holding local rivals at bay at the low end of the market while battling multinationals at the high end. Lenovo, for example, emerged as China’s leading PC maker, for instance, by introducing low priced computers tailored to the local needs, at a time when Dell and IBM introduced products in China six months after launching them in the West.
The harsh competitive environment overwhelms the majority of emerging market firms. Those few that survive this brutal process of Darwinian selection, however, emerge as fierce competitors that excel at agility, the ability to see and seize opportunities to create economic value consistently faster than rivals. Once they have conquered their local markets, these companies have strong incentives to expand abroad. Global expansion allows them to tap new markets, diversify risk geographically, build economies of scale, and engage in multi-point competition with multinationals. A recent survey by the World Economic Forum and the Harvard Business Review found that two-thirds of the CEOs of fast-growing companies, most from emerging markets, intended to expand globally rather than focus exclusively on their domestic market.
Obviously, many of these individual experiments will fail. Recall Acer’s ill-fated attempt to build a global brand from scratch and Daewoo’s failed drive to dominate small emerging markets by partnering with governments. But the most critical element of these emerging market champions is their diversity, which stands in stark contrast with Japan Inc., which was coordinated by MITI, targeted at a handful of industries, and pursued by similar companies coming out of the same cozy home market.
Emerging market champions, in contrast, vary in headquarter country and industry as well as their strategies to globalize. While early pioneers like Samsung built their own R&D and brand from scratch, firms like Mittal, CEMEX, Haier, and Lenovo are attempting to accelerate the process by acquiring Western firms with established brands, technology and distribution.
Executives who lull themselves to sleep with reassuring bedtime stories about Japan Inc., may sleep well for now. But they risk waking up to a very unpleasant reality.