Four hurdles emerging market firms have to overcome on the road to create global brands

Four hurdles emerging market firms have to overcome on the road to create global brands By Nirmalya Kumar and Jan-Benedict E.M. Steenkamp Emerging market brands will become increasingly global in the coming decade, but in order to do so they--China in particular--will have to change certain existing practices. "There is no historical precedence for a major country that has come to economic prominence that has not also developed strong brands.." "Innovation and branding as sustained capabilities are best nurtured in professionally managed firms rather than left to the vagaries of state bureaucrats or the offspring of exceptional entrepreneurs." It is a widely held belief that emerging market companies will not be a threat to existing global - largely Western - powerhouses. In our new book, Brand Blowback: How Emerging Market Brands Will Go Global, we question this conventional wisdom. The top leadership of corporations in the West grew up in a world in which their competitors were all very well-known and because of that many CEOs, marketing practitioners, and even business school students believe that a poor perception of products from these countries, combined with a lack of marketing experience, will doom such brands from becoming global players. We are however advocates of “brand breakout”; and believe that, in the coming decade, emerging market brands will become increasingly global and present in the Western world. Our conviction is based on three fundamental observations. First, the push to global sourcing means leading emerging market firms, especially in China, have now built world-class manufacturing capabilities. Second, the traditional emerging markets model based on low-cost labor is breaking down, again especially in China. The time when emerging market companies could rely on low cost products for export growth has ended. Turning products into globally recognized consumer brands, supported by innovation and marketing has become the ultimate goal for many emerging market firms. Topping it off, emerging markets now account for over half of global GDP and 80% of global growth. Economic might will translate into market might. In fact, there is no historical precedence for a major country that has come to economic prominence that has not also developed strong brands. However, while we are optimistic about the potential of emerging market companies to build global consumer brands, we are not wearing rose-colored glasses. Our research has shown that there are at four significant hurdles emerging market companies have to overcome for their true branding potential to be unleashed. While these four obstacles can be observed in many emerging markets, Chinese firms in particular need to confront them. Hurdle 1: Improve transparency Many Chinese firms lack transparency, particularly with respect to ownership structures and governance standards. Despite our best efforts, it was impossible to penetrate the opaque ownership structures that went through a mother company (parent) and several daughter companies (subsidiaries), some of which might be listed. At one listed company, we learnt that the listed portion referred to only one factory for one product category. Most of these related companies transact significant business with each other. Sometimes, the entire raw materials or key inputs for a listed firm may come from another non-listed firm in the network. In such a case, unless the transfer price mechanism is known and market-compliant, the profits in the listed firm are subject to a degree of arbitrariness. Indian firms used to have such complex shareholding patterns before the reforms of 1991, but in the last decade they have made considerable strides in unraveling them. The composition and profiles of the members of the board of directors is sketchy. As a result, we were unable to gain a full grasp of the ownership and governance structures of Chinese firms. In fact, we were often advised not to raise the ownership issue in our interviews as it would jeopardize the entire interview. Even when brought up with senior Western managers of Chinese firms, it was clear they were uneasy discussing this issue. Greater probing led us to believe that it was not that these executives did not wish to reveal the ownership, but that they were ignorant of it. The state and the Communist Party not only control many of the state-owned firms and their top leadership (which are typically appointments approved by the Party), but, one suspects, also exert significant influence on the behavior of private companies. Illustrative of this is a 2012 front-page article in the leading newspaper China Daily with the headline “Party continues to expand,” celebrating that, to date, close to one million companies (including 47,000 foreign firms) have set established Party organizations in their companies. This, according to Wang Jingqing, vice-minister of the Organization Department of the Communist Party of China Central Committee, has “helped companies learn about the latest national policies and [has] improved relations between employers and employees.” Perhaps. But a less benign explanation is that the hand of the Party is never far away. Russia is the other significant emerging market where one also gets this feeling of the hand of the State. Just ask Shell or British Petroleum (BP). Yet Russia is more privatized than China. It should be noted that Western governments are not without fault either, as exemplified by the recent NSA eavesdropping scandal and extortionate demands for compensation on BP after the Deepwater Horizon oil spill. Nevertheless, the hand of the State weighs more heavily in emerging markets where the Rule of Law often is less firmly established. The lack of transparency is endemic to China as its political system attempts to control the flows of information in society. In Beijing, we were unable to access Facebook and Twitter as well as many other websites. How do you build a global brand in today’s world without social media? The desire to release limited information spills over into the corporate sector. Most of the corporate websites are of poor quality, providing minimal information, and some have not updated their English-language websites in years despite being having annual revenues running into billions of dollars. Many companies are supposedly owned by the employees. For example, the two listed companies that comprise Haier claim to be a collective that is employee owned, yet the employees do not know exactly what they own, nor do they appear to receive dividends. We believe that it is more difficult for state-run and state-employee-managed firms to build global consumer brands. The investment in the marketing efforts required to build brands, where the returns cannot be demonstrated as easily as say in building a factory, is always suspect. Who owns the cash flows being generated by the firm and who can make the decisions on whether to pay them as dividends or invest in the softer aspects of building a global brand is unclear. An important item on the Chinese corporate manifesto for the future must be to open the ownership structure up to scrutiny. We are hopeful that this will happen. One way to do this is to get listed on Western stock exchanges. Our field research revealed that Chinese companies are increasingly becoming aware that improving transparency will be beneficial to them. External forces are also encouraging Chinese firms to change in this respect in order to succeed in their quest to become more global. For example, in 2013, the Financial Times reported that “Huawei has pledged to start disclosing more detailed financial information and shareholding information as the Chinese telecom equipment maker tries to dispel fears about suspected ties to China’s military that are hampering its global expansion.” All that was known until then was that the founder owned 1.4 percent, with the rest in the hands of a “body representing 65,000 Huawei staff.” Hurdle 2: Enhance profitability and integrity of financial statements Many large Chinese firms seem to operate on low profit margins. For example, despite having about similar levels of market share in the PC business, Lenovo’s operating margins in 2012 were a quarter of Hewlett-Packard’s. This led The Economist to observe that the Asian model of capitalism “prizes market share over profits.” But profits are necessary too if one is to invest into building global brands. The low profit margins lead one to question the returns to capital at many Chinese firms, especially in light of the preferential land and capital they receive by being “favored firms” in China. The same article in The Economist went on state: “the state draws up long term plans, funnels cash to industries it deems strategic and works hand-in-glove with national champions, like Huawei and Haier.” If these subsidies were to disappear, and this were combined with increasing Chinese labor costs, one has to wonder whether the Chinese business model would be sustainable. At a minimum, we believe that this model will have to evolve and we are skeptical of a unique “Asian business model.” Beyond the low profit margins, there is the question of integrity of financial statements. Results for firms are often released far after the end of the financial year. For some major, publicly listed firms, the results for 2011 are still not available! Numbers, often round numbers, projected by leaders of these firms during the year have an uncanny way of being met. While many of the firms are audited by international firms, the problems at India’s Satyam demonstrate that this does not always guard against errors and fraud. We want to emphasize here that the integrity of financial statements is not merely a problem in China, or even an emerging market problem. Scandals such as those of Enron, WorldCom, and Lehman Brothers as well as fraud with Greek official statistical data have highlighted that the integrity of financial statements is a worldwide concern. Yet, relatively, emerging market firms need to make greater strides on this front. Brands are about trust; and everything that a firm does, enhances or detracts from the brand. Hurdle 3: Move from imitation to innovation For years, brands from emerging markets focused on the domestic market. In a relatively closed economy, they usually mimicked the products of Western or Japanese firms. The term “reverse-engineering” was common in India to describe the process of figuring out how to manufacture innovative products from the West. Like the Japanese and Koreans before them, Chinese firms are masters at this. In the early stages of a company, it can grow by merely imitating Western products and brands. But as emerging market companies grow and rise to prominence, they must make the transition from imitation to innovation. They have to offer a differentiated product and proposition to the Western consumers. This requires building and acquiring both research and development (R&D) and marketing capabilities, as well as an organizational culture that encourages bottom-up ideas. The highly hierarchical and family-controlled culture that dominates many emerging market firms is not always conducive to innovation and branding. Some state planners in China and family business heads in India love to think that this is the route to world beating innovation and brands. But apart from a few high-profile exceptions, this thinking is mostly delusional. Innovation and branding as sustained capabilities are best nurtured in professionally managed firms rather than left to the vagaries of state bureaucrats or the offspring of exceptional entrepreneurs. Investments in innovation and brands are rational only if intellectual property (IP) is protected and the protections are enforced. In our work, we have noticed numerous examples of the blatant copying of Western products, brand names, and brand logos. If emerging market firms would take these global, they would open their companies up to expensive international lawsuits. Hopefully, this situation will improve as emerging market companies mature and realize that it is in their own interest to support IP protection and enforcement. On this front, one sees great leaps forward in China. Companies such as Huawei, Galanz, Haier, and ZTE have global R&D operations with centers in Americas, Europe, and Japan. The push to register patents abroad is starting to increase among Chinese firms, and has made some of these firms into large filers in the US patent regime. While foreign patent applications by Chinese firms still lag applications by Western firms, the writing is on the wall. The Economist cautions “Geeks in the West should not relax.” The R&D facilities of companies such as Lenovo that we visited were impressive. Lenovo’s Shanghai R&D facility is one of four in China and works closely with the firm’s R&D centers in Yokohama (Japan) and Raleigh (NC, USA). They actively rotate people across these centers and encourage diversity. Hurdle 4: Accept management diversity and a global mindset Building a global brand in today’s world with distributed economic power requires managing across many countries. The consumer insights needed from the different parts of the world require a global mindset in the top management teams of the firm. This is of course not a problem unique to emerging market firms as French, Japanese, and even British firms struggle to incorporate emerging market talent into their top management teams. Emerging market firms desiring to build global brands in Western countries face the opposite problem of how to get Westerners integrated into their top management. There is little history in many of these countries of multicultural management teams. Given the structure of their societies, companies from Brazil, India, and South Africa have some advantage on this front. Firms from these countries are already used to dealing with a top management team that looks different from each other despite sharing a common nationality. Indian and South African companies are also used to doing business in English, even if their mother tongue may be Hindi, Bengali, Afrikaans, or Xhosa. We do recognize that the top management of firms from these countries is still overwhelmingly from the home country. But at least they can potentially work with a more multinational top management team. China, on the other hand, is culturally and linguistically more homogeneous. The language barrier also makes it harder to incorporate foreigners. Chinese firms aspiring to build global brands will have to follow German multinationals such as Allianz, Daimler, and Siemens, where all documents are written in English, which is the company’s working language. Even French firms like Alcatel-Lucent have now adopted English as their working language. Like it or not, the global business language does not seem destined to change even if this turns out to be the Chinese century. It is Chinese firms that will have to change. There are encouraging signs, however, as Lenovo has adopted English as its official internal language. Looking ahead In sum, significant hurdles remain on the path to global success. But Western managers should not be lulled into complacency. They have done that before, and it did not turn out well. Previously, Western managers have been blindsided for first underestimating the Japanese brands (e.g., Toyota, Sony, and Canon), and subsequently the Korean brands (e.g., Hyundai, LG, and Samsung), who swept aside supposedly invulnerable incumbents like Philips, Thomson, General Motors, Ford, and RCA. They surely do not want to be blindsided a third time. The threat is most aptly described by the mantra of Chinese domestic-appliance manufacturer Midea “Never give up, no matter what.” In the inimitable words of The Economist: “The great Western brands should listen to those words and tremble.”

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Note from Editor-In-Chief

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Vast Entrepreneurial Potential in India

Four hurdles emerging market firms have to overcome on the road to create global brands

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