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Business, Featured - Written by on Monday, May 10, 2010 13:57 - 2 Comments

Naumi Haque
Hothouse innovation redux: The world “upside down”

Recently The Economist released a feature report on how innovation in emerging markets may be eclipsing innovation in North America. The report, The world turned upside down (click “Buy PDF” for a complimentary copy courtesy of BASF) reinforces the fact that globalization and disruptive innovation is no longer something that is “driven by the West and imposed on the rest.” The notion that we in the West are the harbingers of all things new and advanced and that “developing” markets are cheap sources of labor and less mature audiences for low-cost, dumbed-down versions of our products and services is false. In response to the question, “Why are countries that were until recently associated with cheap hands now becoming leaders in innovation?” The Economist answers, “The most obvious reason is that the local companies are dreaming bigger dreams.” Of course, the real answer is far more complex.

In 2007, nGenera Insight began writing about what we call “hothouse innovators”—a new breed of global enterprises in Asia, South America, and Eastern Europe that are being built under fertile conditions for accelerated growth, including: A vast pool of low-cost, and increasingly highly-skilled labor; a rapidly growing group of wage-earning domestic customers with few preexisting expectations or brand loyalties; active government involvement in the private sector; and greenfield IT infrastructures that lack legacy complexities.  By exploiting these conditions, global hothouse innovators are developing business models that allow them to move up the value chain, compete with firms in mature markets, and threaten the profit structure of incumbents in almost every industry.

The Economist article touches on all of these elements, but expands the argument by introducing additional factors worth discussing. Specifically:

  • Superior positioning for M&A: Rapid growth has made resulted in cash-rich enterprises with access to highly-developed, public and private capital markets. Additionally, large conglomerates benefit from consolidated ownership which helps diversify risk and increase flexibility. The combination of these two forces is allowing large emerging market companies to use M&A not only to reduce cost or achieve economies of scale (which they have in many cases), but rather as a way to acquire name brand recognition, skilled workers, and global distribution channels.
  • “Frugal” innovation: We tend to think of innovation as “more bells as whistles,” but this mentality is base on the notion that consumers are going to shell-out more money to get the latest-and-greatest gadgets. In contrast, hothouse innovators are dealing with a population with highly-constrained budgets. In many cases, innovation is aimed at the bottom of the pyramid and focused not on growing wallet-share but rather turning non-consumers into first-time consumers. With low margins, the emphasis is on volume and utility; “new and improved” really means “simpler and cheaper,” as well as “tough and easy-to-use.”
  • New Western investment: Think of it as fertilizer for the hothouse. Companies like Cisco, General Electric, Microsoft and many others are investing heavily in emerging markets, and China and India specifically. As The Economist report notes, “Companies in the Fortune 500 list have 98 R&D facilities in China and 63 in India.”

To understand how truly competitive some of these emerging companies are, it helps to study some leading examples. Consider the following, pulled from nGenera’s previous research on the subject:

  • Foxconn: Taiwan’s Foxconn, a once lowly parts manufacturer, is challenging the traditional value chain model by designing and assembling entire products¾often leveraging new innovations and intellectual property to achieve this. In 2007, Foxconn earned $2.6 billion on $38 billion of revenue; its top five competitors combined lost $1.6 billion on sales of $57 billion. Foxconn’s success was bolstered by a record high 81,820 patent applications in 2007; 49,007 of which were granted. By comparison, IBM – the leader in US patent applications –at the time held approximately 40,000 active patents worldwide (out of over 2 million granted since 1974).
  • ICICI Bank: In less than 10 years, and from a standing start, India’s ICICI Bank ICICI has become India’s second largest retail bank, leading in every retail product market that it targets. Using e-lobbies and customer self-service, it drives over 70% of its transaction volume through electronic channels in a country where Internet and mobile phone penetration are below five percent. The company’s IT systems—which are generally based on servers instead of mainframes—are free from complex legacy issues and cost less than one-tenth of developed-country benchmarks. Moreover, the bank operates on 90-day business plans and established its UK subsidiary in only 65 days.
  • Tencent: Although few people outside of China have heard of it, Tencent QQ, China’s premier integrated platform for social networking, media, and mobile gaming currently boasts 400 million active users (the same as Facebook) and 2009 annual revenues of over USD $1.8 billion (more than double the between $600 and $700 million 2009 revenue estimated for Facebook). Perhaps the most remarkable figure around Tencent’s financial model is that over 75 percent of revenues stem from value-added services (paid for by users), not advertising. The company’s virtual currency, Q-Coin, which is used to purchase products (such as shows, online “pets,” games, and music) has become so widely accepted that it is also being used to purchase physical goods from other online retailers.

But opportunity is not without risk. These waters be uncharted and filled with pirates. As The Economist notes:

“These markets are among the toughest in the world. Distribution systems can be hopeless. Income streams can be unpredictable. Pollution can be lung-searing. Governments can be infuriating, sometimes meddling and sometimes failing to provide basic services. Pirating can squeeze profit margins. And poverty is ubiquitous. The islands of success are surrounded by a sea of problems, which have defeated some doughty companies. […] This combination of challenges and opportunities is producing a fizzing cocktail of creativity. Because so many consumers are poor, companies have to go for volume. But because piracy is so commonplace, they also have to keep upgrading their products.”

What this means is that not only are emerging market companies benefiting from hothouse conditions, but they are also operating in markets that pose fairly substantial barriers to entry for Western firms. At a macro level, what we’re seeing is not only a new wave of innovation, but also a global redistribution of wealth. The Economist says, “The emerging world is enjoying the most spectacular growth in history. Its share of global GDP (at purchasing-power parity) increased from 36% in 1980 to 45% in 2008 and looks set to grow to 51% in 2014.” Another source, Worldmapper, provides a visual representation of how this might play out:

World wealth: 1990 to 2015
(map area shows relative wealth)

world wealth

So, is the West doomed? Not by a long shot. But, we probably have a lot to learn from what’s going on in emerging markets. Established companies have to rethink innovation in a way that focuses equally on features and branding, as well as cost, simplicity, volume, distribution, durability, and accessibility. Enterprises can also develop strategies for open innovation that broaden the scope for disruptive ideas and increase the potential for high-yield opportunities.



2 Comments

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Dara MacCaba
Sep 18, 2010 7:53

This article nails the central tension facing many of our multi-national clients in emerging markets such as China – how do we produce something simple enough for scale but complex/unique/special enough to minimize fast-copying from lightening-speed “me too” competitors – it’s a fascinating challenge that is putting both incremental and disruptive innovation at the top of our clients’ agendas.

We’d be delighted to offer perspective on how we have helped our clients to-date think about and overcome these types of challenges: info@lucid360.com

Ong Jiin Joo : Hothouse Innovation requires more than just heat
Sep 19, 2010 10:43

[...] a nice article on wikinomics on Hothouse Innovation which summarizes the concept of a “hothouse innovation” from Asian countries that are [...]

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