Chapter 2: The Lure of the Emerging Markets

The Lure of the Emerging Markets

Background
Doing business with the world’s 4 billion poorest people — two-thirds of the world’s population — will require radical innovations in technology and business models. It will require MNCs to reevaluate price– performance relationships for products and services. It will demand a new level of capital efficiency and new ways of measuring financial success. Companies will be forced to transform their understanding of scale, from a “bigger is better” ideal to an ideal of highly distributed small-scale operations married to world-scale capabilities. In short, the poorest populations raise a prodigious new managerial challenge for the world’s wealthiest companies: selling to the poor and helping them improve their lives by producing and distributing products and services in culturally sensitive, environmentally sustainable, and economically profitable ways.


Global Economic outlook  
The G7 economies are growing at an average of 4% GDP with an industrial output of about 2%. Contrast this with the E8 growth rate of 7% with a combined industrial output growth of more than 6 %. If things go right, in less than 40 years, the BRICs  economies together could be larger than the G6 in US dollar terms. By 2025  they could account for over half the size of the G6. Of the current G6, only the US and Japan may be among the six largest economies in US dollar terms in 2050.

PC numbers  

The number of PCs in use worldwide will reach almost 1.3 billion by the end of the decade — up from about 575 million today. With only about 150 million new PCs coming from mature PC markets in Europe, the US, and Asia, the rest will come from emerging markets like China, Russia, and India. Several research reports forecast that an additional 600 million new PCs will be in use in these countries by the end of 2010. But today's products from Western PC vendors won't dominate in those markets in the long term. Instead, local PC makers like Lenovo Group in China and Aquarius in Russia that can better tailor the PC form factor, price points, and applications to their local markets will ultimately win the market share battle. Lenovo recently announced plans to design PC desktops specifically for the Indian market. the Indian market for PCs was around 3.6 million desktops in 2004 with an annual growth rate of more than 80 ! Regardless of the manufacturers or the software that the PCs will be using, it is critical to take stock of what this means to the software industry in general. About 500 million new users are going to be entering the market as potential customers. Staggering numbers indeed, but unless companies reconcile the fact that these users have very different considerations, requirements and usage scenarios, the expanded market means little to nothing. This chapter focuses on understanding the ways in which these users are different from their counterparts in the developed world. We have to understand the differences first before we can dive into formulating strategies for getting them on board as customers.  
Internet growth rates
In mid 2005, 170 million people or roughly 60% of the population in the US had access to the internet. On the other side, only 7% of Chinese and 2% of Indians had access to the internet. The statistical difference in these numbers is staggering but indicates the immense opportunity that lays ahead of the industry to piggy back on the impending explosion of global internet usage.

At the end of 2004, nearly 700 million people (or about 12% of the total population of the world)
had access to the Internet. This represents an increase of more than 60 million people or 7.8 per cent compared with the figures at the end of 2002. Developing countries account for more than 36 per cent of all the Internet users in the world and their share in the Internet population of the world grew by nearly 50 per cent between 2000 and  2003. However, Internet users in the developing world are concentrated in a handful of countries: China, the Republic of Korea, India, Brazil and Mexico account for 61.52 per cent of them. Almost 75 per cent of the growth in the number of Internet users in the world occurred in the developing world. In spite of rapid rates of improvement in the penetration ratios of developing countries, these remain ten times lower than the average of the developed world.  It needs a very deep understanding of the user characteristics, their constraints and their preferences to develop software for these new generation of internet and PC users.  PC growth rates and the internet usage correlations are almost like the positive correlation between roadways and automobiles in the 40’s and 50’s. Although it is very common to find that a staggering number of desktops in the developed world are connected to the internet, it is a fraction of that in the developing world. It is because of the poor telecom infrastructure and regulatory issues that govern local internet connectivity. We will explore this aspect a little more in detail later on in this chapter. Lets take a minute to examine some of the key factors that are likely to act as a catalyst in hastening the adoption of borad internet usage in the emerging markets.

• Local information through local web sites


• Availability of localized information like maps, weather, yellow pages etc is very critical to create the end user value proposition for end consumers


• Lowering the barrier of entry for hardware


• Having a shared computing model where computing resources are available for “rent” rather than having to pay upfront costs is a key in lowering the barrier to entry


• Single purpose internet browsing appliances


• AMD has been experimenting with an internet appliance that is extremely cost effective and is intended only for one purpose – browsing. The deeper we get into the emerging markets, the lower the affordability of the end consumer gets and it is imperative that we not only look at the software but also lower the footprints of the hardware to enable faster adoption


• Grass roots availability of telecom infrastructure


• Availability of appropriate telecom infrastructure in remote parts of the emerging world cannot be taken for granted and has to be factored into any discussion governing internet adoption. We have to think creatively about leveraging existing infrastructures like cable TV, phone lines etc to ensure minimum investment but maximum connectivity

e-Commerce
Analysis of e-Commerce usage trends worldwide presents an even more interesting problem.
The available data from the United States and the European Union (EU) show that while the value of online transactions is increasing, it is not increasing at the same speed as that at which businesses connect to the Internet. In the United States, e-commerce between enterprises (B2B), which in 2002 represented almost 93 per cent of all e-commerce, accounted for 16.28 per cent of all commercial transactions between enterprises. But the business to consumer e-commerce numbers is less than stellar accounting for less than 2% of the total retail sales in the US. To put this in perspective, the US retail market is probably the most mature and most conducive to end consumer retail sales. To understand why these numbers are low and to understand how the emerging markets will take to this trend, let’s take a detour and examine the evolution of this industry in both retail and the enterprise sectors.

• Maturity of the electronic payment processing


• In many of the emerging economies, the seemingly simple process of electronic payment processing is not established or supported by businesses. End users either don’t have credit cards or are extremely reluctant to use them online. Businesses on the other hand are leery of exchanging payment information with partners that don’t have an established relationship with them in the absence of a regulatory system to back them up. This is discussed in greater detail in the next point.


• Maturity of legal infrastructure to support the payment processing


• Specific regulations governing compliance of the ecommerce transactions are almost non existent in the emerging markets. In most developed countries, e-procurement is a big part of the b2b market. Unless there are regulations that govern the electronic transfer of funds, the electronic paperwork associated with creating and fulfilling an order and all the process behind this business process, this market can’t really take off. The major emerging markets like Brazil, China and India are all in varying levels of maturity in putting these regulations in place. Participation of the respective governments in these process is critical in accelerating this process. E-Procurement in the government sectors like defense or civil supplies is a great catalyst to kick start this process. This is a little challenging in the emerging markets as it means little room for non conformance, tighter auditing and implied accountability – all of which are not given in these countries !


• Maturity of the supply chain to fulfill the process behind the transactions


• Supply chains


• Maturity of the electronic data exchange

Unlike the accessibility of the internet, ecommerce usage on the other hand is a function of many other non technical factors that we will be exploring later on in this chapter in detail.

Mobile devices

Challenges in the Emerging Markets

Shifting Demographics

World population in 2015 will be 7.2 billion, up from 6.1 billion in the year 2000, and in most countries, people will live longer. Ninety-five percent of this increase will happen be in developing countries, nearly all in rapidly expanding urban areas. Increasing lifespan will have significantly divergent impact on our point of interest as well.

Declining birthrates in most of the advanced economies and in a growing number of emerging markets combined with rapid aging will combine to increase health care and pension costs while reducing the relative size of the working population, straining the social contract, and leaving significant shortfalls in the size and capacity of the work force. This has a direct correlation to the impending surge in personal productivity devices and software to power the devices. Automation, personal devices, healthcare systems, hospital software etc are just a few examples that will stand to benefit from this trend. Although the living standards of many people in developing and emerging economies will rise over the next 15-20 years, per capita incomes in most countries will not compare to those of developed nations by 2020.  There will continue to be large numbers of poor even in the rapidly emerging economies, and the proportion of those in the middle stratum is likely to be significantly less than is the case for today’s developed nations.  

1. Some studies show that China’s middle class could make up as much as 40 percent of its population by 2020, double what it is now but it would be still well below the 60 percent level for the US.  And per capita income for China’s middle class would be substantially less than equivalents in the West


2. In India, there are now estimated to be some 300 million middle-income earners making $2,000-$4,000 a year.  Both the number of middle earners and their income levels are likely to rise rapidly, but their incomes will continue to be substantially below averages in the US and other rich countries even by 2020.


3. However, a $3,000 annual income is considered sufficient to spur car purchases in Asia; thus rapidly rising income levels for a growing middle class will combine to mean a huge consumption explosion, which is already evident.

This growing proportion of middle class in the emerging economies means that software companies have an enormous new market to sell their software and services to. This book explores these concepts and provides pointers for making inroads into this untapped market. While discussing these demographics we should also look at the key characteristics of these people. Here are some major characteristics of this target group:

• Wealthy vs middle class


• Wealthy urbanites: The early adopters will be the wealthy, educated urbanites who have the need, means, and motivation to buy PC technology from Western manufacturers like Dell, HP, and IBM. After initially buying entry-level PC configurations, these users will demand more power from their next PC and pay a higher price point as a result. For example, the China Center for Information Industry Development (CCID) reports that the price bar for a new PC has risen from about 5,000 yuan ($600) to about 7,000 yuan ($850), with these more expensive systems now accounting for more than 40% of PC sales.(


• Middle class: As the PC market grows, higher price points won't sit well with the second wave of buyers — literate middle-class consumers stepping into the market for the first time. These buyers, who represent the sweet spot market in terms of PC unit volume sales, will have less discretionary income to spend and won't necessarily latch onto to established Western brands. Instead, local PC makers will tailor the PC form factor, price points, and applications to local market conditions. For example, in August, Dell announced that would it exit the low-end Chinese PC business in response to the aggressive pricing strategies from Lenovo and focus on the higher price bands. Lenovo targeted smaller Chinese cities with an AMD-based Linux machine for about $350 — a low margin configuration that Dell won't copy any time soon. Also, some potential PC buyers in this wave will opt to buy PC alternatives, such as smartphones, instead.


• Urban Vs Rural mix


• User characteristics in the rural markets are very different from those in the urban city areas. These potential users have limited means, need, and motivation and often lack the basic infrastructure to support a PC, such as communications and a reliable source of power. The PC industry will need to go back to the drawing board to develop PC products for this market. For example, AMD has made a start with what it is calling a "Personal Internet Communicator" (PIC) — a sealed case computing device loaded with basic applications like an email client and a browser — that will be branded and either sold or subsidized by local providers for less than $250, including a keyboard and monitor


• Affordability of the new users


• It is not inconceivable that these new users will not all own a desktop PC per household. In individual economies we have to consider the clusters of wealth distribution when predicting how the PC vs other devices ownership patterns and adoption growth. Special attention has to be paid to the shared computing model where multiple users will access computing resources often deployed at ta local library or a kiosk.

Discuss GINI
The Gini Index, published by the World Bank, measures the degree to which income distribution among individuals within each country deviates from a perfectly even distribution among the entire population. A 0 Gini Index score would indicate perfect equality — everyone earns the same. A 100 Gini Index indicates perfect inequality — that one person controls all the wealth.

Software for day to day life

The importance of the above mentioned middle class in the world cannot be over emphasized in the new world order.  With increasing share of disposable incomes, they are shaping the face of global consumer products industry. This segment of the market is notorious for their penchant for price/performance characteristics. Price combined with killer personal usage scenarios led to the explosion of cell phone usage in theses markets explained earlier in this chapter. Areas that had spotty land line access now boasted of 100% cell phone coverage enabling the populace to be aggressive consumers of mobile phones at a far greater pace than the developed economies ever experienced. Another catalyst for this was the phenomenon of skipping technology generations. It is well documented that under developed areas have the advantage of leapfrogging to the latest infrastructural facilities.  
Usage in day to day life is a very important consideration for these consumers.  Consider this- When I am home in Redmond, almost every time I leave home with my family, I need to use the internet for a variety of reasons. Checking directions, weather, schedules of the destination, traffic  etc are some of the few travel related information that I cant imagine living without. On the other hand, when I am in India on vacation or business,  life seems to revolve around the mobile phone instead of the PC. This is a very important aspect of life in an emerging world. Every software company should get this – the consumer is still the king and knows the local environment the best. I cant use the PC in the same way in India as I use it in the US for a variety of reasons. In this example above, getting directions to a location over the web is an in exact science because of the fact that the map information has not been completely digitized and constant construction and acute traffic congestions can lend directions irrelevant most of the times. Also, in most large cities in emerging economies, the public transportation systems are so prevalent that driving your own car is very in efficient for running day to day errands.

Simputer  

Simputer was developed by scientists from the Indian Institute of Science in Bangalore and Encore, a software company. At $200 each, Simputer offers computing at dramatically low costs compared to a $700 PC. Apart from the low cost, Simputer has many other advantages.

• It is roughly the size of a handheld organizer, thereby making it very portable


• It can run on an AAA battery, making power connection not a requirement. Uninterrupted power is a huge problem in the rural areas of India and other developing countries, so a very low power requirement is a major plus.


• It uses IML ( Information Markup Language ) to convert English content from the internet into many local languages


• It uses a text to speech converter to read out the content


• It uses the Smart Card feature to allow for personal information management at the individual level for an unlimited number of users.

All of the above features are indented to make the User interface as easy to use as the telephone keypad or the TV remote. Illiteracy, power , dust and other hostile working conditions, ease of use, multi user capabilities were some of the design factors that went into the Simputer’s original plan. Simputer was designed with multi use capabilities in mind. This was a brilliant idea as it encourages a community purchase of the device that can be shared by multiple people and the smart cards stores the personal information for the individual user. I call this concept Shared Computing and is elaborated upon in Chapter X

Some of the innovative uses the simputer has been put to have been in the following fields

• Rural Economy Applications


• Educational and Content Delivery


• Applications requiring a SmartCard readers


• Micro banking

Regulatory challenges

Being able to develop and build the industry, depends on having an education
system that can provide some basic, entry-level training to the potential
workforce;
It requires the identification, through a basic mapping exercise, of a core reservoir
of computer software and services activities and personne l from which to build a
wider participant and industrial base;
Many of the potential attractions stem from being able to develop and upgrade
past the initial, low skill-based software activities;
This, in turn, is associated with the ability of domestically-owned companies to
tap into and serve sophisticated overseas clients based in the main advanced
economies of the world;
Above all, the development of the industry requires commitment in terms of coordinating
the wide multiplicity of agencies and institutions, both vertically and
horizontally, to deliver the right environment for the industry to prosper and grow.
Policy intervention requires adequate linking and inter-facing and social learning
processes for it to be successfully delivered on a local scale.

Adoption characteristics
Adoption rates, behaviors and requirements are vastly different in emerging economies as we have explored in this chapter so far. The consumers in these countries are guided by a variety of factors like affordability/ disposable income, day to day use of the technology, infrastructure available for support, needs and wants as evident from mass penetration of cell phones etc.  The order of technology adoption is also very different from those in the developed economies in both consumer as well as in the enterprise space. For example there are more cell phones in China than there are people in the United States, but many fewer landlines. Many households in India have cable television but don’t have clean water. We can’t assume that technology diffusion will happen in the same order, at the same rate, or to the same segments as it has in our previous history. Some of these countries have already leapfrogged developed country adoption rates of e-voting and smart-card-based identification. A great example is how India leapfrogged the who mainframe generation to more of the a client server economy because of the fact that software infrastructure was just not there in the 70s and 80s. Couple this with the huge upfront costs of big iron mainframe boxes and it just did not make sense for the companies to jump on the mainframe bandwagon. The maturity level or lack thereof of enterprise 15 years back also played a significant role in this context. It was not until after mid 80’s in china and in early 90s in India that most companies were integrated into the global supply chains.  

Furthermore we can’t assume that the applications useful to information workers in the developed world will be equally desirable.  For example, most software in the developed world that deals with the professional services sector deals with optimizing resources and saving on manpower allocation but this is not a major concern in the developing economies where labor is often cheap. In these countries, the emphasis is on collaboration and reporting in these types of services application to ensure timely billing and visibility into the project lifecycle.

There is also evidence that point to applications and services that are most desirable in these economies are as follows:

• Entertainment— Emerging economies put a premium in the entertainment business. Whether it is in movies in India ,karaoke in Thailand or in gaming in Korea, the regular user in the developing world puts a premium in personal entertainment over other genre of applications


• Communication—Adoption of Text and video chats, VoIP etc is an order of magnitude more than in the developed world.

Filling the tiers of the opportunity matrix with high-value but appropriate offerings will require new thinking about customers, products, and business models. We have to e creative to take advantage of the inherent strengths and preferences of the target segment and not look at them through the prism of the developed world. Bundling software services with mobile phone or delivering movie nuggets using value added software or creating a personal entertainment device are all possibilities we will explore in chapter XX when we will discuss the business model imperatives.
Phones, TVs and PCs that really do more together in a manner a consumer can easily use would be compelling to both emerging market and developed world end users. For the emerging world, creating software more resilient to intermittent power or connectivity would be a strong mobility feature in developed markets.


Business model challenges

Intellectual Property challenges

A key problem for the computer services and software industry is that whilst many of the
products and services produced are costly and often pose a financial risk to develop, they are also easy to copy. Ease of copying creates major disincentives to develop new and innovative software, hindering the development of individual (innovative) firms and the industry overall. It should be recognized that not all aspects of the computer software and services industry are affected by copyright and piracy problems. For some computer services, such as maintenance activities, copying is often not a problem. This is the case for custom made computer software writing, where a specific problem requires a specific solution and adapting this solution to fit another user context can be expensive, difficult and in many cases fruitless.
Moreover, the consumer has little or no incentive to share the knowledge associated with the activity because those who stand to gain most are likely to be competitors. There have been two parallel developments associated with intellectual property within the industry: First, there has been a strengthening of intellectual property rights protection afforded to computer software. Second, there remains the issue of unlawful software copying which has become technically easier over time, but which may become more difficult with new
encryption. Enforcement of intellectual property rights legislation in many countries  remains very weak or non-existent

Although intellectual property rights protection is important for software firms seeking
protection under various intellectual property rights laws, it is not the only mechanism to avoid appropriability of its intellectual property. There are a number of other strategies which computer software and services firms can turn to, in addition to, or as a substitute for, intellectual property law. These are:
Secrecy: Some argue that the best intellectual property rights’ strategy for an innovative
service firm is secrecy, or “secret know-how” (Taylor and Silberston, 1973). How far secrecy
can be sustained in the computer software and services industries is questionable given that
much (packaged) software can be simply reverse-engineered;

“Ensemble” Protection: This, in a sense, is not a substitute for using intellectual property
rights legislation, rather it seeks protection through novel ways by combining different types
of intellectual property rights to provide protection for a new service product. Thus, software
firms may consider protecting their innovations through an ensemble of intellectual property
rights methods, for example using trademarks with patenting and copyright to protect a piece
of software;

Short Innovation Cycles: By seeking to create ever shorter innovation cycles, a firm can
reduce the risk of copying and imitation by reducing “lead times” by such a factor that by the
time a potential competitor does seek to copy or imitate the innovation, it is too late.
Significant barriers to imitation are created by such action. Innovation cycles in the software
industry are often less than six months. This is particularly true where regular updates are
required and are “natural” for the purpose, for example, with computer virus programmes
which need to come out regularly over short periods to keep pace with new viruses and
“trojans”. However, short lead times impose considerable costs to a firm and more
specifically means that innovation costs will need to be amortised over very short periods;

· “Firmware”: There was much discussion in the 1980s that intellectual property protection
for computer software was so weak that firms sought to protect their software by embedding it
in microchips, coining the phrase “firmware” or more formally “embedded microelectronics
software.” A variety of methods exist for incorporating the software (the “micro-code or
micro-programmes”) in the electronic circuit, although a significant proportion of software is
protected this way, if only because all microprocessor systems must by definition incorporate
their own control programme (OECD, 1985). Interestingly, although such micro-code may be
harder to copy, in the United States such code still falls within the meaning of “computer
programme” (Bainbridge, 1996);
· Standards: A major factor that helps protect software companies is the creation of separate
standards on which their software run. This can be a double-edged sword in the sense that to
be truly successful, software companies need other third-party companies to accept and
develop applications software to run on their system software, by controlling the operating
standards the software is based on. There is a danger that the standard setting software
company can lose control of the standard it creates and therefore lose the power that is
involved with standards-setting in terms of determining the framework and conditions of
software being developed that is based on that standard. There is also the other danger of
being seen as wielding too much monopoly power if the standards become too dominant, as
with the case of Microsoft with its DOS and Windows systems used as the de facto operating
standard for IBM-compatible personal computers


Technology awareness challenges

1. Technological learning is a real and significant process. Users and firms using a given technology for similar periods need not be equally proficient. Learning curves are different based on skill level, efficacy of the processes and the urgency of the implementation. This is accentuated in the emerging market by the fact that typical mid market companies often have low skilled laborers in data entry type of jobs.

1. Enterprises in the emerging markets often have archaic business practices that are very labor intensive. There is a lot of in built inertia associated with optimizing these processes as it might entail shrinkage of the labor force. This creates a natural aversion to new software technologies although the productivity gains might be very evident. This phenomenon is changing rapidly with companies and governments coming to grips with reality albeit slowly


2. Technical advancements have to influence all aspects of a company to be effective. For example in a manufacturing set up the shop-floor, product engineering, quality management, procurement, inventory management, logistics and supplier relations etc all have to be touched for the software to yield the expected results.

1. Technological interactions occur within a country and with other countries. Imported technology is generally the most important initial input into learning in developing countries. Since technologies change constantly, moreover, access to foreign sources of innovation is vital to continued technological progress. Technology import is not, however, a substitute for indigenous capability development — the efficacy with which imported technologies are used depends on local efforts to deepen the absorptive base. Some countries are better than the others in this aspect. Even with the BRIC community, India and China have a natural inclination towards using technology wile Brazil and Russia are a little more traditional manufacturing type of economies.