UK: Innovation in Emerging Markets - Strategies for Achieving Commercial Success - Part Two

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Tailoring talent management

To succeed in emerging markets, many manufacturers will need to rethink how they recruit, develop, deploy, and connect the skilled employees on which they rely.¹⁹ Once seen as an inexhaustible supply of low-cost labor, many emerging markets are now facing the same shortages of skilled labor that are all too familiar in developed countries.

Fiercer competition

The competition among multinational corporations for skilled employees, together with the growing demand from local companies, has driven up salaries in emerging markets. For example, salaries for many supervisory positions in India rose by roughly 20 percent in 2005. ²⁰ Companies are hoping that the increase in the supply of engineering graduates may moderate these wage increases. In India, 450,000 new students enrolled in engineering schools in 2005, up from 250,000 the previous year. However, manufacturing companies are finding that they are competing with the booming technology sector for skilled electronics engineers, which has driven up wages and made it more difficult to retain staff.

The talent squeeze has put a premium on training. Global companies often need to increase their investment in upgrading the skills of newly hired employees to global standards in such areas as production control, quality control, and technology applications.

Companies are also recruiting management talent from "returnees", that is, individuals who have had work experience in the United States or Europe. Returnees are especially valuable in bridging global and local business cultures. In China, for example, companies are increasingly tapping talent pools in Singapore, Hong Kong, and Taiwan for operating managers.

Providing opportunities for professional growth and advancement is also proving critical in retaining the best employees. Following the acquisition of Eastern European assets, Mondi has had professionals from Western Europe spend time in the newly-acquired mills and vice versa, providing both with an opportunity to expand their skills and experience. Philips encourages its staff worldwide to patent new technologies and publish high-quality scientific papers. The Indian automotive manufacturer Mahindra & Mahindra has created a separate engineering services company, Mahindra Engineering, that allows its key engineers to expand their skills by working on a wide range of projects across the company.

Global manufacturers are also working with local universities to expand the talent pool. For example, Sealed Air is building a packaging laboratory with Shanghai University. The company is providing equipment, training, and career guidance, as well as being involved with the development of textbooks to ensure the curriculum incorporates the latest practices.

Understanding local Expectations

Global companies have developed company-wide HR policies and practices to create consistency in their operations around the world. But as they expand their operations in emerging markets, many of which may be "culturally distant" from their home markets, they are finding these approaches need to be adjusted to match the local culture and employee expectations.

Employees in some countries routinely expect a variety of benefits not usually provided in developed markets. In Russia, companies often provide far more holidays than in developed markets, while in some Eastern European countries companies find that absenteeism and the use of sick leave are much higher than they are accustomed to in the United States or Western Europe.

In India, companies often provide housing, loans at subsidized interest rates, a car, a lunch allowance, or other benefits. Companies find they need to manage employee expectations when managers are reassigned to a developed market and expect the company to provide housing.

Cultural differences are particularly important when it comes to evaluating performance. In India, for example, it is considered impolite to criticize a person’s performance. This has led many companies to revise their evaluation criteria to include "soft" factors such as the ability to work well with colleagues, loyalty, sincerity, and discipline. Including these softer factors give companies the ability to provide positive comments, when an employee has not met more measurable job expectations or objectives. Some companies in India periodically offer more prestigious titles to employees as a way to reward them, even when their responsibilities have not changed.

In Southeast Asian countries, including Indonesia, Thailand, and the Philippines, although companies have the legal right to terminate an employee, this is not seen as culturally acceptable. There is a great respect for age in these countries and an expectation that promotions will be based on seniority. As a result, companies in Southeast Asia often have salary distributions with many employees clustered near the median, rather than the bell curve that United States and Western European companies prefer.

Although global companies in Mexico may bring in a head of manufacturing or IT from the home office, the importance of understanding both the local culture and local regulations is one reason why a local executive is often chosen to run the HR function. These companies find that a Mexican professional already understands the complexities of labor relations and governmental social and health plans.

Companies operating in emerging markets will often need to modify their approaches to managing talent to respond to varying job expectations and cultural norms if they are to find and keep the talent they need. Accommodations to local conditions will equally be required as companies seek to employ their global supply chains and operating models in emerging markets.

Mastering the complexity of global value chains

For companies to deliver commercially viable products at dramatically lower prices, an efficient global value chain is essential. In its ongoing benchmark research across more than 850 manufacturers around the world, Deloitte has found that only 15 percent of the largest, most global, and most complex companies have successfully mastered the growing complexity of their value chains. Yet these companies have been rewarded handsomely— growing faster and generating profit levels up to 50 percent higher than those achieved by their less capable peers.²¹ As they expand sales in emerging markets, companies will need to balance the efficiency that a global value chain provides with the responsiveness needed for local subsidiaries to compete effectively. One promising approach is to create "micro" operations that can flexibly customize products to meet the needs of local markets or customer segments, while basing them on the efficiency and expertise provided by a global platform.

Adapting to local Realities

The design of a global value chain may look wonderful on paper, but companies have learned that implementation is an entirely different matter. Each emerging market has different conditions that need to be accommodated. In China, for example, inadequate infrastructure often makes shipping difficult. Companies find they need to compensate for long lead times and uncertain schedules by maintaining higher inventory levels than they are accustomed to in more developed markets. To address the distribution challenges, many companies have forged joint ventures with local distribution companies.

In Russia, the best-laid plans can be frozen in place if a company is not prepared for the snow and frigid temperatures that sweep through each winter and can wreak havoc with logistics and distribution operations. Warehouses need to be well-insulated and heated, entailing additional expense. Since it can be difficult or impossible to deliver goods in the depth of winter, companies find they need to maintain more warehouses located throughout the country than they would elsewhere.

Companies operating in India face obstacles in reaching rural villages. Using a nontraditional distribution network, the consumer-goods company Unilever, through its Indian subsidiary Hindustan Lever Limited, is working with community groups of women to sell its products in villages of less than 2,000 people.²² The Indian Tobacco Co. has installed kiosks with Internet access in villages to allow farmers to access the company’s intranet to check prices for their grain, which the company buys to make processed foods.²³ The company has set a goal of having 100,000 villages participating in the program by 2010.

Starting with a clean Sheet

Manufacturers in emerging markets have an opportunity to "clean sheet" their production and delivery models, unconstrained by their legacy infrastructure. To achieve its goal of producing a car that will sell for US$2,200, Tata Motors is redesigning its entire product development, sourcing, manufacturing, and distribution system. For its new car, the company will use a combination of steel and composite plastic, and employ industrial adhesive along with traditional nuts and bolts.²⁴ But perhaps most revolutionary, Tata is restructuring how its cars are assembled and sold. The company has plans to make the basic components and then ship kits to trained franchisees that will assemble them for customers on demand.

The joint venture Decision

A fundamental question that each company must confront is whether to go it alone or instead to enter into a joint venture. Executives were asked how often their company used joint ventures in individual emerging markets. Forty-four (44) percent of the responses were that joint ventures were used at least some of the time, while 19 percent were that they were used frequently. The larger manufacturers surveyed were more likely to report employing joint ventures, with 60 percent of responses from executives at companies with US$1 billion or more in revenues reporting joint ventures were used at least some of the time, compared to just 32 percent for those at smaller enterprises.

When companies first enter an emerging market they often enter into a joint venture or contract with a local firm that offers knowledge of the local market, regulations, business culture, and language. As they become more comfortable, however, many companies prefer to establish wholly owned subsidiaries, unless there is a compelling reason to use a joint venture such as the need to access distribution networks.

Sometimes a company will simply contract for a service until they have gained more experience in an emerging market. When Emerson initially began to source engineering services from India, they contracted with a local firm. Once they were comfortable with how to operate engineering projects across time zones and work with India, however, they established their own Indian operations.

In other cases, the decision to enter into joint ventures in order to establish operations in certain markets is mandated by government regulations. In China, for example, equity ownership by foreign companies in some industries is limited to a maximum of 50 percent. For example, while automotive equipment manufacturers can be owned outright, foreign ownership of Original Equipment Manufacturers ("OEMs") is limited to 50 percent. ²⁵ This may explain why executives said that their company was more likely to employ joint ventures in China— 59 percent said that they employed them either extensively or somewhat, compared to 44 percent for the other Asian countries examined (India, Indonesia, and South Korea), 33 percent for Latin America (Argentina, Brazil, and Mexico), and 30 percent for the Czech Republic, Poland, and Russia.

Gaining visibility

The use of advanced information systems to increase efficiency by providing more accurate, upto- date information has proved especially important in emerging markets. In the United States, CEMEX delivers products directly to work sites. However, many construction activities in emerging markets are small jobs only requiring a few bags of cement, so the company delivers instead to a network of distributors in these countries. CEMEX has also created an ordering system with over 2,000 distributors across Mexico and other Latin American countries that stock its cement and other products. The system not only makes it easier for distributors to reorder products, it provides CEMEX with greater visibility into the distribution chain so it can effectively deliver products and efficiently manage its production schedules and inventories.

The company has also used technology to assist customers in paying for its products. Since many cement purchases in Mexico are financed by relatives working in the United States, CEMEX has created a system through which customers can wire funds at low cost directly from the United States to their family members in Mexico.

IDS, which is listed on the Hong Kong Stock Exchange, is the logistics arm of the Li & Fung Group. It provides integrated distribution services and is rolling out hand-held personal digital assistant computers ("PDAs") to improve order processing and gain visibility of sales, inventory, and receivables. Tested in the Philippines and now being introduced in China, the system will allow sales employees to immediately place their orders online, substantially improving operations management.

TAL provides another example of increased visibility. The company has linked activities in its Asian factories directly to points of sale at retailers in the United States. Instead of receiving store-level data from a retailer such as J.C. Penney, TAL receives point-of-sale data on the retail chain’s customers. The data are fed into TAL’s demand forecasting model so that each of its factories is told which shirt styles, sizes, and colors to replenish for each individual store.

Efficiency is always a paramount consideration in designing an operating model. However, in emerging markets companies often should temper the drive for efficiency with the need to design operations that mitigate the increased risks these countries present.

Managing risks

Operating in any country entails risks, but emerging markets present special challenges. Global companies in these markets must operate effectively in different cultures and languages, guard against increased threats to their intellectual property, be prepared to respond to potential political or economic instability, and comply with myriad local laws, regulations, and tax regimes. Governance risk is an added concern stemming from such issues as the membership of directors in local subsidiaries, corporate ethics and integrity, delegations of authority, and joint venture arrangements. Risks to the supply chain can lead to delays in manufacturing and distributing goods.

To make matters even more challenging, the political and regulatory environments in emerging markets are often in flux. In 2005, more than 3,000 new laws were promulgated at national and provincial levels in China. Changes can occur even more frequently at local levels. In many countries, there is vigorous debate on the level of state participation in commerce, the appropriate level of foreign investment, and the need to preserve and expand employment. Governments and quasi-governmental organizations can promulgate technology and other standards that can effectively constitute non-tariff barriers to trade. Manufacturers have to monitor these changing environments and to join with other companies to advocate for open standards and fewer barriers to competition.²⁶

Currency and other market risks that can reduce the purchasing power of buyers are another concern, and these are often affected by government policies. For example, a number of analysts expect the yuan to appreciate against the U.S. dollar, and India is beginning to consider the full convertibility of the rupee. These changes could significantly affect the costs and profitability of operations in China and India.²⁷

Safeguarding intellectual property

Most companies are particularly focused on threats to their intellectual property in emerging markets. Risks include the theft of key process and product know-how by staff or joint venture partners and the counterfeiting of branded products. The potential increase in risk is one of the concerns that companies have when considering joint ventures in markets where statutory protections for intellectual property are either weak or not enforced effectively. For example, the U.S. government estimates that violations of intellectual property rights in China cost multinational companies US$60 billion each year.²⁸ In a survey by the American Chamber of Commerce in China of its member companies, 90 percent said enforcement of intellectual property rights by the Chinese government was ineffective.²⁹

To mitigate these risks, companies have to assume additional costs in distributing proprietary activities across facilities or selectively moving key processes to more secure locations. For example, one surveyed company has kept the manufacturing of select high-value packaging using proprietary processes in the United States to protect its trade secrets. The company also sources its components from a variety of locations, and then conducts assembly in a different country again—all to reduce risk. Mando, South Korea’s largest automotive parts manufacturer, has taken a similar approach. While it conducts customer-focused research in emerging markets, it has kept basic research and the manufacturing of its higher-value products in South Korea to safeguard its intellectual property.

Acquiring risk Intelligence

How can companies better manage risk in emerging markets? To be successful, manufacturers need to do more than simply protect their assets from "unrewarded" risks such as non-compliance with regulatory requirements or operational failure.

They should also consider the risks of failing to capture the accelerated growth that led them to invest in emerging markets in the first place. Companies should assess the amount of risk they are prepared to accept in each country, identify the potential risks associated with each of their investments, and then compare their risk exposure to their ability to exploit upside opportunities.

The first priority is to take a comprehensive approach that systematically identifies, evaluates, and manages all the types of risk it faces across the organization, considering both emerging and developed markets. By taking a holistic view that integrates local and global risk parameters, companies can achieve risk intelligence that informs decision-making by better calculating the potential impact of risks on enterprise value. For some companies, existing Six Sigma and lean manufacturing quality management processes can be used to roll out integrated risk management practices as companies launch their emerging market ventures.

Some companies are using "operational hedging"—distributing their operations across different countries—to minimize the potential impact of political, economic, and operating risks.³⁰ For example, when a country accounts for five percent to six percent of sales, Emerson will relocate key manufacturing, labor, and sourcing operations to other locations to reduce its risk exposure.

Companies also need to explicitly identify and manage the interdependencies among all the risks they face. Our analysis of the global companies that had suffered the largest declines in share price over a 10-year period found that for 80 percent of these companies the losses were due to interactions among more than one type of risk event.³¹ Companies can capture significant benefits by taking a comprehensive approach to managing all the risks they face.

A consistent organizational approach is important to monitor and mitigate risk across business units and geographies. Clear reporting channels are essential to ensure that risk intelligence can move quickly across the company when an issue arises and be quickly elevated, if necessary, to senior management, the audit committee, and the board of directors.

While risks are inevitable in any business operation, the additional risks present in emerging markets make it even more important for manufacturers to identify the salient risks in each country and implement a comprehensive risk management strategy, paying special attention to intellectual property protection. The effort entails increased costs, and the commitment of senior management attention, but can make an invaluable contribution to long-term success.

Methodology and respondent profile

The study builds on a survey of 418 manufacturing executives from companies headquartered in 28 countries that assessed the strategies and approaches to innovation that companies use in emerging markets. The survey focused specifically on 10 important emerging markets: Argentina, Brazil, China, Czech Republic, India, Indonesia, Mexico, Poland, Russia, and South Korea.

The companies surveyed were headquartered in a variety of regions including United States/Canada (36 percent), Western Europe (36 percent), Latin America (11 percent), Japan, (6 percent), and Australia (5 percent). The industries represented included automotive (28 percent), chemicals, oil, metals, and other process companies (27 percent), nondurable consumer products (22 percent), industrial equipment (18 percent), and durable consumer products (13 percent).

(Note: Percentages total to more than 100 since executives could select multiple industries.)

The survey gained insights from executives at companies of a range of sizes as measured by the annual revenues of their parent company, with a substantial representation of large manufacturers. Thirtythree (33) percent of the executives surveyed worked at companies with annual revenues of less than US$250 million, 23 percent at companies with between US$250 million and US$1 billion in annual revenues, and 44 percent at companies with US$1 billion or more in annual revenues.

Additional information was gathered from in-depth interviews with senior executives at leading manufacturers as well as from the experience of Deloitte member firms in assisting manufacturing companies in emerging markets around the world.

End Notes