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Innovating for the next 3 billion The rise of the global middle class - and how to capitalize on it November 2011
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Innovating for the next 3 billion
The rise of the global middle class - and how to capitalize on it
November 2011
Introduction
Innovating for the next 3 billion Page 3
Introduction
Rapid-growth markets in Africa, Asia, Eastern Europe, Latin America and
the Middle East are:
► Playing an increasingly dominant role in the global economy
► Major hubs of entrepreneurship, innovation and trade, as well as
investment from multinationals from around the world
► Trending away from a dependence on exports toward a model of
increased private consumption
► An unprecedented opportunity for companies that can serve the huge
new middle class with relevant products and services
Innovating for the next 3 billion Page 4
The next 3 billion ...
► The middle class in Asia alone = 525 million people (more than the
entire European Union).
► Between now and 2030, an additional 3 billion people globally will
enter this income bracket .
► We call this emerging demographic ―the next 3 billion.‖
► It represents a valuable opportunity to seize a giant new market by
thinking differently about innovation.
Innovating for the next 3 billion Page 5
Responding to the opportunity
► Between 2009 and 2030, demand from the global middle class could
grow from US$21 trillion to US$56 trillion.
► Many companies will need to:
► Understand the unmet needs of new middle-income customers
► Create different pricing and distribution strategies for these markets
► Rethink their product and service offerings to meet these needs and the
new customers characteristics
► Create entirely new products and services tailored to these customers
Innovating for the next 3 billion Page 6
Shares of global middle-class consumption
Innovating for the next 3 billion Page 7
About Innovating for the next 3 billion
► Based on a survey of 547 executives from around the world
► In-depth interviews with some of the world‘s leading entrepreneurs,
senior executives and thinkers
► Explores: scale of the opportunity and approaches companies are
taking to develop affordable products to meet the needs of customers
on lower incomes
► Concludes: with a model that describes the necessary capabilities
for companies seeking to target the next 3 billion consumers
Innovating for the next 3 billion Page 8
Respondent profile
Respondent location %
India 15
Mexico 15
Russia 14
China 13
Brazil 13
Turkey 12
Indonesia 10
South Korea 8
Revenue %
$20b or more 12
$10b – 19b 6
$5b – 9b 8
$1b – 4b 22
$500m – 999m 15
$250m – 499m 8
$100m– 249m 13
Less than $100m 17
EBITDA growth in last year %
Over 20% increase 16
10% to 20% increase 29
5% to 10% increase 25
1% to 5% increase 16
No change 11
Decrease 4
Stakeholder %
CEO/President/Managing director 21
SVP/VP/Director 19
Head of department 18
CFO/Treasurer/Comptroller 12
Head of business unit 11
Other C-level executive 9
Board member 5
Head of M&A/Corporate development 3
CIO/Technology director 3
Key findings
Innovating for the next 3 billion Page 10
Summary: key research findings
1. Innovating for the next 3 billion is a major opportunity, but
companies have to be realistic about the challenges.
2. Deep customer insight and organizational agility are key to meeting
the needs of the next 3 billion.
3. Companies must balance the need for local customization with
global scale.
4. Understand that in the current economy, low-cost innovations are
not just for rapid-growth markets.
5. Successful innovation in rapid-growth markets goes far beyond
R&D.
6. Local companies have the upper hand in serving lower-income
customers, but multinationals are gaining ground.
The opportunity
Innovating for the next 3 billion Page 12
The opportunity
► In 2000, only 10% of spending by the global middle class took place
in Asia.
► By 2030, this could rise to 40%.
► In 2009, the middle class in Asia-Pacific spent just under US$5 trillion.
► By 2030, this could rise to almost US$33 trillion (according to the
OECD).
Innovating for the next 3 billion Page 13
Finding opportunity in frugal innovation
36
40
20
4
34
41
22
2
37
40
18
6
0
20
40
60
A major opportunity and we are already taking advantage of it
A major opportunity and we intend to take advantage of it
A major opportunity for some companies but not one that we see as
a major priority
Not something that we consider to be a major opportunity
Total Developed market companies with rapid growth market operations Rapid growth markets
Q: Please complete the following sentence based on the statement that best describes your company‘s view on the opportunities for frugal
innovation in rapid-growth markets - Adopting frugal innovation to create products and services is ... Base: Total (547), Developed market
companies with rapid-growth market operations (240), Rapid-growth market companies (307)
Innovating for the next 3 billion Page 14
The size of the opportunity
► Rapid-growth markets account for 80% of the global population and
50% of global GDP at purchasing power parity.
► But the average S&P 500 company earns just 10% of its revenues
from these economies.
► Many companies are missing a significant and increasingly important
opportunity.
► A fundamental rethinking of innovation and go-to-market strategy is
required.
Innovating for the next 3 billion Page 15
Pricing approach in rapid-growth markets
0
10
20
30
40
50
60
70
80
90
100
Total Developed market companies with rapid growth market
operations
Rapid growth market companies
8 6 9
46
40
51
46 54
40
Premium: Top end of market
Mid market
Value: Bottom end of market
Q: How do you typically price your products or services in relation to competitors in your main rapid-growth markets?
Base: Total (547), Developed market companies with rapid-growth market operations (240), Rapid-growth market companies (307)
Implications for business
Innovating for the next 3 billion Page 17
The innovation capabilities model
► Considering all these challenges, we have developed a model to help
you tackle each one of the areas where innovation capabilities need
to focus on.
► The model focuses in the four areas, and develops insights for each:
1. Customer insight
2. People and culture
3. Research and development
4. Operations and business model
Innovating for the next 3 billion Page 18
The innovation capabilities model
There are four key capabilities to focus on:
1. Customer insight
2. People and culture
3. Research and
development
4. Operations and
business model
1. Customer insight
Innovating for the next 3 billion Page 20
1. Customer insight
At a local level:
► Have resources available to observe
potential customers and assess where
their unmet needs lie
► Develop the capability to conduct in-
depth research, including extensive
ethnographic research and qualitative
fieldwork
► Engage customers and treat them as
partners and collaborators in the
innovation process
At a global level:
► Use analytics and technology to gather
information about specific markets and
turn this into actionable insight
► Conduct quantitative research and build
a rigorous understanding of market size
and expected customer behavior
► Spot linkages across markets and derive
economies of scale from reapplying
knowledge about customer needs
Understanding customer needs requires resources on the ground in local markets.
This is why companies should ...
Innovating for the next 3 billion Page 21
Understanding the new customers
► Understanding local customers is the most critical enabling factor for
innovation.
► Traditional analytical tools give basic information about customer
demographics and opportunity, but very limited in rapid-growth
markets because:
1. There is a shortage of good-quality data.
2. Target customers have no history of buying similar products.
3. Demand strength unknown until products and services are offered.
► Therefore: qualitative research is essential to gain genuine insights
from customers and understand what new products and services they
might need.
2. Research and development
Innovating for the next 3 billion Page 23
Reasons for conducting R&D in rapid-growth markets
44
42
40
39
36
25
19
16
43
42
36
38
42
30
21
12
45
43
43
39
31
21
17
20
Proximity to key growth markets
Ability to access low-cost skills
Ability to gain a better understanding of local customer needs
Ability to operate in a low-cost business environment
Relevant expertise of local engineers and scientists
Proximity to key inputs and resources
Ability to transfer skills obtained to compete in developed markets
Ability to partner with local organisations
Total
Developed market companies with rapid-growth market operations
Rapid-growth market companies
Q: What might be the main reasons for conducting R&D in rapid-growth markets?
Base: Total (547), Developed market companies with rapid-growth market operations (240), Rapid-growth market companies (307)
Innovating for the next 3 billion Page 24
2. Research and development
At a local level:
► Develop an increasing proportion of their
R&D close to where these customers
are located — in rapid-growth markets
► Develop ―reverse engineering,‖ where
affordability forms the baseline to
develop new products and services
► Make sure that local R&D centers have
autonomy to make their own decisions
about which projects to pursue
► Put in place mechanisms for new ideas
to reach decision-makers, regardless of
where in the organization they originate
At a global level:
► Set up global innovation networks that
link R&D centers across both developed
and rapid-growth markets to share
relevant intellectual property
► Think about ―platform technologies‖ that
are globally relevant and that can be
combined with local components at the
point of delivery
► Make decisions about how to allocate
R&D resources around the globe — and
move them from one location to another
as the need arises
Meeting the needs of the next 3 billion will require companies to ...
Innovating for the next 3 billion Page 25
Local R&D and global R&D
► Local R&D enables local insight into local customer needs, plus a
rapid response to local demand.
► But a purely local approach to innovation is both inefficient and
expensive.
► Companies must balance local relevance and global scale.
► Building a global network of R&D centers enables application of
innovations across multiple markets.
► Developed market companies are taking innovations from rapid-
growth economies and finding new markets for them in the developed
world.
► 81% agree that frugal innovation has as much relevance in
developed markets as it does in rapid-growth ones.
Innovating for the next 3 billion Page 26
Location of innovation
45
3 5
17
30
64
3 2
14
18
45
3
9
16
27
17
3 5
24
51
0
20
40
60
80
Gobal network of R&D centres across both developed and
rapid-growth markets
Network of R&D centres in developed markets only
Network of R&D centres in rapid-growth markets only
Single R&D centre in a developed market
Single R&D centre in a rapid-growth market
Total
Developed market companies with rapid-growth market operations
Rapid-growth market companies operating internationally
Rapid-growth market companies operating domestically
Q: Which of the following best describes where innovation generally takes place in your company?
Base: Total (547), Developed market companies with rapid-growth market operations (240), rapid-growth market companies operating
internationally (154), rapid-growth market companies operating domestically (153)
Innovating for the next 3 billion Page 27
R&D opportunities
There are several R&D trends that companies can develop in a global
scale:
► Open innovation – companies combining both internal and external
partners from around the world to generate ideas and solutions
► Joint-venture partnerships between multinationals and entrepreneurs
in rapid-growth markets to move up the innovation value chain
► Acquisitions can be a way of gaining access to frugal innovation
capabilities and taking aboard new products, process or business
models
► Cross-fertilization of talent between different R&D centers
3. People and culture
Innovating for the next 3 billion Page 29
3. People and culture
At a local level:
► Delegate decision-making responsibility
to local teams in rapid-growth markets
► Ensure that local managers have the
ability to make recruitment decisions
► Be able to develop new product or
service ideas to meet local needs
► Embed P&L responsibility to ensure that
managers have accountability
► Set pay and reward structures for local
teams that are appropriate for the pace
and growth rate of the market
At a global level:
► Manage talent globally so that managers
can be rotated among key markets and
gain experience across diverse business
environments
► Work to build a culture and set of values
that are global in scope
► Develop a global mindset and the ability
to tolerate ambiguity and integrate
multiple perspectives
► Understand interdependencies among
different regions and how decisions
made in one region will affect another
Managing talent and expertise are critical to successfully innovating for this market ...
Innovating for the next 3 billion Page 30
Cultural adaptation
When serving the next 3 billion customers, you have to consider:
► Cultural barriers can lead to product rejection and venture failure.
► Developed world products at developed world prices are not likely to
sell well in rapid-growth economies.
► For this reason, companies need to:
► Embed the product in the culture
► Adopt a mind-set where the product will be tailored to customer
needs
► Developed-market companies often think innovation means adding
sophistication and features, but innovation can also be making
products streamlined and affordable.
Innovating for the next 3 billion Page 31
Tailoring new product development
52
38 37
26
55
42
39
28
50
35 36
24
0
20
40
60
We change the pricing structure or business model of existing products to
make them more affordable
We create entirely new products with lower-income customers in mind
We simplify current premium products We re-package products and services aimed at higher-income customers (eg,
in smaller sizes)
Total Developed market companies with rapid-growth market operations rapid-growth market companies
Q: Which of the following approaches do you currently take to developing products and services aimed at lower-income customers in rapid-
growth markets?
Base: Total (547), Developed market companies with rapid-growth market operations (240), Rapid-growth market companies (307)
Innovating for the next 3 billion Page 32
Cannibalization
► Developed market companies often think:
―Will low-cost innovations made for rapid-growth markets
‗cannibalize‘ the sales of our premium products?‖
► Lower-cost innovation creates new consumption and demand.
► The added revenue from both the lower-priced and premium products
is far greater than the unadapted model (that fails to reach the next 3
billion).
► Even if there is some cannibalization, competitors will innovate in
these markets – a greater risk is to lose out on the giant growth
markets of the future.
Innovating for the next 3 billion Page 33
Processes for driving innovation
65
55
42
37
36
36
31
29
28
26
19
64
60
40
41
40
30
35
26
31
25
12
66
50
44
34
34
40
28
31
25
26
23
Making the product and service development process more efficient
A dedicated innovation team
Incentivizing employees for successful innovation
Formalized measurement of return on investment
Formalized testing, launch and review process
Direct oversight by local market management
Agreed process of financing for new product launches
A formalized ―go/no go‖ decision process
Relocating experts from developed markets to rapid growth market location
Partnerships with local entrepreneurs or organizations that specialise in innovation
Partnerships with non-governmental or academic organizations
Total
Developed market companies with rapid growth market operations
Rapid growth market companies
Q: Which of the following processes or approaches do you use for innovation in rapid-growth markets at your company?
Base: Total (547), Developed market companies with rapid-growth market operations (240), rapid-growth market companies (307)
4. Operations and business model
Innovating for the next 3 billion Page 35
4. Operations and business model
At a local level:
► Select local partners carefully across
every stage of the value chain
► Ensure operations are highly efficient to
lower cost and maintain margins
► Understand the needs of local
customers and ensure that pricing and
the business model are appropriate
► Develop the agility to respond quickly to
new opportunities and risks
At a global level:
► Have clear policies, including risk
management and compliance
frameworks
► Ensure accountability and ethical
behaviour across the value chain
► Use global supply chain and CRM
systems to optimize the value chain and
ensure that it is efficient and resilient
► Decide what to localize and to maintain
at a global level of the value chain
To be successful in this segment, products need to be affordable and
accessible. Getting the business model right and ensuring that operations are
optimized across the value chain is therefore critical. Companies need to ...
Innovating for the next 3 billion Page 36
Implications: operations and business models
► Changes to the pricing structure or business model in development
products and services for lower-income customers.
► Companies with higher-than-average EBITDA growth are more likely
to create entirely new products and services for lower-income
customers.
► Involve options like reformatting products or adjusting pricing (e.g.,
single-use shampoo sachets for customers who are paid daily).
► Thinking about the underlying business model and ensuring that it is
tailored to the unique business environment.
Innovating for the next 3 billion Page 37
Companies finding opportunity in frugal innovation
37
44
15
4
30
38
27
5
0
20
40
60
A major opportunity and we are already taking advantage of it
A major opportunity and we intend to take advantage of it
A major opportunity for some companies but not one that we see as
a major priority
Not something that we consider to be a major opportunity
High performers Low performers
Q: Please complete the following sentence based on the statement that best describes your company‘s view on the opportunities for frugal
innovation in rapid-growth markets - Adopting frugal innovation to create products and services is ...
Base: EBITDA growth high performers (241), low performers (167)
Innovating for the next 3 billion Page 38
Low-margin mind-set
Changing the way you perceive return and profit is key to developing
products for this new markets:
► Profitability is the most important challenge and requires rethinking
the business and process to understand how to tackle it.
► Companies in developed markets are used to high margins on
premium products.
► Rapid-growth markets have smaller margins, but large volumes.
► Companies need to shift to a ―low-margin mind-set‖:
► Process efficiency is essential.
► Find the right local partners across procurement, distribution and sales.
► Ensure a lean approach to distribution and the supply chain.
Innovating for the next 3 billion Page 39
Barriers of products for low-income customers
54
43
35
26
24
23
12
56
50
40
26
24
18
11
52
37
31
26
25
27
13
Profitability of products and services
Existing or future competition
Distribution of products and services
Poor infrastructure in target markets
The market is currently too small and fragmented
Lack of education and awareness among customers
Concerns that products and services aimed at lower-income customers will cannibalise premium offerings
Total
Developed market companies with rapid-growth market operations
Rapid-growth market companies
Q: What do you consider to be the main barriers for your company to developing products and services that meet the needs of lower-income
customers in rapid-growth markets? Shown top seven responses.
Base: Total (547), Developed market companies with rapid-growth market operations (240), rapid-growth market companies (307)
Innovating for the next 3 billion Page 40
Closing remarks
Innovating for the next 3 billion Page 41
Closing remarks
► Understanding and developing products and services for rapid-growth
markets is a strategic priority that cannot be ignored.
► Innovating for the next 3 billion means formulating a rapid-growth
market strategy while keeping a global perspective.
► Efficiency and adaptation are key – companies should aim to
recognize cross-pollination opportunities, identify key similarities and
adapt to increasingly integrated market forces.
► Product development and strategy execution needs to be localized,
but can draw on global resources and re-apply ideas across wider
markets.
Innovating for the next 3 billion Page 42
Thank you
Innovating for the next 3 billion Page 43
Ernst & Young
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About Ernst & Young
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© 2011 EYGM Limited. All Rights Reserved. EYG No. EX0052
This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.
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