Cheap and Cheerful
The dramatic rise of China, India, and other emerging-market powerhouses to date has been driven by cheap labor and low-cost manufacturing—but they are no longer content with being the world’s workshops. These countries are rapidly moving up the value chain with indigenous and often ingenious approaches to innovation. The resourceful engineers of the East need to be taken seriously, for their frugal innovations are starting to leapfrog their firms to the top of the global heap.
Developing economies are fertile terrain for breakthrough innovation. Booming middle classes with disposable income and rising expectations are creating lucrative markets. Legions of fresh graduates in technical disciplines such as software engineering are providing the brainpower needed to design the future. Add to that the fact that most people in these countries still remember what it means to be poor—meaning firms must operate frugally, producing affordable goods while using fewer resources—and it produces the perfect conditions for creative, clever, and occasionally brilliant products and services.
This chapter shows why the rise of Asia’s frugal innovators puts established firms in health care, energy, automotive, and other historically dominant but now troubled sectors of the rich world on notice. That is forcing these industries to look for fresh approaches to innovation in order to survive. Here’s why this disruption could actually be good news for the middle class in the United States and other parts of the rich world.
Enter the principal cardiac operating room at Bangalore’s Wockhardt Hospital early any given morning, and you are likely to find a patient lying on the operating table with a privacy screen hanging between his head and chest. During a recent visit, the table was occupied by a middle-aged Indian man whose serene look suggested that he was ready for the serious heart operation to come. Asked how he was, he smiled and answered in Kannada that he felt fine. It was only when his visitor stood on a stool to look over the screen did it become apparent that the patient’s chest cavity was already cut wide open.
It turns out that while the patient was chatting away, Vivek Jawali and his team of surgeons had nearly completed the complex bypass operation. Because such “beating heart” surgery causes little pain and does not require general anesthesia or blood thinners, patients are on their feet much faster than normal for this procedure. This approach, pioneered by Wockhardt, has been so safe and successful that medical tourists now come to Bangalore from around the world.
This is but one example of India’s extraordinary innovations in this sector. Private health entrepreneurs are now directing the country’s rich technological and medical talents toward frugal engineering approaches that should make the rich world’s bloated health systems envious. He is fêted today as a pioneer, but Jawali remembers how Western colleagues for years publicly ridiculed him for advocating his inventive surgical techniques.
He thinks that snub reflects an innate cultural advantage enjoyed by countries such as India. Unlike the hidebound health systems of the developed world, he says, “in our country’s patient-centric health system, you must innovate.” He makes clear that this does not mean the adoption of every fancy new piece of equipment. Over the years, he has rejected surgical robots and laparoscopic kits because the costs did not justify the supposed benefits. Instead, he has looked for tools and techniques that spare resources while improving outcomes.
Shivinder Singh, boss of Fortis, a rival Indian hospital chain based in New Delhi that has since acquired Wockhardt as part of a grand pan-Asian expansion strategy, provides more evidence that Western technology multinationals have forgotten the art of frugal engineering. The Duke-educated MBA observes that most of the expensive imaging machines made by such firms are only marginally better than older models. Meanwhile, vast markets for poorer hospitals go unserved. “We got out of this arms race a few years ago,” he says. Fortis now promises its patients only that its scanners are “world-class,” not necessarily the newest. He asks a sensible question: “Why can’t these firms make more of less and less of more?”
He is not alone in thinking that the many medical centers and multinationals of the developed world are looking at innovation the wrong way. Paul Yock is head of the biodesign laboratory at Stanford University. He argues that in the past, medical technology giants such as Europe’s Philips and the U.S. company Medtronic have “looked at need but been blind to cost.” Given growing concerns everywhere about runaway inflation in health care costs, he insists, the business model that has so handsomely benefited Medtronic and other Western med-tech firms “is not going to work any longer.”
He is convinced the only way forward is to turn the industry’s innovation process upside down. He teaches his graduate students to put cost effectiveness much earlier in the invention process. The key, he reckons, is first to identify a gap in the marketplace, rather than coming up with nifty technologies that must then go looking for a need. He finds inspiration in India. Convinced that the country’s combination of technical talent and financial constraints will produce a world-class devices sector, he has recently extended Stanford’s design program to the subcontinent.
Though generic drugs probably come to mind first when thinking of health innovation in India, the country’s health system is actually bursting with many less familiar examples. Inventive firms are coming up with novel devices and information technologies, clever business models, and the integration of all these into radically different approaches to delivering affordable health care. The catalyst is the combination of a vast and poor population suffering from huge unmet health needs and a dynamic private health sector eyeing a huge market opportunity.
Leapfrogging to the Top
How did the also-rans of the corporate world become the new leaders of global management? The answer lies in leapfrogging. Unlike rivals in the industries of developed economies, companies in the developing world are often free of legacy. As Gary Hamel and C. K. Prahalad have written, “The most effective weapon new competitors possess is probably a clean sheet of paper. And . . . an incumbent’s greatest vulnerability is its belief in accepted practice.” These burdensome legacy systems can range from antiquated infrastructure (such as the aging fleet of coal-fired power plants in the United States, which still provide over half of the country’s grid electricity) to outmoded and inefficient management practices (such as some European medical device firms’ insistence on gold-plating every new scanner and testing device).
Frugal engineering is about much more than just cost cutting. Prahalad, the management thinker most closely associated with this thesis, famously argued that there was a fortune at the bottom of the pyramid—but that in order to profit by selling to customers in the developing world, Western firms had to reinvent their business models from the bottom up. Trying to peddle the wares developed for rich markets without the frills will fail, he argued, because costs will still be much too high. Rather, companies need to start from scratch, figure out what the frugal consumer actually wants from a product or service, and strip away all of the extra costs ruthlessly. In one of his last writings before his untimely death in 2010, he argued that elegant frugality will come to trump conspicuous consumption even in rich countries. The recent recession made clear, he argued, that “affordability and sustainability, not premium pricing and abundance, should drive innovation today.”
That is a lesson that third-world innovators have taken to heart. They are reinventing the entire value proposition of business today, from supply chains to talent management to product marketing and distribution. Many of these breakthroughs do not involve snazzy technologies or new patents, though: the advances are often incremental improvements in processes and products. However, because these firms started out by putting the needs of poor consumers first and building business models around them, they do much better than rich-world counterparts that have tried to rejigger Western business models to fit local conditions.
Better Business Models
If you want a motorcycle, go to Chongqing. Although this dusty central Chinese city of drab office buildings and perpetually gray skies is better known as the gateway to the enormous Three Gorges Dam, it is also the two-wheeler capital of the world. Led by the region’s pioneers, China now makes half the world’s motorcycles. But more important than the numbers produced is the way these motorcycles are made—especially the way designers, suppliers, and manufacturers have organized themselves into a dynamic and entrepreneurial network.
Unlike state-run firms, the city’s private sector upstarts, such as Longxin and Zongshen, did not have big foreign partners with deep pockets and proven designs, such as Honda or Suzuki. So they came up with a different business model, one that was simpler and more flexible. Instead of dictating every detail of the parts they want from their suppliers, the motorcycle makers specify only the important features, including size and weight, and let outside designers improvise.
This so-called localized modularization approach has been very successful and delivered big cost reductions and quality improvements, says John Seely Brown, an innovation expert who used to head the legendary Xerox Palo Alto Research Center (PARC). It is one example of the sort of business model innovation that he insists is far more radical than conventional product or process innovation.
China Moves Ahead
Examples of these business model innovations are now bubbling up from developing economies to threaten the established global giants. Seely Brown and his collaborator John Hagel argue that the activity of private entrepreneurs means “China is rapidly emerging as the global center of management innovation, pioneering management techniques that most U.S. companies are struggling to understand.”
Frugal innovators are reinventing business models in several powerful ways. One of them is by outsourcing many activities—and you thought jobs went only one way, from your home state to Indian call centers! It turns out Chinese and Indian bosses also need to worry about cheaper competitors, be they close to home or in cheaper places such as Cambodia and Vietnam. Rather than have vertically integrated business models, for example, Indian telecom operators often outsource many parts of their value chain—and are able to offer among the lowest rates in the world as a result.
Another tactic is the inventive use of hybrid business models and cross subsidies to achieve massive economies of scale. Aravind, a pioneering Indian eye hospital chain, uses a tiered pricing structure that charges wealthier patients more (for example, for fancy meals or air-conditioned rooms), so it is able to cross-subsidize free care for the very poorest. G. Venkataswamy, the firm’s deceased founder, was inspired by McDonald’s, and set off to achieve the same sort of scale in eye care. Aravind staff screen more than 550,000 patients a year via outreach camps in remote areas, referring more than 86,000 per year for surgeries at its hospitals. International experts have confirmed that the care offered is of the highest caliber, not least because its doctors perform so many more surgeries than they normally would in the West that they become extremely good at them. And it is profitable, without donor aid or subsidies.
Indeed, the most vibrant of these third-world entrepreneurs are those who escape the heavy hand of government. Entrepreneurs in China must compete with privileged state firms with access to cheap credit as well as the local arms of multinationals. That makes China’s “bamboo capitalists” extraordinarily resourceful in trying to reach global markets. India has been less integrated into the world economy, so many of its innovative firms have initially concentrated on reaching poor consumers in the domestic market. For instance, Selco, an Indian solar energy pioneer, found that because many of its customers were living in remote areas, it had to set up local networks of trained technicians to sell, install, and repair its products, and it had to provide customers with small loans.
Most of these Chinese and Indian innovators are not well known, but it is only a matter of time before some will be. For example, there are now more than four hundred firms designing integrated circuits in China. So far they produce pragmatic, copycat designs, but some will in time become world-class innovators. One guru who forecast the rise of enterprise in the Asian giants long ago is Tarun Khanna of Harvard Business School. In Billions of Entrepreneurs, he observes that it is now almost commonplace to imagine that one could build a billion-dollar corporation from scratch without having to visit such erstwhile temples of high finance as London or New York, whereas two decades ago such a notion would have been laughable. “Entrepreneurship has truly gone global,” he concludes.
The emergence of Asian world-beaters exemplifies the two forces driving innovation: a new wave of globalization and the spread of information technology. These two forces allow the creation of unexpected and disruptive business models, such as the one used by Chongqing’s motorcycle makers. Other examples include the design networks established by Taiwanese contract producers in the textile industry. Groups of innovative just-in-time suppliers abound in Asia, feeding Western fashion and consumer goods companies.
They are often managed by supply chain experts, such as Hong Kong’s Li & Fung. Unlike Japan’s keiretsu, which bound companies and their suppliers together with interlocking shareholdings, these firms are free to leave their alliances. They stay together only if they continue to learn and profit from the experience. In some ways they resemble the nimble networks of firms that underpinned Silicon Valley’s success.
Low labor costs may have given such firms a head start, but that is a transitory advantage. India’s software innovators were once sniffed at as merely low-cost offshoring and back-office operations. But firms such as Infosys, Wipro, and Tata Consultancy Services (TCS) have become world leaders in business software services. S. Ramadorai, who led TCS to greatness, says his firm sees “innovation as a key enabler of its productivity edge.” He points out that it has been investing in R&D for twenty-five years and holds numerous patents and copyrights. TCS has won praise for its global innovation ecosystem, which brings together academic labs, start-ups, venture capital firms, large independent software firms, and some of its most important customers.
Scourge or Savior?
Innovation is also changing the pharmaceutical industry. Small biotechnology firms, using networked approaches, are getting ahead of Big Pharma. This too opens the way for Asian competitors, such as India’s generic-drug champions. These firms were once copycats, trampling on Western patents to make cheap generic versions of drugs. But increasingly such firms are shifting to process innovation and even the discovery of new drugs, as an intriguing recent Indo-American pharmaceutical deal reveals.
Generic drugs have long been considered a scourge by Western pharmaceutical firms. So it is ironic that the next great opportunity for Big Pharma may lie in doing to Big Biotech exactly what the generic-drug firms have done to traditional pharmaceutical companies: decimate margins with cheaper copies.
Pfizer, the world’s biggest pharmaceutical firm, and Biocon, India’s largest biotechnology outfit, announced in late 2010 that they will work together to bring “biosimilar” insulin treatments to market. Biosimilars are generic impersonations (though, it must be noted, not identical copies) of complicated biotech drugs. Revealingly, it is the Indian upstart that will come up with the original drugs and manufacture them; the American firm will only market them. David Simmons of Pfizer explains that this venture is part of his firm’s new strategy to become a “one-stop shop” for biosimilars.
His enthusiasm is understandable, given that this is the next frontier for the industry. Biotech-based drugs account for only a fifth or so of global drug sales, but sales are projected to grow at double-digit rates. In contrast, many conventional drugs now face declining sales and a steep cliff of patent expirations. Add the fact that many biotech drugs enjoy enormous margins—some treatments cost $100,000 or more per year—and it is easy to see why this looks like a juicy target for generic assault.
The example of biosimilars shows how the innovators of the emerging world could, just possibly, end up rejuvenating rather than burying the bloated industries of the West—if only, like Pfizer, the big multinationals of the West swallow their pride and accept they have much to learn from the brash upstarts.
Growing Global
The resourceful engineers of the East need to be taken seriously. Their frugal and frantic innovations are leapfrogging their firms toward the top tiers of the global heap. Roughly a tenth of the Fortune 500 list of the world’s biggest companies is now Chinese. One of those companies, Huawei, is now one of the most important manufacturers of telecommunications equipment in the world. Tata, an Indian powerhouse, has not only come up with an attractive small car that costs less than $4,000 (the Nano, which it plans to export to Europe from India) but also shocked the car industry by taking over Britain’s Jaguar Land Rover.
And though China and India are in the lead, rich-world innovators would also be wise to keep an eye on Brazilian rivals. While the developed world saw economic growth shrivel during the great recession of recent years, Brazil has grown robustly of late. This will come as a shock to some, but it could overtake Britain and France to become the world’s fifth-biggest economy by 2020.
The Latin American country’s mining and agribusiness giants are among the world’s best, putting established multinationals such as Rio Tinto and Cargill on the back foot on global markets. Its huge and growing middle class already makes it one of the world’s five biggest markets for mobile phones, computers, automobiles, cosmetics, and fizzy drinks. And just as China did a few years ago with the Beijing Olympics and the Shanghai World Expo, Brazil is opening up to the world for the FIFA World Cup (2014) and the Olympics (2016) with a massive infrastructure plan expected to top $50 billion.
While some Western multinationals have clearly understood that an economic tsunami is coming, many others—especially in asset-heavy, slow-moving industries such as steel and energy—seem convinced their particular industries are not so vulnerable. But even those “old economy” industries are now rapidly becoming knowledge industries, whether they realize it or not, and thus are also ripe for disruption, as the case of American health care shows.
Competition Is Good for Your Health
Rather than fear the frugal engineers of the East, consumers in the West should rejoice. By injecting a healthy dose of competition and commonsense innovation into these industries, they may be doing rich countries a favor. If you doubt it, travel an hour and a half northeast out of Beijing on a winter work day. There you will find a research and manufacturing facility built by Weigao, a Chinese med-tech firm that started as a township enterprise. The neatly manicured exterior gives way to a tidy but surprisingly chilly complex of laboratories and shop floors. Only the clean room, it seems, is fully climate controlled. That offers the first lesson in frugal innovation: unlike in the comfortable corporate campuses of the rich world, people shiver here while fancy equipment stays warm.
Brave the cold, though, and you will find such seemingly obscure local labs to be hotbeds of frugal innovation attracting investment from the world’s most successful multinationals. Medtronic, an American med-tech giant, is a good example. After years of selling high-end products, the firm entered into a joint venture in 2009 with Weigao. Now, local and foreign-trained designers and engineers work side by side in the facility outside Beijing. They have already launched half a dozen inexpensive, novel products that Medtronic would not have made on its own.
Impressive, but what led to the U-turn? Simon Li, the well-connected head of the joint venture, says three things persuaded Medtronic’s executive committee to see China “not as a host but as a home.” The growth of secondary cities creates enormous opportunities for less-expensive technologies. The Chinese government’s big push on “indigenous innovation” gives the edge to local firms in tendering, procurement, and so on. (An engineer gleefully points out that as a local entity, the Medtronic joint venture has affordable access to valuable metals such as titanium; to widespread outcry from global manufacturers, the Chinese government now restricts exports of rare-earth metals.) But the most important reason his firm “just had to localize,” says Li, is the astonishing rise of local rivals.
Beyond Frugality
A decade ago, the American med-tech sector towered over all others and China’s was of little relevance. But by the reckoning of PricewaterhouseCoopers (PWC), the U.S. lead will suffer on every important innovation metric in this industry over the next decade, while emerging giants will start catching up. China, in particular, could become a bigger force in this sector than Europe as of 2020—by both creating and consuming med-tech innovations.
First, to creation. For example, says Christopher Wasden of PWC, the traditional approach taken by big multinationals to sutures is to sell disposable versions on the cheap-razor/costly blade business model. But, he observes, local rivals beat them by developing reusable sutures, a frugal and less wasteful option that appealed to local sensibilities and pocketbooks. The local takeover of the market for heart stents is another straw in the wind. Not so long ago, says Li, Western firms such as his thought their dominant market position was unassailable. When Microport came out with products that were 40 percent cheaper, he recalls, doctors were initially skeptical. “But they did hundreds of clinical trials and now they own 70 percent of the Chinese market!” he exclaims.
Similar tales are unfolding in other parts of the industry, and investors are taking note. Microport and Lepu Medical, another local rival in the stent market, have both had successful public placements (the former on the Hong Kong market and the latter on the Shenzhen market). Mindray Medical, which makes inexpensive patient monitors and related equipment, is listed on the New York Stock Exchange; it has substantial exports into developed markets already. Trauson, a local firm specializing in orthopedics, went public on the Hong Kong Exchange.
Not in My Backyard
Consider consumption next. China’s med-tech market is forecast to grow 15 percent a year to 2015, reaching $43 billion by 2019; India’s is galloping at 23 percent and should top $10 billion by the decade’s end. And China is now spending $125 billion in a massive push to expand health care outside the major cities. That creates vast new markets for inexpensive medical technologies.
The dual-track strategy taken by Philips, a Dutch multinational, confirms that there are really two Chinas: one fancy and one frugal. Ronald de Jong of Philips reveals that his firm now sells more high-end CT scanners in China each year than it does in the United States. But, mindful of China’s big push to expand health care into rural areas, Philips has also made numerous local acquisitions. He says the chief benefit is not access to cheap labor but rather access “to a culture of frugality.”
Omar Ishrak, a senior executive at GE for many years, argues that the term “frugal innovation” underplays the revolution at work, as price is only one advantage. The local innovation approach often leapfrogs to the latest technologies, be it miniaturization or mobile communications or advanced materials, that produce devices both cheaper and better than rich-country models. He points to GE’s locally developed Brivo line of MRI and CT machines, which provide “just what is needed.”
All impressive stuff, but this is not to say that Chinese firms are about to take over the med-tech world tomorrow. For one thing, points out Rajesh Parekh of McKinsey, local firms do well only in less-complex and noninvasive fields such as imaging and engineering; they have yet to penetrate highly risky and sophisticated markets such as those for implanted defibrillators. What is more, says Rachel Lee of the Boston Consulting Group, the in-country laboratories set up by foreign firms are doing better at cutting-edge research than are the local rivals, who are focused on development. That suggests the Western giants may have a few years in which they can master frugal innovation overseas and bring home those lessons before the eventual but inevitable Asian assault.
Will the storied multinationals really dance to a new tune? The Western med-tech firms vigorously insist they are already doing this and trot out a few colorful examples of frugalista products they offer in rich countries. Scrutinize their claims, though, and it becomes clear that this—thus far, at least—is a mere trickle.
This is extremely shortsighted, for the sort of frugal innovation now bubbling up in China could yet save American health care. That may seem an extraordinary claim, given that the United States remains the Goliath of the $350 billion medical technology industry. American med-tech firms, historically the world’s most innovative, still make up thirty-two of forty-six firms in this sector with annual sales over $1 billion. And their home market still accounts for some 40 percent of global sales.
It is to their credit that the Western giants have responded to Asia’s rise by investing furiously in those booming emerging markets, and they clearly are learning useful tricks from the thrifty natives. What the giants are reluctant to do is to bring those cheap and cheerful technologies back into developed markets. But that is precisely the dose of competition that bloated health systems such as America’s really need.
Disruption Ahead
To be fair, there are several obstacles to frugal innovations entering the United States that must be swept aside. One is red tape. Since a safety scandal led to the withdrawal in 2004 of Vioxx, a blockbuster painkiller made by Merck, the FDA has grown excessively risk averse. It now often takes twice as long for firms to get new medical technologies approved in the United States than it does in Europe. This discourages upstarts, as they typically lack the army of regulatory experts and deep pockets required to navigate the tricky FDA process.
Another needless barrier holding back the tide of cost savings is the convoluted system of health care payments in the United States. It is not enough for a clever device to be safe and economical. To succeed in the United States it must also be blessed by the official Centers for Medicare and Medicaid Services (CMS). But getting a CMS payment code can take years—again, cosseting the incumbents who drove costs up in the first place.
That points to the most self-interested obstacle—the big Western firms themselves. It’s true that they are not in a defensive crouch the way Detroit’s carmakers were when confronted by the rise of Asia’s car industry several decades ago. But firms such as GE, Philips, and Medtronic are not rushing to sell their frugal inventions back in the United States or Europe. Part of the explanation is structural: salespeople operating on commission and distributors set up to peddle scanners costing $100,000 or more do not know (and do not want to know) how to hawk portable versions costing just $10,000 or even $1,000. The bigger obstacle, confesses one senior executive, is the belief that customers in the United States simply “have more ability to pay.”
A disarmingly honest Omar Ishrak explains that America’s risk-averse regulators and its complex payment system are a problem, but he offers that “manufacturers are also to blame.” The sales and distribution systems at firms such as GE, set up to sell $100,000 scanners, are not suited to sell versions at a tenth that price. And, he confesses, manufacturers “do not present comprehensive evidence of value” before the sale; rather, he thinks, they rely on “an emotional kind of sale.”
That may have worked in the past, but as health budgets get squeezed in the West and cost-effective technologies emerge from the East, emotion will surely yield to economics in time. History suggests that this strategy will ultimately fail, as the eventual assault of well-engineered, affordable Japanese cars taught Detroit’s carmakers—and that Western consumers should welcome the newcomers with open arms. Jeffrey Immelt, GE’s chairman, coauthored a case study published by the Harvard Business Review in 2009 describing the challenges and ultimate triumphs encountered by the dynamic Ishrak, then a rising star at his firm, in developing health care innovations in Asia. In mid-2011, the GE boss was challenged with this question: what about Ishrak’s confession that GE’s own sales and commission structures greatly hindered the flow of frugal innovations to markets such as the United States? Immelt laughed and revealed that on that very day, Medtronic had poached Ishrak to be its new chief executive. As for GE, he accepted the critique: “We’re just going to have to find another way to pay our salesmen.”
That is a sobering insight, especially for those concerned about the middle class squeeze—the subject of the next chapter. But if American firms do not eat their own lunch (Silicon Valley jargon for replacing one’s own business model with a better one), Asia’s rising stars of med-tech will do it soon enough. Technology is advancing at such a breathtaking pace that innovation simply can no longer be suppressed by cozy multinationals keen on milking their assets. That’s why the only real question left is whether the frugal innovators that will come out on top will use forks or chopsticks.