3

MEGAMARKETS AND MICROCUSTOMERS

Fighting for Local Market Dominance

eBay may be a shark in the ocean, but I am a crocodile in the Yangtze River. If we fight in the ocean, we lose—but if we fight in the river, we win.

Jack Ma, chairman and CEO, Alibaba Group¹

Founded in 1995, eBay has been one of the major success stories of the Internet age. Meg Whitman, who was recruited as the company's CEO in early 1998, is widely hailed as the architect who built eBay from before its initial public offering to a market capitalization of over $40 billion at the time of her retirement in March 2008.

Whitman was well aware of China's potential to emerge as the largest Internet market in the world. She noted to security analysts in 2005, “Share of e-commerce in China is likely to be the defining measure of success on the net.”² She made sure that eBay was an early entrant into China. The company did so by spending $30 million in March 2002 to acquire a one-third stake in EachNet, China's equivalent of eBay. EachNet had been founded in 1999 by Tan Haiyin and Shao Yibo, two Harvard M.B.A.s who intended to emulate eBay's success in China by adapting the eBay model to some of the unique features of the Chinese market such as payment systems, demographics, and consumer behavior. In the initial years, EachNet proved to be a roaring success. In June 2003, at the time of eBay's decision to acquire complete ownership of EachNet, its market share in China was 85 percent.

Yet by the end of 2006, eBay's dreams in China appeared to be on the verge of collapse. The company's nemesis was TaoBao, an auction site launched by China's Alibaba Group in May 2003. By early 2006, TaoBao had emerged as the leading customer-to-customer and business-to-customer auction site in China. In December 2006, eBay decided to pull back from China, shut down its local Web site, and become a 49 percent owner in a new operation, TOM EachNet, run by TOM Online, a China-based portal and wireless operator.

EBay is just one of a countless number of companies for which there exists a wide gulf between the potential of the vast market opportunities in China and India and the extent to which the company has been able to realize the potential. Toyota is now the largest auto company in the world, yet its market share in both China and India is tiny and well below that of the leading players. Black & Decker is the number one power tools company in the United States and one of the leading competitors in Europe. Yet its market share in both China and India, the hotbeds of new construction, is minuscule. BusinessWeek is the largest weekly business magazine in the United States with a circulation of nearly 1 million copies every week. Yet in India, it is almost nowhere compared with the top three local business magazines, each with a circulation of around 500,000.

Companies face many external and internal challenges in capturing market opportunities in China and India. External challenges pertain to the fact that for most products and services, these markets are very different from those in the developed countries, present extremely low buying power on a per capita basis, are internally diverse and complex, can be brutally competitive, and in some industries pose regulatory hurdles. Internal challenges pertain to the tendency on the part of many companies to see the market opportunities in China and India as mere extensions of those in their home markets. Such companies demonstrate a strong proclivity to replicate their home country products, services, and business models in these markets instead of being open to inventing new approaches from the ground up. In extreme, albeit rare, cases, a company's leaders may even be blind to the magnitude of market potential in China or India, or both. Take the case of AT&T Wireless. In 1995, AT&T partnered with India's Tata and Birla groups to set up Idea Cellular, a mobile operator, each party acquiring a one-third stake. In October 2004, AT&T Wireless merged with Cingular. In July 2005, Cingular sold its stake in Idea to the other two partners for about $250 million. Barely three years later, India had emerged as the second largest mobile market in the world; if Cingular had not sold its stake, it would be worth about $3 billion in 2008. Cingular, now renamed AT&T Wireless, is once again looking for a (much more expensive) way to get back into India.

In this chapter, we analyze the structure of the market opportunities in China and India and lay out the strategic guidelines that can improve the odds of success in these two vast, rapidly growing, and dynamic markets.

Vast, Diverse, and Dynamic: Market Opportunities in China and India

For any business, there can be no substitute for undertaking one's own investigation into the size and structure of the market opportunities in China and India. The answers obviously vary across industries. Broadly, however, three observations are likely to be pertinent. As of 2008, China and India together account for approximately 10 percent of the world's GDP, 20 percent of the annual growth in the world's GDP, and 40 percent of the world's population. Thus, depending on the specific drivers of demand for an industry's products and services, it is very likely that as of 2008, the combined market size in China and India falls somewhere between 10 and 40 percent of global demand. Furthermore, as these economies continue to grow at a rate three times faster than that of the developed economies, it is all but certain that by the middle of this century, China and India together will account for nearly 40 percent of the global demand for almost every product or service.

In this section, we discuss some of the salient details regarding the vast, diverse, and dynamic nature of market opportunities in China and India.

Large Size and Rapid Growth

China and India are not just two of the largest but also two of the fastest-growing economies in the world. Based on estimates by McKinsey Global Institute, Table 3.1 summarizes the projected levels of aggregate private consumption in these two countries by 2025. Falling in the midrange of projections by other analysts such as Goldman Sachs and HSBC, these data assume a compounded annual growth rate (CAGR) of between 7 and 8 percent for both economies. Applying these growth projections to the actual data for 2005 (and assuming much lower growth rates in the developed economies) leads to the conclusion that by 2025, the total size of aggregate private consumption in China would be twice as large as that in Germany, almost as large as that in Japan, and on a path to catch up with the United States by 2035 to 2040.

Table 3.1 Aggregate Private Consumption in China and India (billions of real 2000 dollars)

Note: By 2025, China's consumption figures are projected to be over twice as large as those for Germany ($1,511 billion in 2000 dollars) and almost as large as those for Japan ($3,718 billion in 2000 dollars). India's consumption figures are projected to be larger than those for Germany but about half as large as those for Japan or China.

Source: Abstracted from McKinsey Global Institute, From “Made in China” to “Sold in China”: The Rise of the Chinese Urban Consumer, Nov. 2006; McKinsey Global Institute, The “Bird of Gold”: The Rise of India's Consumer Market, May 2007.

India is starting from a base about half as large as that of China. Thus, by 2025, India's market size will still be only about half that of China. Nonetheless, aggregate private consumption in India is expected to be larger than that of Germany, making India's the fourth or fifth largest market in the world for most products and services.

Building on these aggregate projections, Table 3.2 summarizes the expected growth rates for selected categories of consumer goods and services. As discretionary incomes rise, the growth in expenditures is likely to be particularly steep in areas such as health care, communication, education and recreation, housing and utilities, and transportation.

Table 3.2 Projected Real Annual Growth Rates for Consumer Goods and Services in China and India, 2005–2025

Source: Abstracted from McKinsey Global Institute, From “Made in China” to “Sold in China”: The Rise of the Chinese Urban Consumer, Nov. 2006; McKinsey Global Institute, The “Bird of Gold”: The Rise of India's Consumer Market, May 2007.

Billionaires Versus Paupers

Aside from their large size and rapid growth, another important reality of the Chinese and Indian markets is the extremely high levels of disparity in incomes and wealth between the haves and have-nots:

• According to recent data by the Asian Development Bank, between 1993 and 2004, the Gini coefficient of inequality increased from 0.41 to 0.47 in China and from 0.33 to 0.36 in India. In comparison, for 2004, the Gini coefficient was 0.46 in the United States but only 0.31 in Japan and 0.28 in Germany.³
• According to Forbes magazine's 2008 list of the world's billionaires, China and India are now home to 42 and 53 billionaires, respectively. The only countries to have a larger number of billionaires are the United States (477), Russia (87), and Germany (59).⁴
• Thirty years of rapid growth in China, especially in the urban centers, have created a particularly sharp disparity between the rich and the poor. According to government estimates, the rural sector of China accounts for 54 percent of the country's population but only 8 percent of its GDP. The interpretation here is not that China's rural citizens have become poorer over the last thirty years. Instead, the reality is that economic growth in the urban centers has far outpaced that in the rural areas.

The Urban-Rural Divide

Tables 3.3 and 3.4 contain summary data on the cities, towns, and villages in China and India. These data highlight vividly the large size of each country and, in the case of China, the very high degree of urbanization:

Table 3.3 Cities, Towns, and Villages in China, 2005

Source: Abstracted from China City Statistical Yearbook 2005; and IBM Institute for Business Value, “Capture the New Market Frontiers: Unlocking the Untapped Mass Markets Within China,” 2007.

Table 3.4 Cities, Towns, and Villages in India, 2005

Source: Abstracted from McKinsey Global Institute, The “Bird of Gold”: The Rise of India's Consumer Market, May 2007.

• Only 9 percent of China's population lives in the twenty-five cities categorized as tier 1 (think Shanghai or Beijing) or tier 2 (think Nanjing or Tianjin). Alternatively stated, even if one were to visit every one of the twenty-five largest cities in China (let alone just the major hubs such as Shanghai and Beijing), one would have barely scratched the surface of the economic and social reality in this vast country. Ninety-one percent of China's population (over 1.1 billion people, which is more than the entire population of India) lives outside the twenty-five largest cities.
• Nearly 700 million Chinese live in rural communities. Their per capita income is a tiny fraction of that in the cities in tiers 1 through 4 and well below the national average.
• India is currently much less urbanized than China. Seventy percent of Indian citizens live in rural areas as compared with 54 percent in China. Furthermore, in India, only about sixty-seven cities have a population of over a half-million. In China, this number is almost ten times larger: above six hundred.

Rapid Growth of the Middle Class

Tables 3.5 and 3.6 summarize the breakdown of consumers in China and India by income categories. These tables also contain projections about the expected growth rates of the categories over the next twenty years. Two major conclusions emerge.

First, the number and buying power of the rich Chinese and Indians will grow by vast amounts. By 2025, in real terms (net of inflation), total consumption by rich citizens in both China and India will be fourteen to sixteen times as large as that in 2005. For many luxury products such as Louis Vuitton bags and Tag Heuer watches, China is already one of the three largest markets in the world. Dassault, the jet manufacturer, sold five business jets in India in 2006 as compared with six in the previous fourteen years. Compared with these numbers, the market in 2025 should be much larger.

Table 3.5 Growth of Private Consumption in China, 2005–2025

Table 3.6 Growth of Private Consumption in India, 2005–2025

Notwithstanding the growing wealth of the rich citizens, the second conclusion is that in absolute terms, the biggest market growth will occur in the middle of the pyramid as vast numbers of today's poor become richer and migrate up. Although there is no consensus definition of what constitutes the middle class, going by the numbers in Tables 3.5 and 3.6, by 2025, each of these two countries will see an additional 500 million people migrate up from the ranks of the poor into the middle income segments. Between 2005 and 2025 in China, real annual consumption by the middle-income segments is expected to grow by 11.9 trillion renminbi (in 2000 renminbi) as compared with 4.2 trillion renminbi for the affluent and richer segments. In India, real annual consumption by the middle-income segments is expected to grow by 38 trillion Indian rupees (in 2000 Indian rupees) as compared with 13 trillion Indian rupees for the rich segments.

Megamarkets But Microcustomers

Given the large size of the markets in China and India, and the glitter of downtown Shanghai, downtown Beijing, and downtown Mumbai, it is easy to forget that the average buying power of most consumers in China and India is very low. This is true not just in the countryside but also in urban areas, even in tier 1 cities such as Beijing and New Delhi.

Consider the hard facts. At market exchange rates, the estimated per capita income in 2007 was just twenty-five hundred dollars in China and a mere thousand dollars in India. Our own field interviews in mid-2008 indicate that even in places such as downtown Beijing, the total annual compensation of a twenty-four-year-old lab technician with a bachelor's degree working in the local subsidiary of a U.S.-based biotech company was only about six thousand dollars, or one-tenth of the figure for a similar employee in the United States. The data for India are roughly similar. In summary, perhaps the best way to view the market realities in China and India is to think of them in terms of megamarkets and microcustomers.

Business leaders need to remember that just as midtown Manhattan and central London do not represent, even remotely, the buying power of the average family in the United States or United Kingdom, this is true also of midtown Shanghai in relation to the rest of China and midtown Mumbai in relation to the rest of India. The bulk of the market reality lies well outside the luxury hotels where the visiting multinational executive is likely to stay. This is true even in the tier 1 cities. Once you go outside the top tier cities, it becomes visibly clear to the naked eye.

Fighting for Local Market Dominance

In this section, we outline the strategy guidelines that companies need to follow in order to capture market opportunities in China and India.

Start with a Defensible Beachhead

The notion of starting with a beachhead is particularly relevant for a company that has yet to enter China or India. Given the growing speed with which relatively young enterprises can now unseat long-established ones, even among the world's five hundred or thousand largest companies, there will always be a sizable proportion for which global expansion, including entry into China and India, will be a fresh question. How to enter China or India, or both, will also remain a fresh question for newly formed business units within established enterprises. Finally, consider the large number of companies within China or India that are growing rapidly and considering global expansion. Thus, companies from China will increasingly face the question of how to enter India, just as companies from India will increasingly face the question of how to enter China.

Each of these two markets, China and India, is too big, too complex, and too diverse for a broad-brush attack. Entering either or both of these markets with all product lines targeted at all relevant market segments guarantees that executives will be taking on too much complexity too soon. Also, a broad-brush attack does not allow the company to make smaller, less costly mistakes that it can learn from before expanding the scale and scope of market entry. In short, a broad-brush attack increases the risk of early failure, which can be debilitating on several fronts: psychological and political costs for the executives leading the charge into China or India, tarnished image in the home as well as host country media, and a significant increase in the costs of entry.

A much smarter approach is to identify and occupy a beachhead that offers the best potential for early success and can serve as a launching pad for deeper market penetration. A beachhead refers to a niche defined in terms of a product line, a customer segment, a geographical area, or some combination of these three. An ideal beachhead has low economic or political entry barriers, low risk of failure, and the ability to serve as a platform for subsequent migration to other desirable market segments. Consider the following examples.

McCormick & Co. is a U.S.-headquartered food products company that sells spices, seasonings, and flavors to two sets of customers: retail stores for ultimate sale to end consumers and industrial businesses such as fast food chains and other food processing companies. When McCormick entered China in the 1990s, it targeted Western fast food chains such as McDonald's as its initial beachhead segment. Since these companies were already McCormick's customers in other markets, selling to them in China was relatively easy. Also, the product specifications and quality requirements of these customers were almost identical to those in the United States, thereby eliminating the risk of a misalignment between the company's offerings and market needs. Finally, given McCormick's established relationships with these customers, there was minimal risk that the company would run into nasty contractual disputes or suffer from nonpayment of invoices. This beachhead strategy allowed McCormick to launch its China operations in a relatively low-risk manner. Over time, the company was able to capitalize on its initial manufacturing presence, a growing pool of local managers, and a rapidly growing knowledge of the broader Chinese market to diversify its customer (as well as product) base to include Chinese fast food chains, Chinese retailers, and Chinese food processing companies.

Another example is Germany-headquartered Metro Group, one of the world's largest retailers whose various businesses include a cash-and-carry wholesale business targeted at professional customers such as hotels, restaurants, caterers, and small retailers; hypermarkets and supermarkets; department stores; and online retailing. When Metro entered India in the early part of this decade, it chose cash-and-carry wholesale operations as its beachhead segment. The reasoning was simple: India's regulations did not permit foreign multibrand retailers to operate within the country. However, there were no such restrictions on business-to-business wholesaling. Thus, a cash-and-carry operation has permitted Metro to enter India years ahead of players such as Wal-Mart and Carrefour. It has built procurement capabilities, logistics systems, distribution centers, and market knowledge that could prove to be potent if the company were to enter the retail business more directly through franchisees or, if the regulations change, its own retail stores.

Pursue a Multisegment Strategy

We discussed the vast disparities in buying power that exist not only across Chinese and Indian cities, towns, and villages but even within the major cities. However, income is not the only dimension along which extreme diversity is a defining feature of the societies in China and India. Given their large geographical size and vast populations, each country is almost like a continent. Thus, each also exhibits high diversity along multiple dimensions: languages and dialects, climates, religions, and cultural proclivities, for example. Given this diversity, unless a company makes niche products targeted at a very narrow customer base, such as Hugo Boss apparel or Ferrari sports cars, market success in China and India is almost impossible without finely segmenting the local market in each country, developing a strategy tailored to the needs of each segment, and exploiting a strong position in one segment to enter and occupy one or more adjacent segments.

Nokia serves as an excellent example of a company that has benefited from a disciplined pursuit of a multisegment strategy. Other than the United States, Nokia is a clear market leader in all of the world's major markets: Europe, China, and India. In early 2008, its global market share stood at over 40 percent, larger than the combined market share of its three biggest competitors: Samsung, Motorola, and Sony Ericsson. Among the many factors that explain Nokia's success, we view its multisegment strategy as one of the most important. Consider its strategy for India, where it has a well over 50 percent market share in mobile phones. Its product offerings in India cover the entire range from the high-end N- and E-series phones, which retail for over a thousand dollars and are targeted at urban professionals, to the Nokia 1200, which retails for around thirty dollars and is targeted at low-income customers, including vast numbers of urban and rural workers who work in physically rough environments.

The 1200 model is designed to be dust- and splash-proof with a rubberized keypad and antislip back cover, a bright flashlight for emergency use in a country that suffers from too many power outages, a time-tracking feature to help the user control the duration of each call, multiple phonebooks that make sharing the phone easier, and an easy-to-use menu in multiple languages with calendars. Most of these features would be of little use to affluent professionals who never have to share their phones and who live and work in air-conditioned homes and offices supported by backup power generators. Nokia's multisegment strategy is reflected also in its choice of distribution channels. The high-end phones are marketed through Nokia's own concept stores; in contrast, the low-end phones are sold in approximately seventy thousand outlets through the length and breadth of India, including rural markets. Nokia derives many benefits from its multisegment strategy: a dominant market share; huge economies of scale in R&D, component sourcing, and production; and brand loyalty, which pays off handsomely as lower-income customers get richer and trade up to higher-priced phones.

Otis China is another good example of a multisegment strategy. Given the vast scale of urban construction in China, it is now the largest market for new elevators in the world. Not surprisingly, the market is also very diverse and varies along many dimensions, including use for passengers versus freight, building height, elevator speed, passenger capacity, elevator technology, and customer price sensitivity. Otis has wisely followed a strategy of covering virtually all segments. Focusing on only the high-end segments would not only have deprived Otis of major revenue opportunities but would also have left it vulnerable to serious competitiveness risks. Although the market for high-end elevators is very large, that for other types of elevators is even larger, given the ongoing urbanization of China. Leaving these middle- and lower-end opportunities to other players would have implied that Otis would deprive itself of the enormous and life-long maintenance and service business that follows the installation of a new elevator. At least as important, it would have given Otis's competitors an opportunity to amass technological capabilities and scale that could be leveraged against Otis in its high-end niche. Otis uses different brand names to target different segments: Otis, Xizi Otis, Sigma, and Express. As is evident, some of the brands do not even use the name Otis. The different brands also use different and appropriately tailored sourcing, production, and marketing strategies.

Adidas in China provides an interesting example of a different type of multisegment strategy—one that is driven by the realization that even within the same local market, buyer preferences may differ based on cultural factors. The company has adopted a two-pronged retail strategy in China. One type of store emphasizes new designs that originate at Adidas's design center in Shanghai, tap into local creativity, and are tailored specifically to Asian bodies and tastes (for example, the rise of a pair of pants, how the shoulders fit, how funky the colors should be). The other type of store emphasizes the company's eighty-seven-year heritage and carries more global designs and products. The mall beneath the company's headquarters in Shanghai has one store of each type within the same building.⁵ This type of a multisegment strategy not only enables Adidas to capture a larger portion of the market opportunity but also serves as a useful vehicle to develop deeper knowledge of the diverse and changing preferences of its customers in China.

Make Your Mantra “Market-Centric, Market-Centric, Market-Centric”

Whenever a company enters a new market, it must make fundamental decisions regarding the extent to which it will carry over its existing brand names, products and services, designs, and business models to the new market versus the extent to which it will engage in local adaptation or even outright innovation from the ground up. The choice can range from a near-complete replication of existing approaches at one end to a near-complete bottom-up innovation at the other. When the U.K.-based business newspaper Financial Times entered the U.S. market in the 1990s, it could have, at one extreme, chosen to merely reprint the U.K. edition and sell it in the United States. At the other extreme, it could have chosen to create an entirely new business publication with a new look and new brand name for the U.S. market. Instead of going with either of these two extremes, the publisher chose an intermediate approach. The brand name, the look and feel (such as the pink color of the paper and the type used), and much of the content remained identical. However, the U.S. edition has more in-depth coverage of U.S. news and gives greater prominence to that international news which would be of more relevance or interest to U.S. readers.

The same question (how much replication, how much adaptation, and how much innovation; see Table 3.7) applies to every company that must design or reassess its strategy for the China and India markets. Based on our analysis of and discussions with executives in over a hundred companies with operations in China and India, it is our contention that the vast majority of incumbents from the developed countries reflect naiveté in their strategies for these two markets. The roots of this naiveté lie in the history of companies' experience at globalization.

Until recently, for most multinational corporations (MNCs), globalization meant going to countries that could be classified as either rich-and-rich (large market size and high per capita incomes, as in the case of the United States, European countries, Japan, Canada, and Australia) or poor-and-poor (small market size and low per capita incomes, as in the case of virtually all developing countries). The rich-and-rich markets were not very different from the home market or from each other; thus, a strategy of replication or partial local adaptation would often suffice. The poor-and-poor markets were very different from the MNCs' home markets and quite small in size; as a result, there was little economic justification for undertaking the cost and effort of wholesale business model innovation. Since the cost of a suboptimal strategy for the poor-and-poor markets was fairly small, it made sense for the MNC to bring its developed country products and practices to the developing country market and be satisfied with skimming the top layer of the available economic pie.

Table 3.7 How Much Adaptation? Alternative Strategies

The large size and rapid growth of China and India force MNCs to confront an entirely new reality for the first time: markets that are simultaneously rich-and-poor: very large in terms of market size but very poor in terms of per capita incomes and buying power. Yes, there is a market of affluent buyers at the top of the economic pyramid. However, the size of the market in the middle of the pyramid is even bigger and will become vastly larger over the next twenty years. Economically as well as culturally, the needs, the buying power, and the buyer behavior of this middle market are very different from those of the affluent buyers. Thus, attacking the China and India markets from a mindset of replication or even partial adaptation means that the company would be leaving the bulk of the market opportunity to other players. Domestic players from within China and India are likely to have a particularly strong advantage in capturing these middle and low-end markets. They understand these markets well, have a radically lower-cost structure, and, as local players, can respond speedily to the diverse and changing needs of these customers. Given the scale of these middle and low-end markets, it is inevitable that within a few years, these domestic players will have the size and capability to attack the established MNCs not just within China and India but also in the latter's home markets.

This is how ArcelorMittal, which started out as a small steel mill in Indonesia, has become the world's largest steel company; SABMiller, which started out as a South Africa-based domestic beer company, has become the world's largest brewer; and Cemex, which started out as a midsized cement producer in Mexico, has become one of the world's largest building products companies. Hundreds of such aspiring global champions are currently serving the middle and low-income markets in China and India. In short, in most industries, a China and/or India strategy that rests primarily on replication or even partial adaptation of home country products, services, and business models may be not merely suboptimal for established MNCs but also dangerous from the perspective of long-term survival.

As depicted in Table 3.8, the implementation of a market-centric approach requires that corporate leaders see their company first and foremost as a portfolio of capabilities rather than as a portfolio of brands, products, and services. Of course, existing brands and product and service concepts matter. However, a market-centric company views home country brands and product and service concepts merely as a subset of possible options that they could deploy in big, emerging markets such as China and India. For a market-centric company, the primary focus must be on figuring out what the market needs are and then developing and deploying its own and its business partners' capabilities to create products, services, and solutions that meet these needs at affordable prices and sustainable profit margins.

Table 3.8 Home Country-Centric Versus Market-Centric Approaches to China and India Markets

Yum Brands, the parent company of Pizza Hut, KFC, and Taco Bell, provides an interesting example of a market-centric approach. Sam Su, president of Yum's China operations, has adopted a market-centric approach at both levels: individual brands as well as the parent company. In the United States, for example, the Pizza Hut brand stands for fast food. However, pizza is a new and relatively more expensive food for Chinese consumers. Thus, Sam Su has made Pizza Hut outlets in China more upscale and fancier than in the United States. They are positioned as a sit-down casual dining experience for middle-income consumers rather than as fast and inexpensive food for people on the go. At the parent company level, Sam Su's approach is even more innovative. He has launched an entirely new brand of restaurants, East Dawning, currently being test-marketed in Shanghai and Beijing. East Dawning serves a carefully selected menu of Chinese dishes at reasonable prices. At the level of underlying capabilities, there is much that carries over from Yum's core businesses to East Dawning. However, at the level of the storefront brand, the store design, and the menu, East Dawning reflects ground-up innovation. It is easy to see that the market for Chinese food in China is much bigger than for Western fare such as pizza, fried chicken, and tacos.

As reflected in comments at the beginning of this chapter by Alibaba's Jack Ma about the dangers that a shark could face when battling a crocodile in the Yangtze River, eBay's problems in China are starkly indicative of the downside of forgetting to be market-centric, especially in a market such as China, which differs from Western markets not just economically and culturally but also in terms of language and political system. After acquiring complete control over EachNet in 2003, eBay was reported to have centralized the management of its China operations to such an extent that even decisions such as office expansion required corporate approval. eBay also decided to harmonize its customer-facing activities in China with those in the United States. As in the United States, it made the interface simple. However, local customers liked Web sites that were “loaded with information, links, graphics, banners, and multimedia” and thus regarded eBay EachNet's Web site as “too empty.”⁶ Ebay also did not permit direct interaction between a buyer and a seller until the sale had been completed. In contrast, TaoBao permitted the parties to contact each other and haggle over prices, a practice more consistent with Chinese customers' preferred approach. Compared with TaoBao, eBay was also late in incorporating an escrow into its online payment system. These are just some of the problems that eBay created for itself—problems that could have been avoided if it had been more market-centric.

Focus on Market Development, Not Just Market Share Development

Given the fast pace of economic development, millions of consumers in China and India each year buy their first cell phone, their first PC, their first washing machine, their first car, their first apartment, and, if they can afford to sit down and relax, their first glass of wine. Considering that in each country, over the next twenty years, 500 million citizens are likely to migrate up from the ranks of the poor to the middle class, this pace of new customer addition is unlikely to abate. A direct implication of this reality is that companies aiming for market leadership in China and India must focus at least as squarely on market development as they would on protecting and increasing their market share.

A company can play two types of complementary roles in the market development process. One role pertains to the ecosystem within which the company will operate within China and India. The question to ask here is, What can we do to make the entire ecosystem more robust (more productive, more efficient, higher value creating, and so forth)? The second role pertains to individuals who could potentially become your industry's customers and consumers. The question to ask here is, What can we do to help these individuals become more interested in buying our products and services and smarter at using them?

The German company Metro Cash & Carry's operations in India illustrate what we mean by ecosystem development. As a wholesale operation that sells to other businesses, such as hotels, restaurants, caterers, and small retailers, its development challenge is on the buy side rather than the sell side. In India, the supply chain from the farm to the end consumer suffers from many pathologies: as many as six to seven intermediaries, poor transport and roads, and ignorant farmers and other workers who handle the farm produce. As a result, an estimated 35 to 45 percent of farm produce rots and never makes it to the market. Not surprisingly, modernizing the supply chain has become one of Metro's major focus areas in India. The following are some of the many ways in which the company is attempting to develop the ecosystem in which it is embedded:

• Teaching farmers to stop watering the spinach the night before it is to be picked
• Teaching farmers to stop piling vegetables on the ground after they are picked since bacteria from the ground decrease shelf life
• Giving farmers plastic crates to enable the direct transfer of vegetables from the vines into the crates
• Teaching fishing crews how to cool fish by immediately gutting it and stuffing it with shaved ice to increase the shelf life and enable Metro to create a market for fish in locations far from the coast
• Teaching shepherds to vaccinate their herds and treat them for sicknesses such as foot-and-mouth disease
• Cutting out middlemen by sending refrigerated trucks straight to the farms⁷

The result of these ecosystem development efforts has been an increase in farm productivity, an increase in farmers' compensation, and a more varied and fresher supply of produce at lower prices to Metro's own customers.

Caterpillar provides a vivid example of customer education by persuading customers in China to consider using its Cat 627G Wheel Tractor-Scraper. The normal approach in the earth-moving industry is to publish technical articles with statistics on productivity and efficiency in trade magazines. However, in a market such as China, it is still uncommon for construction companies to keep data on productivity and efficiency. In order to make its case in a manner that would hit home with key groups of customers, Caterpillar picked an existing project in Jilin province to convert 900,000 acres of wasteland into arable land. The company invited local contractors, landowners, government officials, and the media to a demonstration event featuring the new Cat machines. The event was able to make a persuasive case that use of these machines would cut the work schedule by five months, thereby enabling farmers to start earning a living that much sooner. Where technical data on productivity and efficiency might have fallen on deaf ears, being able to demonstrate that their machines could help farmers start making money five months ahead of schedule was a powerful message. The news, featuring the Cat machines, hit the local media and within a few days was picked up by the national CCTV network.⁸

Since the goal of market development is to help the market make the transition from one state to another, effectiveness at this task requires acute sensitivity to the peculiarities of the market's current state, a commitment to leading the market development efforts, and ingenuity in figuring out how to lubricate the transition. These ideas are illustrated well by the efforts of Future Group, India's largest retail conglomerate. As a company that is five times as big as its nearest competitor, Future Group and its units easily have a bigger stake in market development than in market share development. Market development in this context includes helping mostly lower-middle-income customers at the company's newly built supermarkets feel comfortable in an environment that looks utterly different from the hustle and bustle of small shops operating in crowded spaces. One of the mechanisms that the company uses to ease the transition is the creation of organized chaos. The company redesigned the stores and replaced wide and straight aisles with narrow and crooked ones. By design, this made the stores more congested, noisier, and more chaotic. As Kishore Biyani, the founder of Future Group, noted in an interview with the Wall Street Journal, “The shouting, the untidiness, the chaos is part of the design. … With long aisles, the customers never stopped. They kept on walking on and on so we had to create blockages. … Making it chaotic is not easy.”⁹

Develop Ultra-Low-Cost Solutions

Except in the case of companies supplying only high-end niche products such as Hermès accessories or Audi cars, the imperative to develop ultra-low-cost solutions derives directly from the fact that the buying power of the middle- and low-income Chinese and Indian consumers is extremely low and, by the standards of the rich economies, will remain low for at least the next two decades. Even when China's GDP becomes the largest in the world (perhaps around 2030), its per capita income will still be less than one-fourth that in the United States. Thus, as a critical element of their multisegment strategy to become market leaders in China and India, companies must figure out how to develop and deliver ultra-low-cost products, services, and solutions.

It is crucial to remember that while low labor costs play an important role in cost reduction, they are not the most important factor in the creation and delivery of ultra-low-cost solutions. The most important factor is smart design: of the entire business model, the end product or service, and the components. Design decisions dictate the choice of activities, how the various activities will be performed, who will perform them, the magnitude of scale economies, the choice of materials, and operating, use, and maintenance costs, to name just a few of the factors that affect total cost. The importance of design as a major driver of cost was noted years ago in a study by the Defense Advanced Research Projects Agency, an arm of the U.S. government, which noted that “cost reduction opportunities decreased as products moved from concept to production. At the beginning of the conceptual design phase, 90 percent of the cost reduction opportunities remained, while at the start of production only 7 percent of these opportunities remained.”¹⁰

The importance of business model design as the primary driver of cost is illustrated well by Bharti Airtel, India's largest mobile operator. Bharti Airtel offers nationwide cellular services at less than two cents per minute, perhaps the lowest in the world. Even China Mobile, the number one operator in China, has prices that are twice as high. Notwithstanding the low prices, Bharti Airtel has consistently delivered some of the highest profit margins in mobile telephony. One of the major factors in its ability to drive costs down has been an innovative business model whereby the company has outsourced two of the major components of its business system: provision of network capacity to Nokia Siemens Networks (NSN) and Ericsson and provision of end-to-end management services to IBM. NSN and Ericsson get paid not for selling the equipment but for providing network capacity; importantly, they are paid “only when the capacity is up and running and has been used by customers, thereby excluding payment for unused capacity at any point in time.”¹¹ Regarding management services, Bharti Airtel has handed over complete responsibility for supplying, installing, and managing all hardware and software requirements to IBM. In turn, IBM is paid a share of Bharti Airtel's revenues.

These outsourcing agreements, the first of their kind in the global telecommunications industry, have transformed the relationship between the vendors and Bharti. Instead of the vendors wanting to stuff as much hardware and software as they possibly could into the Bharti system, they are now driven to minimize the total cost of the system and expand the system's delivery capacity while meeting the agreed service-level requirements. As experts in their domains, NSN, Ericsson, and IBM ought to be much smarter than Bharti in figuring out how to do so. These outsourcing arrangements have also eliminated large chunks of wasted time and effort spent in contract negotiations with the vendors every few months.

At the end of 2007, the number of cell phone subscribers in India stood at about 200 million. Over the next five years, this figure is expected to reach over 500 million. This growth can happen only if companies such as Bharti Airtel (and its competitors Reliance, Idea, and Vodafone) figure out how to extend mobile telephony to rural areas, where the distances are larger, infrastructure weaker, and income levels much lower than in urban India. As a way to address these challenges in a commercially viable manner, some of the experiments that the wireless operators and their equipment providers are working on include a small antenna that could be installed on the roof to serve a tiny village, antennae that are powered by solar and wind energy, towers that are made from light steel and have more efficient designs, and sharing of towers among competitors.¹² These innovations have little to do with thinking of low labor costs in India as the primary driver of the companies' ability to offer ultra-low-cost wireless services to the rapidly expanding pool of low-income customers.

Opportunities to offer ultra-low-cost solutions exist in virtually every sector of the Chinese and Indian economies: computing, Internet services, transportation, banking, health care, education, housing, hotels, recreation, and many others. In every one of these cases, innovations in the business model, product or service designs, and component designs will be the most important driver of cost reduction, with low labor costs playing an important, albeit secondary, role.

Position Your Company as a Partner to China and India

It should be clear by now that the market environment in China and India is such that a company that wants to achieve market leadership there must adopt a long-term perspective to its presence in and commitment to these two societies. These markets are not just very different but also physically distant from the developed economies of North America and Europe. Internally too, both markets are vast, highly diverse, and complex. Thus, except in rare cases, most companies will find that their existing knowledge about how to succeed in other markets teaches them little about how to succeed in China and India. If they want to aim for market leadership rather than merely skimming the cream at the top, they will need to engage in considerable learning from scratch. Also, given the rapid pace of change, much of this year's market knowledge is likely to become obsolete a year from now. Thus, companies have little choice but to build strong managerial capabilities on the ground and give these managers considerable autonomy to devise locally tailored market-facing solutions. These actions require that companies view China and India as long-term stories and as their permanent homes.

Other factors reinforce the importance of positioning a company as a partner to China and India. Given the importance of market development, companies need to make investments in understanding the ecosystem within which their Chinese and Indian operations will be embedded and in improving the productivity, efficiency, and value added by the ecosystem. The ecosystem will consist of business partners on all fronts: buy side, sell side, providers of complementary products and services, educational institutions, nongovernmental organizations, the media, and government and political entities at various levels. A company that does not come across as having a long-term commitment to the local economy is unlikely to be viewed as a trustworthy partner. Such a company will be confined to playing a secondary role after new market opportunities have already been developed, discovered, and captured by their more committed competitors.

Yet another factor that reinforces the need to view China and India as permanent homes is that in almost every sector of the economy, the market environment in these countries is extremely competitive. Whether it is cars, computers, cell phones, or hotels, every major company from every major economy in the world is eager to capture a share of the market opportunity. In addition, each country has dozens of local competitors that bring their own ambitions, local knowledge, and local capabilities to the marketplace. In such an environment, a company viewed as wavering in its commitment to the local economy is likely to find that it ranks low on the list of preferred employers by top talent and the list of preferred partners by other companies.

Suggesting that the company should position itself as a long-term partner to China and India does not imply that the company would necessarily have to incur major losses for several years before seeing a satisfactory return on investment. Depending on how effective a company has been at developing a beachhead strategy in the early years, how market-centric the company is, and how rapidly it can develop low-cost solutions to serve these markets, the economic returns can start flowing fairly early. B&Q, a chain of home improvement stores and a unit of the British retailer Kingfisher, entered China in 1998 and is now the market leader in the home improvement retail industry there. It turned profitable in 2003 and, according to the company's managers, has been improving its profit margins by about 1 percent a year.¹³

Given the long-term growth prospects of the Chinese and Indian markets, the goal must always be to focus on both the short and the long terms. No company can afford to go bankrupt while chasing distant prospects. At the same time, an excessively short-term orientation means either that the company will give up too soon or that it will end up as a marginal player pursuing a niche segment at the top. Either way, the company's long-term viability is likely to be in jeopardy.

Cisco Systems provides a good example of how a company can position itself as a long-term partner to India and China. In December 2006, Cisco created a second global headquarters (internally called Cisco East) in Bangalore and began relocating several of the most senior executives to India. Building on several China-focused announcements over the next year, in April 2008, John Chambers, the company's CEO, announced the next stage of the company's strategy for China. The new initiatives under this strategy included memoranda of understanding between Cisco and two of the major policymaking bodies in China: the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM).

The agreement with NDRC was aimed at broadening and deepening cooperation between Cisco and China “in the areas of manufacturing and service outsourcing, next-generation Internet, venture investment, training and development, as well as environmentally-focused research and development including energy efficiency, emission reduction and network-based green urban development.” Every one of these areas is of significant and long-term importance to China and the Chinese government. In turn, the agreement with MOFCOM was aimed at helping MOFCOM “implement the Thousand-Hundred-Ten Project for China's business process operations industry.” Cisco announced that through this program, it would provide training to improve employees' skills in China's business process operations sector with the goal of transferring portions of its global business process services to China over the coming three to five years.¹⁴

Conclusion

A 2006 report by the American Chamber of Commerce in Shanghai reported that 65 percent of its member companies were profitable; of these, nearly one-third had profit levels equal to or higher than in other countries. At first blush, these data may suggest that multinational companies are finally beginning to get their China (and, by extension, perhaps also India) strategy right. But based on our field interviews with managers in and analysis of over a hundred companies, we question the validity of any such conclusion. As a more recent report by the IBM Institute for Business Value on MNC strategies in China noted, “Although a small, but growing, number of companies are tapping the mass market, the majority of MNCs still rely on premium-end products in the top cities for the bulk of their revenues and profits.”¹⁵

It is easy to figure out how to keep headquarters executives happy by delivering reports that show attractive profit margins from operations in China and India. We believe, however, that focusing exclusively on profit margins as the measure of success runs a serious risk of leading to misplaced priorities. Pursuing market opportunities in China and India is like entering a large and rapidly growing new line of business. If you just skim the surface, it will appear as if you are doing well. However, what you may not know is that you have a rather small and declining market share and that you are setting yourself up for being pushed aside. Nevertheless, you cannot afford to go in blindly, bet the company on ill-conceived moves, and go down in flames. What China and India require is a mindset of logical incrementalism.¹⁶ By this, we refer to a mindset where an overall strategic logic, as put forward in this chapter, guides your moves, and yet you operate with the fundamental premise that there is much about the future of China and India that you will discover over time as these societies evolve and become very different from what they are today.