Chapter 9

Understanding Emerging Markets International Business Strategy, Management & the New Realities by Cavusgil, Knight and Riesenberger

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Learning Objectives

1. The distinction between advanced economies, developing economies, and emerging markets 2. What makes emerging markets attractive for international business 3. Estimating the true potential of emerging markets 4. Risks and challenges of doing business in emerging markets 5. Strategies for doing business in emerging markets 6. Catering to economic development needs of emerging markets and developing economies

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Classifying Countries based on Economic Development

•

Advanced economies

are post-industrial countries characterized by high per capita income, highly competitive industries, and well-developed commercial infrastructure.

Examples

world’s richest countries and include Australia, Canada, Japan, New Zealand, the United States, and Western European countries. •

Developing economies

are low-income countries characterized by limited industrialization and stagnant economies

.

Examples

- low-income countries, with limited industrialization and stagnant economies- e.g. Bangladesh, Nicaragua and Zaire. •

Emerging market economies

economic growth

.

are a subset of former developing economies that have achieved substantial industrialization, modernization, improved living standards and remarkable

Examples

- some 27 countries in East and South Asia, Latin America, Middle East and Eastern Europe- including Brazil, Russia, India, China (so called BRIC countries).

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Advanced Economies

• • Mature state of industrial development; transitioned from manufacturing economies into service-based economies. • Home to 14% of the world’s population, and account for half of world GDP, over half of world trade in products, and three quarters of world trade in services.

Political systems

government.

- democratic, multiparty systems of • •

Economic systems

- typically based on capitalism, with relatively little government intervention in business.

• Serious purchasing power; few restrictions on international trade and investment.

• They host the world's largest MNEs.

Example

Ireland, which has one of the world’s best performing economies, with much FDI from foreign manufacturers in high-tech industries such as Gateway.

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Developing Economies

• Low discretionary incomes, limited proportion of personal income spent on purchases other than food, clothing, and housing. • In developing economies, 17% live on less than $1 per day; 40% live on less than $2 per day.

• The combination of low income and high birth rates tends to perpetuate poverty.

• Misnomer-sometimes called

underdeveloped countries

or

third-world countries-

these terms are imprecise because, despite poor economic conditions, the countries tend to be highly developed in historical and cultural terms.

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Developing Economies

• • Hindered by high infant mortality, malnutrition, short life expectancy, illiteracy, and poor education systems; correlates with economic development, the vicious cycle of poverty. • Productivity is stagnant; living standards deteriorate.

Debt-

Governments in developing economies are often severely indebted- countries in Africa, Latin America, and South Asia have debt levels close to their annual GDP.

•

Bureaucracy

much of Africa’s poverty is the result of government policies that discourage entrepreneurship, trade, and investment.

Example

and 17 days to complete.

- starting a new business: • In sub-Saharan countries in Africa involves an average of 11 different approvals, and takes 62 days to complete. • In advanced economies, takes an average of 6 approvals,

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Emerging Market Economies

• Most distinguishing characteristic- countries are enjoying rapidly improving living standards and a growing middle class with rising economic aspirations. • Importance in the world economy is increasing as attractive destinations for exports, FDI, and sourcing.

• Emerging market countries are evolving towards wealthy nation status.

•

Examples

: Hong Kong, Israel, Saudi Arabia, Singapore, South Korea, and Taiwan have developed beyond the emerging market stage. • 2004- emerging markets- the Czech Republic, Hungary, and Poland, received a boost when they became members of the European Union. By joining the EU, these countries had to adopt stable monetary and trade policies. They leverage their low-cost labor to attract investment from Western Europe, thereby boosting their economies.

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Emerging Market Dynamics

• Emerging markets account for over 40 percent of world GDP. They represent over 30 percent of exports and receive over 20 percent of FDI.

• Mid-2000s, the emerging markets collectively enjoyed an average annual GDP growth rate of nearly

7%

, a remarkable feat – much faster than advanced economies • Benefit from: low-cost labor, knowledge workers, government support, low-cost capital, and powerful, highly networked conglomerates

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The New Global Challengers (

Boston Consulting Group Study)

Some 100 companies from Emerging Markets (called Rapidly Developing Economies in the BCG study) are poised to become important 21 st -century multinationals.

•

Examples: Brazil

: Embraer, Sadia & Perdiago, Natura Mexico: America Movil, Groupo Modelo

India

: Ranbaxy, Infosys, Tata Tea, WIPRO

China

: Galanz, Haier, Chunlan Group Corp., Lenovo, Pearl River Piano

Turkey

: Koc Holding, Vestel & Sisecam

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The New Global Challengers

• RDEs have rapidly growing markets, some of which are very large • RDEs have low-cost resources • Difficult operating environments at home produce some highly capable companies • RDEs are training grounds for competing with global incumbents

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Six Strategic Globalization Patterns of the New Global Challengers from EMs

1.

2.

3.

4.

5.

6.

Taking RDE brands global (China’s Hisense, taking consumer electronics to Africa) Turning RDE engineering into global innovation (India’s Wipro) Assuming global category leadership (Hong Kong’s Johnson Electric) Monetizing RDE natural resources (Brazilian food processors Sadia and Perdiago) Rolling out new business models to multiple markets (Mexico’s cement conglomerate Cemex’s global acquisition strategy) Acquiring natural resources (Shanghai Baosteel group expanding globally to secure stable iron-ore supplies)

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Developing Economies Evolving into Emerging Markets

• • European countries of Estonia, Latvia, Lithuania, Slovakia. • Latin American countries of Costa Rica, Panama, and Uruguay.

• Kazakhstan, Nigeria, Vietnam, and the United Arab Emirates.

• Economic prosperity varies

within

emerging markets there are usually two sets of economies – those in urban areas (more developed economic infrastructure) and those in rural areas (less discretionary income).

Transition economies = Privatization

of former state enterprises

-

since 1989 after transition from

centrally planned economies into liberalized markets:

Czech Republic, Hungary, and Poland; also China and Russia.

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Transition Economies

• Transition economies engaged in large-scale privatization of state-owned enterprises.

• Excessive regulation and entrenched government bureaucracy, now are introducing legal frameworks to protect business and consumer interests and ensure intellectual private property rights. • Russia endured high inflation with annual price increases reaching 100%, hindering foreign investment and economic development. • Shaking off the Soviet legacy required the country to restructure not just firms and institutions, but also adopt new values about private ownership, profits, intellectual property, etc. • Initially, western companies doing business in Russia found it difficult to recruit managers who understand modern management practices.

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Intense Market Liberalization in Transition Economies

•

Transition economies

foreign companies initiated trade and investment relationships with them. liberalized their markets- many •

Privatization

provided many opportunities for foreign firms to enter these markets by purchasing former state enterprises. In Eastern Europe, Western companies are leveraging inexpensive labor and other advantages in the region to manufacture products bound for export markets. • Hungary, Poland, the Czech Republic, and other former East Bloc countries have made great strides in

political

and

economic

development.

restructuring. These countries are well on their way to more advanced stages of economic

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Opportunities for Foreign Firms in China

• Ample opportunities for firms marketing technologies and environmental protection equipment • Foreign firms can profit from China’s low-cost labor and growing affluence, numerous foreign companies set up sales offices and manufacturing facilities, but success is slow. • Wal-Mart sourced over $30 billion of merchandise from China in 2007- saves immensely.

• A sizeable consumer segment: 250 million ‘middle-class’ residents.

• Success requires deep understanding of the market and long term commitment: Coca-Cola, General Motors, McDonald's, Motorola, Airbus, and Volkswagen. • Challenges: Disparate rates of development between the coastal areas vs. West; poverty; environmental degradation.

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What Makes Emerging Markets Attractive?

Emerging markets are attractive as target markets, manufacturing bases, and sourcing destinations.

1. Emerging Markets as Target Markets

• Growing middle class - emerging markets have become important –represent substantial demand for electronics and automobiles and health care services.

• The largest emerging markets have doubled their share of world imports in the last few years.

• Emerging markets are excellent targets for manufactured products, technology, and sophisticated technology: • Textile machinery industry in India is huge • Oil and gas exploration plays a vital role in Russia • Agriculture is a major sector in China.

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Emerging Markets can Serve as Niche Markets

• Lockheed Aircraft, whose Hercules turboprop is a popular airliner in poorer countries, has developed transport planes that carry bulk commodities at relatively low costs. • Novartis and Pfizer are pharmaceutical firms that reap big profits from selling vaccines and medicines that can be stored without refrigeration when shipped to distant markets. • Demand is growing fastest in emerging markets- Black & Decker and Robert Bosch, the fastest-growing markets are in Asia, Latin America, Africa, and the Middle East • Governments and state enterprises are targets for sale of infrastructure-related products/services- machinery, power transmission equipment, transportation equipment, high-technology products, etc.

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Emerging Markets As Manufacturing Bases

2. Emerging markets as manufacturing bases

• Home to low-wage, high-quality labor for manufacturing and assembly operations. • Large reserves of raw materials and natural resources. • South Africa is a key source for industrial diamonds. • Brazil long has been a center for mining bauxite, the main ingredient in aluminum. • Thailand has become an important manufacturing location for Japanese MNEs such as Sony, Sharp, and Mitsubishi. • Malaysia and Taiwan- Motorola, Intel, and Philips manufacture semiconductors there.

• Mexico and China- platforms for consumer electronics and auto assembly.

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Emerging Markets As Sourcing Destinations

• • •

Outsourcing

advantage. - procurement of selected value adding activities, including production of intermediate goods or finished products, from independent, external suppliers. Helps foreign firms become more efficient, concentrate on their core competences, and obtain competitive

Offshoring -

when sourcing involves foreign suppliers or production bases.

Global sourcing

- refers to the procurement of products and services from foreign locations. Procurement can be from either independent suppliers or company-owned subsidiaries.

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Emerging Markets As Sourcing Destinations

3. Emerging markets as sourcing destinations

• MNEs have established call centers in Eastern Europe, India, and the Philippines. • Dell and IBM outsource certain technological functions to knowledge workers in India. • Intel and Microsoft have much of their programming activities performed in Bangalore, India. • Investments from abroad benefit emerging markets as they lead to new jobs and production capacity, transfer of technology and linkages to the global marketplace.

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Estimating the Potential of Emerging Markets

• Estimating the true potential of emerging market demand is challenging. The economic and social environments in these countries are highly peculiar.

• Limited availability of data sources or reliability of information.

• Market research may be more costly and less precise than in advanced economies • Market potential indicators include: GDP growth rate, income distribution, commercial infrastructure, the rate of urbanization, consumer expenditures for discretionary items and unemployment rate.

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Market Potential Indicators

• Three practical approaches firms employ in assessing market potential of individual countries are:    per-capita income size of middle-class, and A mix of market potential indicators • Market potential may be assessed with aggregate country data, such as gross national income (GNI) or per-capita GDP, expressed in terms of a reference currency, such as the U.S. dollar.

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Purchasing Power Parity Adjustment to per capita GDP

• In relying on per capita GDP for comparison of different countries, one should use purchasing power parity exchange rates, rather than the market exchange rates. • Purchasing power parity adjustment provides a more realistic indicator of purchasing power of consumers in emerging and developing economies.

• PPP adjusted per capita GDP more accurately represents the amount of products that consumers can buy in a given country, using

their own currency

and consistent with

their own standard of living. International Business: Strategy, Management, and the New Realities

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Big Mac Index (The Economist)

• •

Big Mac Index

- another way to illustrate the PPP concept is to examine the

Big Mac Index

available at globalEDGE™ and developed by the

Economist

(www.economist.com).

The Economist

's Big Mac index is based on the theory of purchasing-power parity (PPP), according to which exchange rates should adjust to equalise the price of a basket of goods and services around the world. The Economist publication selects a single product for the basket of goods: a McDonald’s Big Mac.

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What the Big Mac Index Suggests

• The Big Mac Index first gathers information on the price of hamburgers at McDonald’s restaurants worldwide. It then compares the prices based on actual exchange rates to those based on the PPP price of Big Macs to see whether a nation’s currency is under-valued (most developing economies or emerging markets) or over valued (most European countries).

• The index is supposed to serve as a guide to the direction in which currencies should, in theory, head in the long run. • In its most current version, the big Mac index suggests that the Japanese yen is 28% undervalued against the dollar, and the euro is 19% overvalued.

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Big Mac Index

Source:

The Economist

, July 2007 Big Mac prices The EURO € British Pound

£

Japanese Yen ¥ Chinese yuan 元 11 In local currency 3.06

1.99

280 Norwegian kroner kr 40.0

In U.S. dollars 4.17

4.01

2.29

1.45

6.88

Swiss francs CHF 6.30

South African rand R 15.5

5.20

2.22

Russian ruble руб 52.0

2.03

15.2

Implied PPP of the Actual dollar exchange rate July 2007 Under (-)/over (+) valuation against the dollar, % 1.12

1.71

82.1

3.23

11.7

1.85

4.55

1.36

2.01

122 7.60

5.81

1.21

6.97

+22 +18 -33 -58 +102 +53 -35 25.6

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Limitations to the Use of Per Capita GDP

1.

2.

3.

4.

Managers must adjust the numbers for the existence of an

informal economy

—

economic transactions that are not officially recorded and therefore left out of government calculations of a nation's GDP, e.g. barter exchanges. The great majority of the population is on the low end of the income scale in emerging markets (and developing economies), ‘

mean’ or ‘average’ does not accurately represent a non-normal distribution

; often, the median or the modal income would yield a better understanding. Household income is several times larger than per-capita income because of

multiple wage earners

in these countries.

Governments in these countries may

under-report national income

so they can qualify for low-interest loans and grants from international aid agencies and development banks.

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Middle Class as an Indicator of Market Potential

• The middle class represents the proportion of people in between the wealthy and the poor, has economic independence and consume many discretionary items, including electronics, furniture, automobiles, recreation, and education. • In emerging markets, the size and growth rate of the middle class serve as signals of a dynamic market economy • Demographic trends indicate that, in the coming two decades, the proportion of middle-class households in emerging markets will become much bigger, with enormous spending power.

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Progress of Emerging Markets in Building Their Middle Classes

• While India and Indonesia feature large middle class populations in absolute terms, per-capita GDP in these countries is rather modest, especially when compared to South Korea, China, Russia, and Mexico - although income is relatively high at 49 and 48%, respectively. • Brazil- middle class citizens control only about 35% of national income. • In relative terms, South Korea has made the most progress towards building a sizable middle class; its middle-class accounts for about 55% of national income.

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Emerging Market Potential Index (EMPI)

• • • • • • • • The

EMPI

combines factors that provide firms with a realistic measure of export market potential:

Market Size:

population the country’s population, especially urban

Market Growth Rate: Market Intensity:

the country’s real GDP growth rate private consumption and GNI represent discretionary expenditures of citizens

Market Consumption Capacity:

The percentage share of income held by the country’s middle class

Commercial Infrastructure:

characteristics such as number of mobile phone subscribers, density of telephone lines, number of PCs, density of paved roads, and population per retail outlet

Economic Freedom: Market Receptivity:

the degree of government intervention the particular country’s inclination to trade with the exporter’s country as estimated by the volume of imports

Country Risk:

the degree of political risk

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Managers can use EMPI in Many Ways

1. Rankings can provide an objective method for prioritizing emerging markets in the course of planning international expansion. 2. On-line EMPI at

EMPI

rankings are interactive, so users can rank markets on the basis on any of the eight dimensions making up the overall Index (see the

globalEDGE™

). 3. Managers can modify the assigned weights to fit the unique characteristics of their own industry. 4. Managers may add additional indicators that are not currently included in the represented in the

Index

.

EMPI

as a way of refining the tool for greater precision, or they may add additional countries beyond the emerging markets already

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Challenges of Doing Business in EMs: Political Stability

• • The absence of reliable government authorities adds to business costs, increases risks, and reduces managers’ ability to forecast business conditions. • Political instability is associated with corruption and weak legal frameworks that discourage investment.

Example

- Russia- Bureaucratic practices favor well-connected, home-grown firms threaten the business activities of foreign firms, i.e. denying access to Russia’s energy resources- harming foreign investor confidence.

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Challenges of Doing Business in EMs: Weak Intellectual Property Protection

• Even if they exist, laws that safeguard intellectual property rights may not be enforced, or the judicial process may be painfully slow. • Argentina- enforcement of copyrights on recorded music, videos, books, and computer software is inconsistent- laws against Internet piracy are weak and ineffective.

• China Indonesia, and Russia - counterfeiting is common, especially with software, DVDs, and CDs. • India- weak patent laws discourage investment by foreign firms.

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Challenges of Doing Business in EMs: Bureaucracy and Lack of Transparency

• Burdensome administrative rules, as well as excessive requirements for licenses, approvals, and paperwork, delay business activities. •

Example

- American International Group (AIG) formed a joint venture with the giant Indian conglomerate Tata, to enter India's underserved $8 billion insurance market, and it still took six years before the Indian government granted AIG permission to sell property and life insurance. • Excessive bureaucracy means lack of transparency, i.e. legal and political systems are not open and accountable. Where anti-corruption laws are weak, bribery, kickbacks and extortion are common. • In

Transparency International’s

rankings, emerging markets such as Argentina, Indonesia, and Venezuela experience substantial corruption.

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Challenges of Doing Business in EMs: Partner Availability and Qualifications

• Foreign firms need to seek alliances with local partners in countries characterized by inadequate legal and political frameworks gaining access to local market knowledge, supplier and distributor networks, and key government contacts. • Qualified business partners in emerging markets are not readily available. Often in emerging markets, one has to contend with second-best or third-best partner candidate, and provide much technical and managerial assistance to upgrade the partner’s capacity.

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Challenges of Doing Business in EMs: Dominance of Family Conglomerates

• Many emerging market economies are dominated by family-owned rather than publicly-owned businesses. •

Family conglomerate

(FC) is a large, privately-owned company that is highly diversified, and control economic activity and employment in emerging markets.

• South Korea, where they are called FCs account for nearly half the assets and industry revenues in the Korean economy. Samsung, the most famous Korean FC, has annual revenues of $140 billion.

• India where they are called

business houses

• Latin America where they are called • Turkey where they are called

chaebols grupos holding companies

Group accounts for about 20 percent of trading on the Istanbul Stock Exchange, and Sabanci provides over five percent of Turkey’s national tax revenue.

the top 30 - the Koc

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Characteristics of Family Conglomerates

• A typical FC may hold the largest market share in each of several industries in its home country. • FCs enjoy various competitive advantages in their home countries, such as government protection and support, extensive networks in various industries, superior market knowledge, and access to capital, e.g. Hyundai’s advantages were overwhelming to foreign automakers. • The origin and growth of FCs are partly attributable to governments, which protect FCs by providing subsidies, loans, tax incentives, and market entry barriers to competitors. • FCs provide huge tax revenues and facilitate national economic development.

• FC dominance in emerging markets suggests that they will be formidable competitors or capable partners.

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Managerial Strategies: Partnering with Family Conglomerates

• Most major FCs in Korea; Koc and Sabanci in Turkey; Vitro in Mexico; Astra in Indonesia are highly diversified; own their own financing operations, banks, and distribution channels. FCs make valuable venture partners in emerging markets. They can: 1. reduce risks, time, and capital requirements for new market entry 2. develop relationships with governments and other key, local players 3. target market opportunities more rapidly and effectively 4. overcome infrastructure-related hurdles 5.

leverage FC’s resources and local contacts.

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Examples of Partnering with Family Conglomerates

• Ford partnered with Kia to introduce the Sable line of cars in South Korea-Kia's strong distribution and after service network. • Digital Equipment Corporation (DEC) designated Tatung, a Taiwanese FC, as the main distributor of its workstations and client-server products in Taiwan Tatung's local experience and distribution network. • In Turkey, Sabanci entered a joint venture with Danone, the French yogurt producer and owner of the Evian brand of bottled water. Danone brought ample technical knowledge in packaging and bottling, and a reputation for healthy and environmentally friendly products, but it lacked information on the local market. As the Turkish market leader, Sabanci knows the market, retailers, and distributors- resulting in making Danone the bottled water market leader in the first year.

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Managerial Strategies: Marketing to Governments

• In EMs, government agencies and state-owned enterprises are important customer groups: • Governments buy enormous quantities of products (such as computers, furniture, office supplies, and motor vehicles) and services (such as architectural, legal, and consulting services). • State enterprises operate in areas such as railways, airlines, banking, oil, chemicals and steel, and buy goods and services from foreign companies. • Public sector influences the procurement activities of various private or semi-private corporations.

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Aspects of Marketing to Governments

• • •

Request for proposals (RFPs)

(buyer) seeking bids from suppliers to procure bulk commodities, equipment, and technology or to build power plants, highways, dams, and public housing. • Governments prefer dealing with vendors that offer complete sales and service packages -- in addition to financing (e.g., low-interest loans). country-level advantages.

or

tenders

- government agencies • Governments are attracted by deals that create local jobs, employ local resources, reduce import dependence, and provide other

Examples

Bechtel, Siemens, General Electric, Hitachi, KBR… regularly participate in bidding for global tenders from emerging market governments.

Three Gorges Dam

on the Yangtze River in China, will be fully operational in 2009, following 16 years of construction- will cost $25 billion, will be the largest hydroelectric dam in the world- global contractors involved- ABB, Kvaerner, Voith, Siemens, and GE.

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Major International Contractors

Managerial Strategies: Skillfully Challenging EM Competitors

• • Advantages such as low-cost labor, skilled workforce, government support, and FCs, are fostering the rise of firms that are capturing market share from incumbent international players.

Example

India’s Mahindra & Mahindra (farm equipment industry) has been grabbing market share from John Deere and Komatsu, with brands such as the Mahindra 5500, a powerful, high-quality tractor that sells for far less than competing models. Advanced economy firms must: • Conduct research to understand the indigenous challengers • Acquire new capabilities that build competitive advantages (R&D investment, partnering with competitors, leveraging low-cost labor).

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Catering to Economic Development Needs of EMs

• Internationalizing firms are more involved in fostering economic development in Ems -- a form of corporate social responsibility because they help developing economies grow- most cases they also make good business sense.

• Economic development through profitable modernization projects • Entrepreneurship through small-scale loans • Fostering economic development with profitable projects • Historically few firms targeted poor countries- however- If firms market appropriate products and employ suitable strategies, doing business in EMS and developing economies can be profitable.

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Innovative Solutions to Local Economic Development

• Unilever and P&G sell Sunsilk and Pantene shampoo in India for less than $0.02 per mini-sachet. • Narayana Hrudayalaya sells health insurance for less than $0.20 per person per month in India. • Amul, one of India’s largest processed food companies, sells a wide range of food products to millions of poor people.

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Ericsson’s Experience with Local Economic Development

• Ericsson, the Swedish telecom modernized the telecom infrastructure in rural parts of Tanzania, and other parts of Africa. Between 1998 and 2004, the number of mobile-phone users in Africa grew to 81 million – the fastest growth worldwide. • The emergence of a significant cell phone market in Africa led to the development of related industries and the launch of local firms that produce accessories, such as devices for recharging cell phone batteries. Ericsson’s experiences suggest that market-based solutions not only contribute to social and economic transformation, but can be profitable as well.

• Ericsson also modernized much of Russia’s antiquated phone systems; installed Hungary’s digital telephone system (in partnership with local government); was instrumental in expanding Vietnam’s telecommunications network, and manufactured optical fiber cables in partnership with the Birla Group in India- one of the largest family conglomerates.

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Partnering with State-Owned Enterprises

• Partnering with state-owned enterprises builds competitive advantages in EMs. • Development of infrastructure in transportation, communications, and energy systems • Job creation and contribute to regional and sector development. • Investment generates local tax revenues, which can be spent to improve living standards among the poor. • Technology transfer promotes local innovation and enterprise. • Corporate citizenship- community-oriented social programs that foster economic and social development.

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Microfinance to Facilitate Entrepreneurship

•

Microfinance

refers to providing small-scale financial services, such as “microcredit” and “microloans,” that assist entrepreneurs in poor countries-providing small loans, frequently less than $100, small-scale entrepreneurs (primarily women) accumulate sufficient capital to launch businesses that help pull them out of poverty. • This concept led economics professor Muhammad Yunus to found the Grameen Bank in Bangladesh in 1974- now has over 2,100 branches- with 17 microfinance organizations in China- and has helped millions of Grameen borrowers in Bangladesh rise out of acute poverty.

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Experience with Microfinance Projects

• World Bank estimates there are more than 7,000 microfinance institutions, serving some 16 million poor people in developing economies.

• Thanks to the success of microfinance, Yunus was awarded the 2006 Nobel Peace Prize. • Similar efforts have been inspired in dozens of poor countries worldwide, often sponsored by philanthropic organizations such as the Bill and Melinda Gates Foundation.

• Proponents point to how a small amount of money can have a dynamic, ripple effect on many lives in a village. • Microfinance has gained credibility in the mainstream banking industry- with other forms of small-scale financial services offered in poor countries worldwide, including insurance and mortgage lending.

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