Second, rough diamonds create inclusive market niches and segments. In emerging markets, demand is not only nascent, but often extremely fragmented as well. The enormous diversity in customs, cultures, and languages can be bewildering, especially in continent-sized markets, such as China and India. Rough diamonds leverage their superior knowledge of local markets and customers to anticipate demand, secure first-mover advantages, differentiate their products and services, and consolidate their positions ahead of their foreign competitors. For example, Esmaltec, a Brazilian appliance manufacturer, changed production from one-door to two-door refrigerators, added frost-free technology, and lowered the energy consumption on every one of its products, all without a large increase in price, while its Western competitors were waiting for high-end demand to grow.
Third, rough diamonds craft operational excellence. The authors found that these companies all spend a good deal of time and effort developing efficient and flexible operations. Since distribution and logistics systems tend to be extremely fragmented in emerging markets, rough diamonds invest heavily in both backward and forward integration, often building out complete supply chains of their own. In Brazil, for example, Magnesita developed an integrated supply chain from scratch, establishing a network that stretched from mining to the manufacturing of its nonclay refractory products to distribution and logistics. Rough diamonds also pay much attention to ensuring quality along the entire value chain, because trust in a company’s integrity can be even more important in emerging markets than elsewhere, due to weak institutions and a lack of enforcement power. And they are innovative, building up their R&D capabilities by making investments in education, hiring top researchers, and creating focused learning centers.
Finally, rough diamonds cultivate profitable growth. The conventional wisdom holds that success in emerging markets is a function more of rapid revenue and market share growth than of early profitability. However, such a top-line growth fetish often leads to overextension in emerging markets, because the requisites of growth—such as manufacturing facilities, managerial talent, and physical infrastructure—are limited by underdeveloped market institutions. In examining more than 105,000 BRIC companies over consecutive five-year periods, the authors reported that more than 70 percent of the firms that adopted a profit-oriented strategy in Phase I retained their higher profitability in Phase II, whereas fewer than 10 percent successfully made the switch from a sales-first strategy to profits later. Thus, it is not surprising that virtually all rough diamonds adopt a more balanced approach to growth that doesn’t overtax their internal resources or incur unnecessary risks. These companies recognize that growth is important, but pursue it in a phased approach of gradual and incremental expansion, while remaining intently focused on sustaining high levels of profitability. Accordingly, the authors also find that rough diamonds do not engage in M&A nearly as much as do many state-owned enterprises, especially those in China. Undoubtedly this is partially due to their incrementalist management philosophy, but perhaps it also reflects their relatively small size and few resources.
The book’s focus on a hitherto little known set of private companies, instead of Huawei, Lenovo, Tata, and the other usual suspects, makes it a valuable addition to the growing body of literature on emerging market multinationals. In addition, the authors’ data on the long-term benefits of adopting a profit-first versus a top-line growth orientation is truly insightful, and their extensive experience and insight into the peculiarities of doing business in emerging markets shine through on every page. For these reasons, Rough Diamonds is my choice for the best business book on globalization in 2013.
A Tidal Wave of Entrepreneurialism
The emergence of rough diamonds, and indeed of any national economy, depends on an environment that encourages and supports entrepreneurial activity. China’s economic growth spurt didn’t start until the early 1980s, when Deng Xiaoping unleashed a wave of entrepreneurship via township and village enterprises, which were effectively private firms at the local level. Similarly, India’s economy took off only after it finally abandoned the stifling bureaucracy of the License Raj in the early 1990s (although India continues to have a large number of rules and regulations that, for example, make it difficult to start a new business).