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 / Spring 2004 / Issue 34(originally published by Booz & Company)


6 Truths about Emerging-Market Consumers

Even if small-scale retailers’ services are minimal and their merchandising techniques simple when compared to large chain supermarkets, they’re appropriate for the emerging consumer.

Second, small-scale retailers have a sustainable business model predicated on a strong value proposition for emerging consumers and a business model centered on the quick conversion of inventory into cash.

Small businesses operate completely differently than large chain stores. They focus on cash flow; their concern is whether they can cover their costs each month and have money left to replenish inventory. As a result, they typically do not manage according to such metrics as return on invested capital, sales per employee, or inventory turnover.

That said, standard analytical frameworks that apply to modern retail stores are useful to highlight some distinct advantages of the small-scale retail business model. Although our productivity research showed the small-scale retailers’ monthly gross margin per full-time employee and sales per square meter of selling surface were significantly lower than those of large retail chains, small-scale retailers excel in managing inventory turnover. We found that the monthly gross margin return on inventory for small shops is more than double that of large chain supermarkets. (See Exhibit 2.)

Small-scale retailers’ dependence on cash, plus the fact that inventory mismanagement is so obvious in a small shop — the products gathering dust, the empty space when products are out of stock — forces them to impose rigorous discipline on their inventory management. Even if small retailers lack sophisticated inventory management tools, they commonly receive help from distributors and direct-delivery manufacturers, so they can keep accurate records and determine appropriate order size.

Yet inventory management is not the secret of their resilience. To really understand why the small retailers’ business model is sustainable, it is necessary to look closely at net operating profit, particularly their labor cost advantage. Small retailers’ labor costs are generally lower and more variable than those of the large supermarkets because most of their employees are family members. Employing a close relative gives the small retailer greater flexibility to adapt the employee’s hours to fluctuations in store traffic. It also means retailers can often make the bulk of their employees’ pay noncash remuneration — for example, room and board for the son or daughter who lives at home. There is a lower risk of theft, and evasion of employment and other social taxes is easier since there is little threat of a family member filing an employee grievance.

Informal business practices, especially tax evasion, can have a significant, advantageous impact on a small-scale retailer’s profitability. However, even if informality were totally eliminated, only truly poorly performing traditional shops would fail. The stronger ones would simply absorb the costs of operating according to formal business rules by raising their prices.

Small retailers can also save on such general expenses as security, cleaning, marketing services, and administrative costs, which account for 3 to 10 percent of sales for larger chain retailers, because store owners or employees handle these tasks themselves. Energy costs are low since there usually are no air conditioners or large banks of refrigerators and freezers in the small stores, and lighting is kept low.

Measured as a percentage of sales, we found small retailers have operating expenses lower than or comparable to chain supermarkets’. One well-known chain in Argentina reported operating expenses as 32 percent of net sales — more than double the 14 percent observed at selected small-scale retailers.

Serving the Segment
Retailers who don’t want to wait for the theoretical and long-term “trickle down” effects of rising incomes to grow their markets have several business options to consider. One is to target subsegments of emerging consumers in certain geographic areas, and to develop a business model that can be replicated in an extended network of stores. But companies will need to be more inventive and bolder than they have been in the past to profitably meet emerging segments’ needs.

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  1. James A. Gingrich, “Five Rules for Winning Emerging-Market Consumers,” s+b, Second Quarter 1999; Click here.
  2. Alonso Martinez, Ivan De Souza, and Francis Liu, “Multinationals vs. Multilatinas: Latin America’s Great Race,” s+b, Fall 2003; Click here.
  3. C.K. Prahalad and Stuart L. Hart, “The Fortune at the Bottom of the Pyramid,” s+b, First Quarter 2002; Click here.
  4. David Luhnow and Chad Terhune, “A Low-Budget Cola Shakes Up Markets South of the Border,” Wall Street Journal, October 27, 2003
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