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 / Spring 2008 / Issue 50(originally published by Booz & Company)


Twenty Hubs and No HQ

Metrics for Emerging Markets
Admittedly, many corporate leaders may find the very concept of the gateway–hub structure discomfiting. Some may seek to avoid it altogether by remaining in their home regions. But they run a terrible risk if they do. Western corporate strategists have understood in principle the importance of a global strategy, but they consistently underestimate the value creation potential of developing nations. The assumptions persist that emerging countries do not represent viable markets, because their consumers cannot afford to buy products and services sold by MNCs. Western managers also tend to underestimate the skill base and talent in these countries, often on the grounds that potential employees lack the education and training to meet Western standards. And they overestimate the prevalence of corruption, quality flaws, risky supply lines, and unreliability when sourcing from these nations. (For example, Western managers may treat the recent quality scandals in toys and pharmaceutical ingredients from China as symptomatic of the entire country.)

Most important, Western managers typically misjudge the relative profitability of activity in emerging markets. One reason for this is a flaw in the way that national economic activity is typically measured. The most generally accepted metric, the gross domestic product (GDP) — the financial value of all goods and services produced in a country in a given year — is converted from local currencies into U.S. dollars for comparison. It is thus distorted by exchange rates. A more accurate conversion measure, representing the purchasing power of consumers in that local market, is purchasing power parity (PPP), which is based on a comparison of the prices of a typical basket of goods in different markets.

When looked at in PPP dollars, the GDP data tells us how significantly the world has changed since 1997. In that year, no emerging nation was included in the International Monetary Fund’s list of the world’s highest-ranked 10 economies (by volume of activity). In 2007, China, India, Brazil, and Russia made it onto that list. In these PPP-based rankings, China has a higher GDP than Japan; China and India are both ahead of Germany, the U.K., France, and Italy; and Brazil, Russia, and Mexico all outrank Spain, Canada, Australia, and the Netherlands in GDP. And the economies of the developing world are growing at more than 5 percent per year, which is twice the rate forecast for the developed nations. China and India are growing at a rate of more than 9 percent.

If nothing else, this data challenges the traditional categorization of economies as rich and poor. That distinction is rapidly becoming a thing of the past, as the “poor” economies of emerging markets grow rapidly in scale and sophistication. The purchasing power of households in South Korea, South Africa, Mexico, Russia, and Brazil is not much different from that of households in Spain or Portugal. The growth opportunities are especially evident when it comes to products that are normally associated with a vibrant economy: cell phones, cars, televisions, and personal computers. Similarly, the opportunities to profit by serving the economic “bottom of the pyramid” no longer exist just in emerging markets. For example, people in the U.S. who cannot afford health care are not just a political constituency; they are a market for low-cost preventive health-care services, which a few retailers, like Wal-Mart, are beginning to serve with in-store clinics.

There is one more financial implication, often forgotten by corporate strategists. When revenues or returns from an emerging market such as India are computed in U.S. dollars or euros, they often appear smaller than they should because of currency exchange rate conversions. In other words, most companies do not incorporate the effect of PPP and foreign exchange in evaluating their investments.

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