Going Local to Go Global

Wharton's Marshall Meyer has written a new paper titled, "Going Out by Going In."   Meyer describes how Chinese firms such as Haier (an appliance manufacturer) "draw revenues from overseas by penetrating previously inaccessible domestic markets and then renting their distribution and service channels to foreign competitors.”   After all, foreign firms often find it very difficult to establish a route to market (distribution and sales channels) in the vast rural areas of emerging markets such as China or India.  If a domestic firm such as Haier has already established a route to market capability in those rural areas, they can generate significant revenue by providing services to foreign manufacturers who do not have the resources or the knowledge to replicate that rural presence quickly.  Meyer takes it one step further though.  He suggests that firms such as Haier develop experience and knowledge from building new routes to market in these rural areas in their home country, and that expertise may facilitate international expansion as well.  In other words, the knowledge and processes developed at home may be transferable as these firms from emerging markets try to establish a route to market in other countries, even those in the industrialized world.  Check out this video below, in which Meyer explains his research on this topic. 

Diversified Firms in Emerging Markets

Harvard Professor Tarun Khanna has conducted extensive research on large business groups (conglomerates) in emerging markets.  He has found that the so-called conglomerate discount doesn't exist in many emerging markets.  Why?  Khanna argues that institutional voids exist in these countries.   Capital, labor, and product markets are not very efficient.  Therefore, large organizations and their management teams fill these "voids" in those countries.  In other words, the conglomerate serves a useful function, because it does what the efficient labor, product, and capital markets do in more developed countries. 

On the other hand, in more advanced economies like the United States, unrelated diversification makes much less sense.  Investors, for instance, can diversify risk quite inexpensively on their own; they don't need a CEO to diversify into many unrelated units to reduce risk.   That type of strategic move proves far more expensive than simply having the investor buy an index fund to achieve risk diversification.  

A new paper by Venkat Kuppuswamy, George Serafeim, and Belén Villalonga examines this concept in more detail.  They look at capital, product, and labor market efficiency in 38 countries over a 15 year period.   They find that the value of corporate diversification does indeed fall as capital and labor markets get more efficient.   However, they did not find a significant effect for product market factors.   In sum, corporate strategy should look different as we move across the globe, and not just because of cultural differences.  Fundamental differences in the institutional environment call for different approaches to corporate strategy as we move from more advanced economies to emerging markets. 

Do Some Global Firms Exhibit Excessive Localization?

Experts frequently criticize large multinationals for failing to customize their products adequately for local markets.  We hear about the fabulous flops, in which firms try to export a popular product developed in the United States or Western Europe, only to experience a huge failure in an emerging market.  I'm quite sure that multinationals do make these mistakes often.  However, I think we hear far less about an equally serious mistake that many firms make.   Some companies have far too many local variations of essentially the same product.  They adapt their goods for every local market around the world, yet perhaps they don't quite need that level of localization. 

These firms don't encounter the same level of criticism. Why?  The economic damage is not as apparent.  After all, these goods may sell very well in each local market.  However, the localization strategy comes with some costs.   By constantly adapting their products for each country, the firms fail to take advantage of potential economies of scale and learning.  As a result, their costs are much higher than they should be.  Moreover, they spend excessive amounts of money building multiple brands in the same product category, rather than investing in the growth of fewer truly global brands.   I'm not saying such a global strategy is ALWAYS better than localization.  Naturally, localization is essential in some products and markets.  However, I do think we fail to levy the same amount of criticism at firms that miss out on key cost savings because of the constant adaptation that they engage in from country to country.

Why does this excessive localization take place in some multinationals?  I would argue that the explanation lies in the organizational structure, not in the minds of those senior executives plotting global strategy.   In many firms, country managers and regional presidents push for localization because it gives them more control and power.  It justifies the existence of larger brand management staffs at the local level, and in general, the country managers control more financial, physical, and human resources.  All else equal, country managers have some personal incentives to push a level of localization that may be higher than optimal.   We often don't hear experts discuss this failure; instead, we hear often about the firm that failed to adapt to a local market.  Yet, both types of mistakes can be equally costly. 

Reverse Innovation

Vijay Govindarajan of Dartmouth's Tuck School of Business gave a terrific presentation yesterday at the Academy of Management conference. He spoke about reverse innovation, a concept he introduced in an HBR article he wrote with GE CEO Jeff Immelt. Vijay described how most multinationals develop innovations in industrialized nations and then try to sell them in emerging markets. Reverse innovation occurs when innovations arise in emerging markets and then multinationals find markets for those products in the developed world. He gave the example of a EKG machine that GE sells in the US for $25,000. Naturally most Indian health care providers cannot afford these machines, particularly in rural areas. Thus, GE developed a simple $500 mobile device well-suited to rural India. Then, they realized a market for those devices exists in the US. Specifically, they have found that ambulances can carry these low cost mobile devices. Vijay argued that reverse innovation represents a huge opportunity for many multinationals. I think it's a fascinating phenomenon to watch.