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Mapping China’s middle class

The explosive growth of China’s emerging middle class has brought sweeping economic change and social transformation—and it’s not over yet. By 2022, our research suggests, more than 75 percent of China’s urban consumers will earn 60,000 to 229,000 renminbi ($9,000 to $34,000) a year.

In purchasing-power-parity terms, that range is between the average income of Brazil and Italy. Just 4 percent of urban Chinese households were within it in 2000—but 68 percent were in 2012. In the decade ahead, the middle class’s continued expansion will be powered by labor-market and policy initiatives that push wages up, financial reforms that stimulate employment and income growth, and the rising role of private enterprise, which should encourage productivity and help more income accrue to households. Should all this play out as expected, urban-household income will at least double by 2022.

Beneath the topline figures are significant shifts in consumption dynamics, which we have been tracking since 2005 using a combination of questionnaires and in-depth interviews to create a detailed portrait by income level, age profile, geographic location, and shopping behavior. Our latest research suggests that within the burgeoning middle class, the upper middle class is poised to become the principal engine of consumer spending over the next decade.

As that happens, a new, more globally minded generation of Chinese will exercise disproportionate influence in the market. Middle-class growth will be stronger in smaller, inland cities than in the urban strongholds of the eastern seaboard. And the Internet’s consumer impact will continue to expand. Already, 68 percent of the middle class has access to it, compared with 57 percent of the total urban population.

Importance of the ‘upper’ cut

The evolution of the middle class means that sophisticated and seasoned shoppers—those able and willing to pay a premium for quality and to consider discretionary goods and not just basic necessities—will soon emerge as the dominant force. To underscore this group’s growing importance, we have described it in past research as the “new mainstream.” For the sake of simplicity, we now call consumers with household incomes in the 106,000 to 229,000 renminbi range upper middle class. In 2012, this segment, accounting for just 14 percent of urban households, was dwarfed by the mass middle class, with household incomes from 60,000 to 106,000 renminbi. By 2022, we estimate, the upper middle class will account for 54 percent of urban households and 56 percent of urban private consumption. The mass middle will dwindle to 22 percent of urban households (Exhibit 1).

Exhibit 1

The magnitude of China’s middle-class growth is transforming the nation.

The behavior of today’s upper middle class provides some clues to China’s future. Our research indicates that these consumers are more likely to buy laptops, digital cameras, and specialized household items, such as laundry softeners (purchased by 56 percent of the upper-middle-class consumers we surveyed last year, compared with just 36 percent of the mass middle). Along with affluent and ultrawealthy consumers, upper-middle-class ones are stimulating rapid growth in luxury-goods consumption, which has surged at rates of 16 to 20 percent per annum for the past four years. By 2015, barring unforeseen events, more than one-third of the money spent around the world on high-end bags, shoes, watches, jewelry, and ready-to-wear clothing will come from Chinese consumers in the domestic market or outside the mainland.

Generation 2 comes of age

China’s new middle class also divides into different generations, the most striking of which we call Generation 2 (G2). It comprised nearly 200 million consumers in 2012 and accounted for 15 percent of urban consumption. In ten years’ time, their share of urban consumer demand should more than double, to 35 percent. By then, G2 consumers will be almost three times as numerous as the baby-boomer population that has been shaping US consumption for years.

These G2 consumers today are typically teenagers and people in their early 20s, born after the mid-1980s and raised in a period of relative abundance. Their parents, who lived through years of shortage, focused primarily on building economic security. But many G2 consumers were born after Deng Xiaoping’s visit to the southern region—the beginning of a new era of economic reform and of China’s opening up to the world. They are confident, independent minded, and determined to display that independence through their consumption. Most of them are the only children in their families because when they were born, the government was starting to enforce its one-child policy quite strictly.

McKinsey research has shown that this generation of Chinese consumers is the most Westernized to date. Prone to regard expensive products as intrinsically better than less expensive ones, they are happy to try new things, such as personal digital gadgetry. They are also more likely than previous generations to check the Internet for other people’s usage experiences or comments. These consumers seek emotional satisfaction through better taste or higher status, are loyal to the brands they trust, and prefer niche over mass brands (Exhibit 2). Teenage members of this cohort already have a big influence on decisions about family purchases, according to our research.

Exhibit 2

Generation 2—Chinese consumers in their teens and early 20s—takes a more Western approach to shopping.

Even as the G2 cohort reshapes Chinese consumption patterns, it appears to be maintaining continuity with some of the previous generations’ values. Many G2 consumers share with their parents and grandparents a bias for saving, an aversion to borrowing, a determination to work hard, and a definition of success in terms of money, power, and social status. For the G2 cohort, however, continuity in values doesn’t translate into similar consumer behavior. Likewise, 25- to 44-year-old G1 consumers, despite their loyalty to established brands, are more open than their parents to a variety of schools of thought, and as retirees in the years ahead they will certainly demonstrate a “younger” consumption mind-set than today’s elderly do.

The rise of the west (and the north)

In 2002, 40 percent of China’s relatively small urban middle class lived in the four Tier-one cities: Beijing, Shanghai, Guangzhou, and Shenzhen. By 2022, the share of those megacities will probably fall to about 16 percent (Exhibit 3). They won’t be shrinking, of course; rather, middle-class growth rates will be far greater in the smaller cities of the north and west. Many are classified as Tier-three cities, whose share of China’s upper-middle-class households should reach more than 30 percent by 2022, up from 15 percent in 2002.

Exhibit 3

The geographic center of middle-class growth is shifting.

Tier-four cities, smaller still, will also be part of that geographic transition. Consider Jiaohe, in Jilin Province. This northern inland Tier-four city is growing quickly because of its position as a transportation center at the heart of the northeast Asian economic zone, an abundance of natural resources (such as Chinese forest herbs and edible fungi), and the fact that it is one of China’s most important production bases for grape and rice wine. In 2000, less than 1,000 households out of 70,000 were middle class, but by 2022, those figures are set to rise to 90,000 and 160,000, respectively.

Another Tier-four city, Wuwei, in Gansu Province, is growing rapidly because it’s within the Jinchang–Wuwei regional-development zone and at the junction of two railways and several highways. Wuwei too had less than 1,000 middle-class households (out of 87,000 total) in 2000. By 2022, though, 390,000 of the city’s 650,000 households should be middle class.

Continued strong growth in the size and diversity of China’s middle class will create new market opportunities for both domestic and international companies. Yet strategies that succeeded in the past, given the wide distribution of standardized products for mass consumers, must be adjusted in a new environment with millions of Chinese trading up and becoming more picky in their tastes. A detailed understanding of what consumers are doing, how their preferences are evolving, and the underlying reasons for their behavior will be needed.

Armed with better information, companies can begin tailoring their product portfolios to the needs of increasingly sophisticated consumers and revising brand architectures to differentiate offerings and attract younger consumers eager for fresh buying experiences. There will be not only challenges but also plenty of opportunities for companies whose strategies reflect China’s new constellation of rising incomes, shifting urban landscapes, and generational change.

Winning the battle for China’s new middle class

The rapid emergence of a prosperous, more individualistic, and more sophisticated class of consumers in China is creating unprecedented opportunities and challenges for companies serving them. The opportunity is clear: in less than a decade, more than three-fourths of China’s urban households will approach middle-class status on a purchasing-power-parity basis.

But the market is rapidly bifurcating between a still large (but less affluent) mass market and a new, even bigger group of upper-middle-class consumers—one that’s so large and significant we’ve referred to it in the past as the “new mainstream.”1The people in this more affluent segment tend to live in China’s higher-tier cities and coastal areas, enjoy household incomes between 106,000 and 229,000 renminbi ($16,000 to $34,000) a year, and have opinions strikingly different from those of their mass-market middle-class counterparts.

As China’s new upper middle class swells to include more than half of the country’s urban households by 2020—up from just 14 percent in 2012—it will strain many of today’s business models. Companies that have long catered to consumers trying to meet basic needs at affordable prices will face a shrinking market and risk losing millions of customers looking to trade up.

Simultaneously serving a familiar but declining mass market and an uncertain but promising new upper-middle-class one will require novel approaches. This article is a report from the front lines: how consumer-goods companies can craft brands that appeal to the rising middle class, develop “dual strategies” and transition plans for the evolving landscape, and build the marketing muscle to compete in an increasingly complex environment.

1. Aspirational brands

Until recently, Chinese consumers were generally too new to the market to focus on anything beyond the basic functional attributes of most products. These shoppers were also historically quite pragmatic, particularly in making purchase decisions in prosaic product categories where emotional connections aren’t strong. So for every Dove Chocolate or Starbucks that prospered by learning to create strong emotional ties as “occasion” products—emphasizing attributes such as “chocolate indulgence” or “the coffee break experience”— other equally recognizable brands struggled. China’s consumers simply weren’t ready for them.

How times have changed. As recently as 2010, functional benefits dominated the list of key buying factors for just about all of the 40 consumer-goods categories we studied. Just two years later, emotional benefits had become a top-five key buying factor in these same categories—and in many cases the top one or two. In the shampoo category, for example, upper-middle-class shoppers are 50 percent more likely than their mass-market counterparts to regard emotional factors as an important purchase consideration.

Consider the experience of SCA, a Swedish manufacturer of personal-care and forest products. The company uses traditional consumer roadshows to demonstrate the basic, functional benefits of its facial tissues to a broad base of Chinese consumers. But SCA also wants to position the products as affordable luxuries to which upper-middle-class consumers should aspire (the company already follows a similar approach in the wealthier Hong Kong market). “Our target is the white-collar young professional woman,” notes Stephan Dyckerhoff, president of SCA’s North Asia Hygiene Products division. “We want her to show off our product in much the same way she might show off using an iPhone.”

To achieve such big aspirations, the company looks for unique ways to strengthen the emotional connection between consumers and its products. One approach involves karaoke lounges, where SCA distributes special small packs of tissues to create a positive association between the product and activities customers enjoy. Such clever approaches to execution will probably be differentiators in a crowded market. Similarly, other leading companies are working hard on in-store execution and word-of-mouth effects (including social-media platforms where more and more consumers exchange ideas) to help ensure that China’s increasingly affluent consumers notice their products.3

2. Dual strategies

Aspirational brands, already relevant for China’s new upper middle class, will become even more important as it grows. “The new upper-middle-class opportunity is where the future is,” says Alan Jope, the head of Unilever’s businesses in north Asia. “It’s huge across categories and even more important than the luxury class of consumers.”

Yet as Unilever and other leading companies size up the new consumer, they also recognize the power that China’s consumer mass market still wields. “Consumers in coastal China may be getting wealthier and trading up,” notes Michael Yeung, the president of Wrigley Asia Pacific, “but China’s interior and lower-tier cities will continue to be a vast market for us.”

A few forward-looking companies are responding with dual strategies: a mass-market business designed for volume alongside an upper-middle-class one for profits. In practical terms, such a strategy often plays out along geographic lines: large regions divided into smaller clusters, each, perhaps, with its own product portfolio, pricing, marketing approach, and execution plan. The most sophisticated players establish clear profit-and-loss responsibilities for regions and recognize that the “shape” of that P&L—the relative importance of volume, value, cost control, and margins—will inevitably vary.

A major snack manufacturer uses such a strategy to create relatively cheap entry-level mass-market products while reserving higher-margin offerings for customers who trade up. To minimize product cannibalization, the company limits the distribution of entry-level products to lower-tier cities with average incomes below a certain threshold—and even there, only in more traditional “mom and pop” stores.4 This approach helps keep the company’s low-end products off the shelves of modern retailers that carry its premium ones. The company doesn’t stop at distribution: to combat gray-market sales, its employees routinely visit retail outlets, inspecting the shelves and using scan codes to determine where products originated and where they belong. Distributors that violate the rules are first warned, then cut loose if they don’t comply.

Meanwhile, the company reserves its more expensive offerings for wealthier cities in coastal areas, carefully marketing and packaging products to attract more sophisticated, aspirational shoppers who view higher-priced snacks as a way to reward themselves. This approach has helped the company to increase its revenues in China by more than 15 percent annually over the past three years. Volume growth leads the way in the country’s interior, while the richer coastal cities drive profitability.

Bayer Consumer Care has adopted a similar approach. The company recently undertook an initiative to widen its sales and distribution coverage in China’s smaller cities. But it also added sales representatives in 28 core municipalities in top-tier ones, where the company hopes to raise its game with new upper-middle-class consumers.

3. Disciplined transition timing

Timing is a crucial element of effective dual strategies. Companies must recognize the nature of shifts under way in different geographies and move fast to stay ahead of competitors. But they can’t move so quickly that their mass-market business is destabilized. All that takes discipline.

Consider the timing discipline of a global consumer-goods manufacturer pursuing a dual strategy. The company’s executives started by dividing consumers into about 40 geographic microclusters based on their income levels and preferences, as well as the activities of competitors. Next, teams representing each of the company’s major product categories looked at the microclusters with an eye toward grouping them into archetypes based on the stages of their evolution: solidly mass market, beginning the transition, or rapidly uptrading. The company then reviewed these recommendations and, to sharpen its thinking, used differences the teams had identified— for example, one microcluster was rapidly uptrading in shampoos but not yet in soaps.

The company’s activities in microclusters that remained solidly mass market went largely unchanged. Microclusters in the second category (beginning the transition) were included in a marketing plan to introduce more upmarket brands and products over a 12- to 24-month horizon. For the rapid uptraders, the company ramped up the pace: a 6- to 9-month window for new brands and stock-keeping units, as well as new promotional messages to help drive up average prices. To avoid being wrong-footed by rivals, the company created competitive-intelligence teams that travel through the country to collect insights and work with the sales force to coordinate the appropriate response. When a rival’s new product or strategy appears to affect the transition plan, the company can quickly change the pace of the shift to shut out competitors quickly and avoid losing market share.

This company’s ability to adapt quickly has been instrumental in the strategy’s success. The results have been impressive: 12 to 15 percent volume growth and a 15 to 20 percent boost in revenues in each of the past three years, along with a clear increase in earnings before interest and taxes (EBIT) as investments to establish the strategy begin to pay off.

As this example clearly shows, timing and geography often intersect when companies make strategic choices. Consider the balancing act of a multinational personal-care company with its body-care-products business. Recognizing that tastes are different in northern China—a relatively low-income region with a large mass market—the company focuses heavily on sales of its more traditional bar-soap products to match local preferences there. Meanwhile, the company is gearing up its marketing efforts to begin converting those customers to higher-margin liquid soap as they transition into the new upper middle class. By contrast, mass-market consumers in southern China already prefer liquid soap. As these customers become more affluent, the company works to persuade them to upgrade from cheaper, local brands.

4. State-of-the-art marketing

Successfully implementing sophisticated, time-based dual strategies requires serious marketing muscle. Multiple touch points are not only important but also, in many cases, increasingly digital. The key is to use them creatively to balance the tension between reaching a large mass audience and appealing to the greater individuality of the new middle class.

Consider Nike, long familiar for its TV advertising in China and for its ubiquitous urban billboards showing famous athletes. More recently, the company launched its first marketing campaign on WeChat, a popular Chinese mobile-messaging platform. The campaign, billed as a sports-subscription service, allowed users to “follow” the company and receive daily updates about an upcoming Nike sports festival. To encourage participation, the company aggressively placed QR codes5on taxis, outdoor posters, and other noticeable spots. WeChat’s broad reach—it has 200 million users—helped Nike to keep in touch with the mainstream, while opportunities for user participation helped heighten the sense of individuality for upscale consumers.

Pulling off such campaigns calls for sophisticated customer insights, which are becoming ever more important as the upper middle class grows and its tastes evolve. One global food and beverage maker has responded by creating “insights centers” in six regions of China to stay ahead of changing customer preferences and behavior. Similarly, in P&G’s Beijing Innovation Center, the company built a small hutong neighborhood—a set of narrow, traditional Chinese lanes formed by the walls of siheyuan, or traditional courtyard homes. Researchers in P&G’s simulated hutong observe consumers as they brush their teeth or change diapers, standing ready to propose immediate changes to product prototypes, much as researchers do in the simulated baby playrooms at the company’s Cincinnati, Ohio, headquarters. In the same Beijing facility, P&G stocks simulated supermarket shelves with its own products and those of competitors to better understand how consumers shop.

There’s another increasingly important source of insights: social media. In 2006 L’Oréal, for example, launched the social platform Rose Beauty by Lancôme, an online community where women in China could exchange beauty tips and seek expert advice. The community now has close to a million members, many of them active—in 2011, two-thirds of site visitors returned more than once a day, and nearly half of the discussion topics the company posted had more than five comments from users. The platform is not only an important promotional tool but also a valuable source of information for L’Oréal, allowing the company to better understand the expectations of Chinese women and to tailor its product-development efforts accordingly. Such smart applications of social media are just one example of how technology and data sources are becoming increasingly important in the world’s largest market (see sidebar, “Tech-enabled customer engagement”).

But technology will never eliminate the need for creativity, which remains central to smart marketing in China and sometimes generates lucky breaks. SCA recently invited Chinese consumers to come up with their own clever uses for an empty box of facial tissues to drive home associations between its products and resource sustainability. The winner received a trip to the company’s private forest in Sweden, where SCA grows trees in a sustainable way to be used as raw material in its products. What started as a marketing experiment soon drew the attention of a Chinese TV station, which flew reporters to Sweden along with the contest winner. The station ultimately aired a two-hour documentary on the experience, an outcome that exceeded even the company’s most optimistic expectations for the campaign.

China’s new middle class is becoming more important more quickly than most companies could have anticipated. Multinationals that haven’t begun preparing to serve increasingly affluent and demanding shoppers should start now—or risk watching their businesses deteriorate as the market shifts beneath them.

Why do translation services cost so much?

For a company that has not yet had a need for translation services, it might seem as if translation services cost quite a bit.

But once you analyze what really needs to happen in a translation, you’ll see that it is more economical to hire a professional translation services company like EPIC Translations rather than hiring your own translators.

For example, when you hire an employee in the Marketing department, you’re actually incurring quite a bit of cost in addition to the salary:

  1. taxes
  2. health insurance
  3. vacation
  4. and other overhead costs

If you’re paying $50,000 to your Marketing resource then the actual cost of having that resource is somewhere closer to $70,000 annually.

If you’re looking to export your business to other countries/markets, it is better to have your content (product manuals, marketing plan, company policies, legal agreements, etc) professionally translated.

Why, you might ask?

Because finding a qualified translator to hire on your own is quite an ordeal. Even if you decide to work thru this ordeal, you’ll have to sit the translator at least a week or two until he/she becomes familiar with your content type and target audience in order to produce an acceptable quality driven translation. Furthermore, if you’re expanding to Brazil, the translator you’re hiring in your U.S. office might not have recent familiarity with the Brazilian market. You’ll be paying quite a bit of money to bring in a translator to produce a translation that might lack the desired quality to take your company to new countries.

With that being said, it is better to hire a professional translation services company like EPIC Translations to produce cost-effective and quality driven translations because we will employ translators for you who are located in your target country and are part of your industry where you compete in! When it’s all done and said, it is cheaper to outsource to EPIC Translations than to hire your own translators.

 

 

Givers take all: The hidden dimension of corporate culture

By encouraging employees to both seek and provide help, rewarding givers, and screening out takers, companies can reap significant and lasting benefits.

After the tragic events of 9/11, a team of Harvard psychologists quietly “invaded” the US intelligence system. The team, led by Richard Hackman, wanted to determine what makes intelligence units effective. By surveying, interviewing, and observing hundreds of analysts across 64 different intelligence groups, the researchers ranked those units from best to worst.

Then they identified what they thought was a comprehensive list of factors that drive a unit’s effectiveness—only to discover, after parsing the data, that the most important factor wasn’t on their list. The critical factor wasn’t having stable team membership and the right number of people. It wasn’t having a vision that is clear, challenging, and meaningful. Nor was it well-defined roles and responsibilities; appropriate rewards, recognition, and resources; or strong leadership.

Rather, the single strongest predictor of group effectiveness was the amount of help that analysts gave to each other. In the highest-performing teams, analysts invested extensive time and energy in coaching, teaching, and consulting with their colleagues. These contributions helped analysts question their own assumptions, fill gaps in their knowledge, gain access to novel perspectives, and recognize patterns in seemingly disconnected threads of information. In the lowest-rated units, analysts exchanged little help and struggled to make sense of tangled webs of data. Just knowing the amount of help-giving that occurred allowed the Harvard researchers to predict the effectiveness rank of nearly every unit accurately.

The importance of helping-behavior for organizational effectiveness stretches far beyond intelligence work. Evidence from studies led by Indiana University’s Philip Podsakoff demonstrates that the frequency with which employees help one another predicts sales revenues in pharmaceutical units and retail stores; profits, costs, and customer service in banks; creativity in consulting and engineering firms; productivity in paper mills; and revenues, operating efficiency, customer satisfaction, and performance quality in restaurants.

Across these diverse contexts, organizations benefit when employees freely contribute their knowledge and skills to others. Podsakoff’s research suggests that this helping-behavior facilitates organizational effectiveness by:

  • enabling employees to solve problems and get work done faster
  • enhancing team cohesion and coordination
  • ensuring that expertise is transferred from experienced to new employees
  • reducing variability in performance when some members are overloaded or distracted
  • establishing an environment in which customers and suppliers feel that their needs are the organization’s top priority

Yet far too few companies enjoy these benefits. One major barrier is company culture—the norms and values in organizations often don’t support helping. After a decade of studying work performance, I’ve identified different types of reciprocity norms that characterize the interactions between people in organizations. At the extremes, I call them “giver cultures” and “taker cultures.”

Give, take, or match

In giver cultures, employees operate as the high-performing intelligence units do: helping others, sharing knowledge, offering mentoring, and making connections without expecting anything in return. Meanwhile, in taker cultures, the norm is to get as much as possible from others while contributing less in return. Employees help only when they expect the personal benefits to exceed the costs, as opposed to when the organizational benefits outweigh the personal costs.

Most organizations fall somewhere in the middle. These are “matcher cultures,” where the norm is for employees to help those who help them, maintaining an equal balance of give and take. Although matcher cultures benefit from collaboration more than taker cultures do, they are inefficient vehicles for exchange, as employees trade favors in closed loops. Should you need ideas or information from someone in a different division or region, you could be out of luck unless you have an existing relationship. Instead, you would probably seek out people you trust, regardless of their expertise. By contrast, in giver cultures, where colleagues aim to add value without keeping score, you would probably reach out more broadly and count on help from the most qualified person.

In light of the benefits of more open systems of helping, why don’t more organizations develop giver cultures? All too often, leaders create structures that get in the way. According to Cornell economist Robert Frank, many organizations are essentially winner-take-all markets, dominated by zero-sum competitions for rewards and promotions. When leaders implement forced-ranking systems to reward individual performance, they stack the deck against giver cultures.

Pitting employees against one another for resources makes it unwise for them to provide help unless they expect to receive at least as much—or more—in return. Employees who give discover the costs quickly: their productivity suffers as takers exploit them by monopolizing their time or even stealing their ideas. Over time, employees anticipate taking-behavior and protect themselves by operating like takers or by becoming matchers, who expect and seek reciprocity whenever they give help.

Fortunately, it is possible to disrupt these cycles. My research suggests that committed leaders can turn things around through three practices: facilitating help-seeking, recognizing and rewarding givers, and screening out takers.

Help-seeking: Erase the shadow of doubt

Giver cultures depend on employees making requests; otherwise, it’s difficult to figure out who needs help and what to give. In fact, studies reviewed by psychologists Stella Anderson and Larry Williams show that direct requests for help between colleagues drive 75 to 90 percent of all the help exchanged within organizations.

Yet many people are naturally reluctant to seek help. They may think it’s pointless, particularly in taker cultures. They also may fear burdening their colleagues, lack knowledge about who is willing and able to help, or be concerned about appearing vulnerable, incompetent, and dependent.

Reciprocity rings

It’s possible to overcome these barriers. For example, University of Michigan professor Wayne Baker and his wife, Cheryl Baker, at Humax Networks developed an exercise called the “reciprocity ring.” The exercise generally gathers employees in groups of between ten and two dozen members. Each employee makes a request, and group members use their knowledge, resources, and connections to grant it. The Bakers typically run the exercise in two 60-to 90-minute rounds—the first for personal requests, so that people begin to open up, and the second for professional requests. Since everyone is asking for help, people rarely feel uncomfortable.

The monetary value of the help offered can be significant. One pharmaceutical executive attending a reciprocity ring involving executives from a mix of industry players saved $50,000 on the spot when a fellow participant who had slack capacity in a lab offered to synthesize an alkaloid free of charge. And that’s no outlier: the Bakers find that executive reciprocity-ring participants in large corporate settings report an average benefit exceeding $50,000—all for spending a few hours seeking and giving help. This is true even when the participants are from a single company. For example, 30 reciprocity-ring participants from a professional-services firm estimated that they had received $261,400 worth of value and saved 1,244 hours. The ring encourages people to ask for help that their colleagues weren’t aware they needed and efficiently sources each request to the people most able to fulfill it.

Beyond any financial benefits, the act of organizing people to seek and provide help in this way can shift cultures in the giver direction. Employees have an opportunity to see what their colleagues need, which often sparks ideas in the ensuing weeks and months for new ways to help them. Even employees who personally operate as takers (regardless of the company’s culture) tend to get involved: in one study of more than 100 reciprocity-ring participants, Wayne Baker and I found that people with strong giver values made an average of four offers of help, but those who reported caring more about personal achievements and power than about helping others still averaged three offers.

During the exercise, it becomes clear that giving is more efficient than matching, as employees recognize how they gain access to a wider network of support when everyone is willing to help others without expecting anything in return rather than trading favors in pairs. After running the exercise at companies such as Lincoln Financial and Estée Lauder, I have seen many executives and employees take the initiative to continue running it on a weekly or monthly basis, which allows the help-seeking to continue and opens the door for greater giving as well as receiving.

Dream on

There are other ways to stimulate help-seeking. Consider what a company called Appletree Answers, a provider of call-center services, did back in 2008. John Ratliff, the founder and CEO, was alarmed by the 97 percent employee-turnover rate in his call centers. The underlying challenge, Ratliff believed, was that rapid expansion had cost the company its sense of community. Appletree had undergone 13 acquisitions in just six years and grown from a tiny operation to a company with more than 350 employees. As the cohesion of the group eroded, employees began prioritizing their own exit opportunities over the company’s need for them to contribute, and customer service suffered.

During a brainstorming meeting, the director of operations suggested a novel approach to improving the culture: creating an internal program modeled after the Make-A-Wish Foundation. Ratliff and colleagues designed a program called Dream On, inviting employees to request the one thing they wanted most in their personal lives but felt they could not achieve on their own. Soon, a secret committee was making some of these requests happen—from sending an employee’s severely ill husband to meet his favorite players at a Philadelphia Eagles game to helping an employee throw a special birthday party for his daughter.

After granting more than 100 requests, the program has helped promote a company culture where, in the words of one insider, “employees look to do things for each other and literally are ‘paying it forward.’” Indeed, employees often submit requests on behalf of their colleagues. The program has helped reduce the uncertainty and discomfort often associated with seeking help: employees know where to turn, and they know they’re not alone. In the six months after Dream On was implemented, retention among frontline staff soared to 67 percent, from 3 percent, and the company had its two most profitable quarters ever. “You’re either a giver or a taker,” Ratliff says. “Givers tend to get stuff back while takers fight for every last nickel . . . they never have abundance.”

Such programs aren’t limited to small companies. In a study of a similar program at a Fortune 500 retailer, Jane Dutton, Brent Rosso, and I found that participants became more committed to the company and felt the program strengthened their sense of belonging in a community at work. They reported feeling grateful for the opportunity to show concern for their colleagues and took pride in the company for supporting their efforts.

Boundaries and roles

Despite the power of help-seeking in shaping a giver culture, encouraging it also carries a danger. Employees can become so consumed with responding to each other’s requests that they lack the time and energy to complete their own responsibilities. Over time, employees face two choices: allow their work to suffer or shift from giving to taking or matching.

To avoid this trade-off, leaders need to set boundaries, as one Fortune 500 technology company did when its engineers found themselves constantly interrupted with requests for help. Harvard professor Leslie Perlow worked with them to create windows for quiet time (Tuesdays, Thursdays, and Fridays until noon), when interruptions were not allowed. After the implementation of quiet time, the majority of the engineers reported above-average productivity, and later their division was able to launch a product on schedule for the second time in history. By placing clear time boundaries around helping, leaders can better leverage the benefits of giver cultures while minimizing the costs.

Alternatively, some organizations designate formal “helping” roles to coordinate more efficient help-seeking and -giving behavior. In a study at a hospital, David Hofmann, Zhike Lei, and I examined the importance of adding a nurse-preceptor role—a person responsible for helping new employees and consulting on problems. Employees felt more comfortable seeking help and perceived that they had greater access to expertise when the preceptor role existed. Outside of health-care settings, companies often develop this function by training liaisons for new employees and leadership coaches for executives and high-potential managers. Designating helping roles can provide employees with a clear sense of direction on where to turn for help without creating undue burdens across a unit.

Rewards: To the givers go the spoils

In a perfect world, leaders could promote strong giver cultures by simply rewarding employees for their collective helping output. The reality, however, is more complicated.

In a landmark study led by Michael Johnson at the University of Washington, participants worked in teams that received either cooperative or competitive incentives for completing difficult tasks. For teams receiving cooperative incentives, cash prizes went to the highest-performing team as a whole, prompting members to work together as givers. In competitive teams, cash prizes went to the highest-performing individual within each team, encouraging a taker culture. The result? The competitive teams finished their tasks faster than the cooperative teams did, but less accurately, as members withheld critical information from each other.

To boost the accuracy of the competitive teams, the researchers next had them complete a second task under the cooperative reward structure (rewarding the entire team for high performance). Notably, accuracy didn’t go up—and speed actually dropped.

People struggled to transition from competitive to cooperative rewards. Instead of shifting from taking to giving, they developed a pattern of cutthroat cooperation. Once they had seen their colleagues as competitors, they couldn’t trust them. Completing a single task under a structure that rewarded taking created win–lose mind-sets, which persisted even after the structure was removed.

Johnson’s work reminds us that giver cultures depend on a more comprehensive set of practices for recognizing and rewarding helping behavior in organizations. Creating such a culture starts with expanding performance evaluations beyond results, to include their impact on other individuals and groups. For example, when assessing the performance of managers, the leadership can examine not only the results their teams achieve but also their record in having direct reports promoted.

Yet even when giving-metrics are included in performance evaluations, there will still be pressures toward taking. It’s difficult to eliminate zero-sum contests from organizations altogether, and indeed doing so risks extinguishing the productive competitive fires that often burn within employees.

To meet the challenge of rewarding giving without undercutting healthy competition, some companies are devising novel approaches. In 2005, Cory Ondrejka was the chief technology officer at Linden Lab, the company behind the virtual world Second Life. Ondrejka wanted to recognize and reward employees for going beyond the call of duty, so he borrowed an idea from the restaurant industry: tipping.

The program allowed employees to tip peers for help given, by sending a “love message” that adds an average of $3 to the helper’s paycheck. The messages are visible to all employees, making reputations for generosity visible. Employees still compete for bonuses and promotions—but also to be the most helpful. This system “gives us a way of rewarding and encouraging collaborative behavior,” founder Philip Rosedale explained.

Evidence highlights the importance of keeping incentives small and spontaneous. If the rewards are too large and the giving-behavior necessary to earn them is too clearly scripted, some participants will game the system, and the focus on extrinsic rewards may undermine the intrinsic motivation to give, leading employees to provide help with the expectation of receiving.

The peer-bonus and -recognition programs that have become increasingly popular at companies such as Google, IGN, Shopify, Southwest Airlines, and Zappos reduce such “gaming” behavior. When employees witness unique or time-consuming acts of helping, they can nominate the givers for small bonuses or recognition. One common model is to grant employees an equal number of tokens they can freely award to colleagues. By supporting such programs, leaders empower employees to recognize and reinforce giving—while sending a clear signal that it matters. Otherwise, many acts of giving occur behind closed doors, obscuring the presence and value of helping-norms.

Sincerity screening: Keep the wrong people off the bus

Encouraging help-seeking and recognizing those who provide it are valuable steps toward enabling a giver culture. These steps are likely to be especially powerful in organizations that already screen out employees with taker tendencies. Psychologist Roy Baumeister observes that negative forces typically have a stronger weight than positive ones. Research by Patrick Dunlop and Kibeom Lee backs up this insight for cultures: takers often do more harm than givers do good.

As a result, Stanford professor Robert Sutton notes, many companies, from Robert W. Baird and Berkshire Hathaway to IDEO and Gold’s Gym, have policies against hiring people who act like takers. But what techniques actually help identify a taker personality? After reviewing the evidence, I see three valid and reliable ways to distinguish takers from others.

First, takers tend to claim personal credit for successes. In one study of computer-industry CEOs, researchers Arijit Chatterjee and Donald Hambrick found that the takers were substantially more likely to use pronouns like I and me instead of usand we. When interviewers ask questions about successes, screening for self-glorifying responses can be revealing. Mindful of this pattern, Barton Hill, a managing director at Citi Transaction Services, explicitly looks for applicants to describe accomplishments in collective rather than personal terms.

Second, takers tend to follow a pattern of “kissing up, kicking down.” When dealing with powerful people, they’re often good fakers, coming across as charming and charismatic. But when interacting with peers and subordinates, they feel powerful, which leads them to let down their guard and reveal their true colors. Therefore, recommendations and references from colleagues and direct reports are likely to be more revealing than those from bosses.

General Electric’s Durham Engine Facility goes further still: candidates for mechanic positions work in teams of six to build helicopters out of Legos. One member is allowed to look at a model and report back to the team, and trained observers assess the candidates’ behavior, with an eye toward how well they take the initiative while remaining collaborative and open. In such environments, the fakers are often easy to spot through their empty gestures: as London Business School’s Dan Cable reports, the takers “try to ‘demonstrate leadership’ and ‘take initiative’ by jumping up first.” When it comes to predicting how people will actually treat others in a company, few pieces of information are more valuable than observing their behavior directly.

Finally, takers sometimes engage in antagonistic behavior at the expense of others—say, badmouthing a peer who’s up for a promotion or overcharging an uninformed customer—simply to ensure that they come out on top. To maintain a positive view of themselves, takers often rely on creative rationalizations, such as “My colleague didn’t really deserve the promotion anyway” or “that customer should have done his homework.” They come to view antagonism as an appropriate, morally defensible response to threats, injustices, or opportunities to claim value at the expense of others.

With this logic in mind, Georgia Tech professor Larry James has led a pioneering series of studies validating an assessment called the “conditional reasoning test of aggression,” a questionnaire cleverly designed to unveil these antagonistic tendencies through reasoning problems that lack obvious answers. It has an impressive body of evidence behind it. People who score high on the test are significantly more likely to engage in theft, plagiarism, forgery, other kinds of cheating, vandalism, and violence; to receive lower performance ratings from supervisors, coworkers, and subordinates; and to be absent from work or quit unexpectedly. By screening out candidates with such tendencies, leaders can increase the odds of selecting applicants who will embrace a giver culture.

Walk the talk

Giver cultures, despite their power, can be fragile. To sustain them, leaders need to do more than simply encourage employees to seek help, reward givers, and screen out takers.

In 1985, a film company facing financial pressure hired a new president. In an effort to cut costs, the president asked the two leaders of a division, Ed and Alvy, to conduct layoffs. Ed and Alvy resisted—eliminating employees would dilute the company’s value. The president issued an ultimatum: a list of names was due to him at nine o’clock the next morning.

When the president received the list, it contained two names: Ed and Alvy.

No layoffs were conducted, and a few months later Steve Jobs bought the division from Lucasfilm and started Pixar with Ed Catmull and Alvy Ray Smith.

Employees were grateful that “managers would put their own jobs on the line for the good of their teams,” marvels Stanford’s Robert Sutton, noting that even a quarter century later, this “still drives and inspires people at Pixar.”

When it comes to giver cultures, the role-modeling lesson here is a powerful one: if you want it, go and give it.

Printed from McKinsey Insights & Publications

Whither the US equity markets?

The underlying drivers of performance suggest that over the long term, a dramatic decline in equity returns is unlikely.

US equity markets stretched once again into record territory in April, setting new highs on both the Dow and the S&P 500 indexes. That’s good news for investors—it wasn’t that long ago when the market was headed in the other direction. The question on everyone’s mind, though, is where the market is headed next.

In the short term, of course, there’s no telling what will happen—and speculation is risky. Investors and companies alike are notoriously weak at timing their investments to the market. But those are short-term questions; what really matters from a corporate-strategy perspective is the long term, and what really counts in the long term is the market’s relationship to the real economy.

In fact, much of the equity market’s performance in the United States, as we’ve seen over at least the past 50 years, is clearly linked to the performance of the real economy, including GDP growth, corporate profits, interest rates, and inflation—in spite of short-term volatility. And in the absence of some disruption of that link, the market should continue to thrive. In a nutshell, if GDP were to grow at rates comparable to the 2 to 3 percent annual real growth of the past 50 years and inflation is kept in check, investors should be able to expect annual stock-market returns of 5 to 7 percent in real dollars over the next 10 to 20 years.

Of course, it’s worth remembering the old saw about economists predicting nine of the past four recessions: in economics, it’s often easier to predict the long term than the short term. The same applies to the stock market. So while we’d never attempt to forecast periods as short as even five years—affected as they are by volatile shifts in investor expectations—today’s fundamentals make us relatively sanguine about the market’s performance over the longer term. Indeed, it would take catastrophic changes in real economic performance spread over multiple decades in the real economy or a fundamental shift in investor behavior—unlike anything we’ve seen in more than a century—to reduce long-term equity returns to below around 5 percent in developed markets. In this article, we’ll first examine the connection between equities and the real economy and then consider the likely causes of breaks in that connection over specific periods of time.

Stock-market performance and the real economy

Over the past century, stocks have earned about 9 to 10 percent per year. Adjusted for inflation, that means investors have earned annual real returns on US common stocks of about 6 percent per year.

That 6 percent is no random number—and understanding where it has come from in the past tells us something about how likely it is to continue in the future. In fact, that number is a natural consequence of economic forces derived from the long-term performance of companies and industries in aggregate and from the relationships among economic growth, corporate profits, and returns on capital—and how they convert into shareholder returns (TRS). Once these relationships are made clear, the connection between the stock market and the real economy becomes apparent, and historical returns make sense: that is, share-price appreciation combined with cash yield has resulted in about 6 percent real TRS—depending on the precise measuring period. Here’s how it works, using the last 50 years of the S&P 500 index as an example.

Share-price appreciation. From the end of 1962 through the end of 2012, real share prices grew at 2.7 percent per year, roughly the same rate as real profit growth and real GDP growth. Share prices and real profit tend to grow at the same rate because the P/E ratio tends to revert to a normal level of around 15 times earnings—as long as the economy, inflation, and interest rates are in a “normal” range of stable longer-term levels. In fact, both theory and the data show that a P/E ratio of 15 is consistent with average returns on equity of 13 percent, a real cost of capital of about 7 percent, inflation of 2 percent, and long-term profit growth of 2.5 percent.

Cash yield. Over the 50-year period, investors earned another 3.1 percent per year in dividends and share repurchases, as companies paid out around 55 to 65 percent of their profits to shareholders. That payout ratio, combined with an average P/E ratio of 15, results in a cash yield on stocks between 3 and 4 percent per year. Payout levels may be volatile over the short term, but over the longer term, dividend and share-repurchase payouts are driven by company cash flows—the profits a company earns less the portion of these profits it must reinvest to grow. Anything left over must eventually be paid back to shareholders, even among companies that sit on their cash for years.

Combined, that level of share-price appreciation and dividend yield results in a total real return of 5.8 percent per year, slightly lower than the 100-year average due to recessions and high inflation in the 1970s. It’s not inconceivable that fundamental economic forces might tilt the balance and undermine the equity markets. Radical shifts in investor risk preferences, for example, could permanently shift the long-term P/E ratio from 15 to some other number. So could extreme changes in the performance of the economy, such as substantially higher or lower long-term GDP growth or a large change in the ratio of corporate profits to GDP, bigger than the one that has taken place in recent years.

But such things haven’t happened thus far, and as long as they don’t, shareholder returns are unlikely to deviate much from the 6 percent real long-term return. In fact, even with relatively extreme assumptions about long-term earnings growth, it is difficult to foresee real long-term shareholder returns of less than about 5 percent (Exhibit 1). (Readers can explore the likely impact on shareholder returns of a range of assumptions on earnings growth and on the value of today’s share prices relative to historical norms using an interactive calculator.

 

Exhibit 1

Absent radical shifts, returns are unlikely to deviate much from the long-term norm.

 

Stock-market eras, 1962–2012

It would be hard to argue that the market’s movements can be explained by anything other than a random process over periods as short as a day, a week, or even several years. There are simply too many moving parts. Shifts are often as much about changes in expectations as they are about actual performance. Market observers like to focus on trough-to-peak periods, like the 11 percent real returns from 1983 to the market’s peak in 2000. But linking the market to the real economy does let us tease out the impact of different fundamental forces behind its performance over longer periods. By understanding what shaped past events, we are in a better position to explain where we are today and what the future might look like.

To better understand why the market has deviated from its long-term trajectory in the past, it helps to look at its performance through the lens of underlying economic trends rather than the usual approach of examining calendar decades or peak-to-trough cycles. We defined five eras in the past 50 years, distinguished by key events in the real economy—inflation, interest rates, and corporate-profit growth (Exhibit 2).

Exhibit 2

Five eras illustrate the market’s connection to the real economy.

The era from 1962 to 1968 was a robust period, with a fast-growing economy and low, stable inflation and interest rates. Not surprisingly, then, the real return to shareholders was 9.4 percent, above the long-term average.

Contrast that fairly short period of calm to the years 1968 to 1996, when real returns fell below the long-term average to about 5 percent. During the first era of this much longer period, from 1968 to 1981, inflation (and the resulting high interest rates) slowed the real economy and the stock market and led to low P/E ratios. As most economics observers understand, when inflation is high, companies are unable to increase their returns on capital enough to make up for it. This leads to higher investment and lower cash flows for a given level of growth, and therefore lower P/E ratios. Inflation also depresses P/E levels because investors discount expected cash flows at a higher cost of capital. Indeed, high inflation and interest rates drove down the P/E ratio from 17 in 1968 to about 9 in 1981, when inflation was 9.4 percent and interest rates were nearly 14 percent. That decline in P/E ratios, plus the negative effects on economic growth, resulted in real returns to shareholders of –1.3 percent per year.

As inflation was brought under control in the early 1980s, P/E ratios and economic growth returned to normal levels. Real returns to shareholders were 13 percent per year. While commentators have held those returns up almost as a golden age of stocks, the reality was more mundane; it was just a return to normalcy.

The years 1996 to 2004 appear very different depending on whether you look at the total return over the entire period or only at what happened in the middle. From beginning to end, real returns to shareholders were about 6 percent. What everyone remembers, though, is what happened in the middle. The S&P 500 index went from 741 at the beginning of 1997 to a peak of 1,527 in mid-2000 before falling back to 1,212 at the end of 2004.

This movement was caused not by a market-wide bubble but by a very large sector bubble in technology and megacap stocks, whose P/E ratios ballooned in 1999–2000 to twice those of rest of the index. The S&P 500 index is weighted by the value of its stocks—and while the range of P/Es is typically fairly narrow, movements in a handful of the largest stocks can shape the entire index. The collapse of the bubble in 2000 led to a convergence of P/Es and a return to normal over the next four years.

Similar circumstances define the period from 2004 to 2012. This time around, it was unusually high corporate profits, not a high P/E ratio, that drove the S&P 500 up to a new high of 1,565 in October 2007. These profits, however, were concentrated in the energy sector, with oil prices reaching $145 per barrel, and in the banking sector, with overoptimistic assumptions about the value of loans and unsustainable speculative activities. In their initial panic over the credit crisis, investors drove the S&P 500 index briefly as low as 676 in March 2009. That lasted just a couple of months, however, as investors realized that as bad as the recession might be, the long-term outlook couldn’t be so bleak. For the rest of the period (2010 to 2012), corporate profits and P/E ratios began to return to normal. At the end of 2012, corporate profits and GDP had not yet returned to long-term trend levels, leading to subpar real shareholder returns of about 2 percent for the 2004–12 period.

By early March 2013, as the S&P 500 again neared record-high levels, the forward P/E multiple stood at around 16. However, at this writing, there is still great uncertainty about the trend in corporate profits and whether GDP and corporate profits will return to long-term trends in 2013 or 2014.

Unlike the market for fine art or exotic cars, where value is determined by changing investor tastes and fads, the stock market is underpinned by companies that generate real profits and cash flows. Most of the time, its performance can be explained by those profits, cash flows, and the behavior of inflation and interest rates. Deviations from those linkages, as in the tech bubble in 1999–2000 or the panic in 2009, tend to be short-lived.

Printed from McKinsey Insights & Publications

Building superior capabilities for strategic sourcing

Purchased materials and services often make up 60 to 80 percent of a product’s cost. Companies that don’t invest in the purchasing team’s capabilities are throwing away value.

Jack Welch once notoriously said that “engineers who can’t add, operators who can’t run their equipment, and accountants who can’t foot numbers become purchasing professionals.” Hyperbole aside, General Electric’s legendary boss was reflecting a common perception: the purchasing function is little more than a necessary evil in business. No surprise, then, that many companies underinvest in the purchasing team’s capabilities and leave sourcing out of strategic decision-making processes in favor of functions, such as manufacturing and sales, that drive revenue.

Over time, of course, a negative compounding effect sets in: up-and-coming talent flows to the higher-status functions, often exacerbating the capabilities mismatch when difficult sourcing negotiations come up. If a supplier’s heavily supported sales team squares off against an underdeveloped purchasing team, the result, like that of a football match between Fiji and Brazil, is fairly predictable.

Yet purchased materials and services make up 60 to 80 percent of a product’s total cost in many industries. As a result, companies that do not invest appropriately in the purchasing team’s capabilities and culture are throwing away more value than they realize. Organizations that employ leading-edge purchasing practices achieve almost double the margins of companies with below-average purchasing departments (20.2 percent versus 10.9 percent, respectively). Among the dimensions that affect purchasing’s success, capabilities and culture were correlated 1.5 to 2.2 times more strongly with a company’s financial performance than the others we studied (exhibit).

Exhibit

Capabilities and culture are key to purchasing success.

We have developed an approach that emphasizes speed and scale to build and institutionalize capabilities, so that performance improves rapidly and continues to get better over the long term. When applied to purchasing, the approach helps to raise the function’s profile and to give high-performing procurement professionals more leadership-development opportunities and exposure to senior management. In our experience, companies that employ this program in purchasing are able to attract and retain better purchasing talent and capture the financial impact more quickly and sustainably. This article will discuss how the approach has improved the performance of purchasing organizations and helped several of them realize their goals.

Identifying and building capabilities

To turn the purchasing function into a high-functioning strategic asset, an organization must first identify the specific capabilities that will create the most value. They vary by company but may include technical skills such as the ability to reverse-engineer a supplier’s cost structure accurately or to conduct a thorough supply-market analysis that produces insights leading to a competitive advantage. Leadership capabilities—such as the ability to navigate complex cross-functional interests, to manage the trade-offs required to meet competing needs, and to identify alternatives with perspicacity and tact—may also be important.

A company can figure out which capabilities have the greatest potential to contribute to performance by conducting a bottom-up assessment of its technical and leadership capabilities and comparing them with relevant benchmarks. For one leading chemical company, this type of assessment revealed a need to improve advanced “should-cost” analytics (that is, clean-sheet modeling) and cross-functional leadership. The company created a tailored capability-building program to build these specific skills. One year later, it was routinely convening cross-functional sourcing teams and using clean-sheet-based negotiations to capture savings that ranged from 10 to 20 percent for many categories.

Beyond building individual employees’ skills, an organization must embed them in its processes, systems, and tools. For example, after completing an initial phase of capability building for individuals, a leading basic-materials company took the next step. This effort included the implementation of an improved organizational structure to place a greater focus on value-generating priorities: transactional activities, such as purchase-order processing, were organizationally separated from strategic activities, such as category management. Data-collection tools and clear processes were instituted to support a more strategic kind of category management. The company also worked to ensure that the right individuals were placed in the right roles. Finally, performance-management systems were put in place to measure and provide incentives for total-cost-of-ownership savings and continuous improvement.

Use real work and adult-learning principles

According to our research, the traditional method of providing corporate training, through infrequent classroom sessions, is one of the least effective ways to build capabilities. Adults retain new ones more successfully if learning occurs through shorter, more frequent interventions in which the content is delivered “just in time.” That is, when training is tied to real work and the specific activities an individual must complete, trainees get immediate practice in incremental new skills that directly affect their day-to-day responsibilities. Over time, these new skills build on each other and develop into a complete set of improved capabilities.

One of the most effective ways to act on these adult-learning principles and scale new capabilities quickly is the “train the trainer” approach. In this technique, a small number of highly skilled and motivated change agents go through a structured “field and forum” program covering technical and leadership capabilities. While these change agents are in this program, they are expected to transfer their newly acquired capabilities to others by acting as mentors for a cohort of key purchasing employees going through an actual category-sourcing process. These purchasing staffers, with some further training, then go on to become coaches and mentors themselves. Through this approach, a combination of coaching and on-the-job training creates an organizational-talent engine that scales up new capabilities rapidly.

The global chemical company mentioned above followed this approach for its purchasing-transformation program. The company’s purchasing leaders identified a core set of trainers, who were 100 percent dedicated to driving change in the organization. Every week, these trainers received seven hours of technical and leadership training, and in tandem each of them co-led a cross-functional category-sourcing team. Over the course of 16 weeks, the trainers led their teams through the full sourcing process while also receiving regular coaching, training, and mentoring from their leaders. At the end of the period, the trainers unanimously declared that this experience had been the most transformative time in their careers, both professionally and personally, and that it helped improve their own skills and mind-sets, as well as the attitudes and capabilities of their colleagues. The trainers went on to train others independently and to become highly respected leaders in the organization. Many were recognized by C-level executives for their achievements.

Scale up and institutionalize

After the first phase of individual and institutional capability building, a company must focus on scaling, across the entire organization, the new way of doing business, so that it is sustainable over the long term. For example, at the basic-materials company mentioned above, this scale-up was accomplished by first setting an austere goal of 7 percent cost reductions across the entire third-party spending base and creating a clear action plan to reach that level in two years. This plan involved a sequence of category-sourcing efforts, with assigned team members and a center of excellence of core trainers and leaders to provide category teams with the necessary capabilities and expertise. A robust mechanism reported results to the whole organization to build excitement and credibility for the cost reductions. Two years later, the organization is well on its way to achieving what many thought a nearly impossible goal.

The final important piece in the capability-building effort relates to culture: creating an environment in which purchasing professionals are proud of the value they add to the organization and have the confidence to take a leadership role in finding and delivering new sources of value. Such cultural change is the bedrock of a sustainable transformation in a purchasing organization. Companies can push this change by creating highly visible senior role models who act out the new culture. These companies do so in several ways: instituting joint purchasing councils with responsibility for ensuring cross-functional collaboration and making use of the right forums to publicize successes throughout the organization and build excitement. Continuing to measure the attitudes and mind-sets of the staff carefully (using employee questionnaires and focus groups, for example) and then making targeted interventions to address challenges are important as well.

For example, at one leading global chemical company, a “victim” mind-set predominated in the purchasing function. Professionals within the group felt directionless and disheartened by an environment in which key sourcing decisions were often made without their involvement. To change this attitude, the company made sure senior leadership was involved in redesigning the purchasing organization, developing and institutionalizing a formal sourcing process, and implementing new databases and tools. Executives participated in weekly stakeholder meetings and periodic gatherings to address concerns as they arose. The company also made a significant effort to communicate the project’s successes to the whole organization. Eighteen months after launch, the purchasing transformation was on track to exceed some radical savings goals in many categories. The transformation was recognized as one of the most significant efforts the company had ever undertaken, not only because of the bottom-line impact, but also because the project fundamentally changed the way the organization operated.

Companies that have invested in developing best-in-class purchasing capabilities have nearly double the margins of those that have not. By identifying the capabilities that will drive value, building them in real work situations using adult-learning principles, and institutionalizing them, a company can create sustainable performance improvements that enhance the bottom line.
Printed from McKinsey & Company

The coming era of ‘on-demand’ marketing

Emerging technologies are poised to personalize the consumer experience radically—in real time and almost everywhere. It’s not too early to prepare.

Digital marketing is about to enter more challenging territory. Building on the vast increase in consumer power brought on by the digital age, marketing is headed toward being on demand—not just always “on,” but also always relevant, responsive to the consumer’s desire for marketing that cuts through the noise with pinpoint delivery.

What’s fueling on-demand marketing is the continued, symbiotic evolution of technology and consumer expectations. Already, search technologies have made product information ubiquitous; social media encourages consumers to share, compare, and rate experiences; and mobile devices add a “wherever” dimension to the digital environment. Executives encounter this empowerment daily when, for example, cable customers push for video programming on any device at any time or travelers expect a few taps on a smartphone app to deliver a full complement of airline services.

Remarkably, all this is starting to seem common and routine. Most leading marketers know how to think through customer-search needs, and optimizing search positioning has become one of the biggest media outlays. Companies have ramped up their publishing and monitoring activities on social channels, hoping to create positive media experiences customers will share. They are even “engineering” advocacy by creating easy, automatic ways for consumers to post favorable reviews or to describe their engagement with brands.

But we’re just getting started. The developments pushing marketing experiences even further include the growth of mobile connectivity, better-designed online spaces created with the powerful new HTML5 Web language, the activation of the Internet of Things in many devices through inexpensive communications tags and microtransmitters, and advances in handling “big data.” Consumers may soon be able to search by image, voice, and gesture; automatically participate with others by taking pictures or making transactions; and discover new opportunities with devices that augment reality in their field of vision (think Google glasses).

As these digital capabilities multiply, consumer demands will rise in four areas:

1. Now: Consumers will want to interact anywhere at any time.

2. Can I: They will want to do truly new things as disparate kinds of information (from financial accounts to data on physical activity) are deployed more effectively in ways that create value for them.

3. For me: They will expect all data stored about them to be targeted precisely to their needs or used to personalize what they experience.

4. Simply: They will expect all interactions to be easy.

This article seeks to paint a picture of this new world and its implications for leaders across the enterprise. One thing is clear: the consumer’s experiences with brands and categories are set to become even more intense and defining. That matters profoundly because such experiences drive two-thirds of the decisions customers make, according to research by our colleagues; prices often drive the rest.

It’s also apparent that each company as a whole must mobilize to deliver high-quality experiences across sales, service, product use, and marketing. Few companies can execute at this level today. As interactions multiply, companies will want to use techniques such as design thinking to shape consumer experiences. They also will need to be familiar with emerging tools for gathering the right data across the consumer decision journey. Finally, the marketing organization’s structure will need to be rethought as collaboration across functions and businesses becomes ever more essential.

What to expect in 2020

Over the next several years, we’re likely to see the consumer experience radically integrated across the physical and virtual environment. Most of the technologies needed to make this scenario happen are available now. One that’s gaining particular traction is near-field communication (NFC): embedded chips in phones exchange data on contact with objects that have NFC tags. The price of such tags is already as low as 15 cents, and new research could make them even cheaper, so more companies could build them into almost any device, generating a massive expansion of new interactive experiences. To understand that near future, follow a hypothetical, tech-enabled consumer, Diane, who purchases an audio headset.
on demand info graphic

Taken together, the scenes from Diane’s consumer journey illustrate the four emerging areas of consumer demands we touched on above.

Now

Marketers have gotten a foretaste of the consumer’s desire for more urgency and ubiquity. Bank balances running low? Send the consumer an alert on her cell phone. A question about fees shows up on the bank’s Twitter handle? Post an immediate response. An executive of one major bank believes that the immediacy of smartphone apps has already made brick-and-mortar contact unnecessary for many young consumers, who use a range of mobile services to manage their accounts and rarely interact with the brand physically. Yet having an entire bank in your phone may be only a baseline for the experiences on the horizon. Consider one European beverage company’s beta test of beer coasters embedded with NFC technology. A club patron contemplating a new brew can tap a coaster with a cell phone and get a history of the beer, bars where it is served, upcoming promotions, and a list of friends who have given it a thumbs-up.

In this environment, a marketer’s “publishing” extends to virtualized media such as the coaster or Diane’s headphones, which become touch points for considering and evaluating products and services. Digital information technologies, operating behind the scenes to integrate data on all interactions a consumer has across the decision journey, will provide insights into the best influence pathways for companies, while also triggering new personalized experiences for consumers.

Can I

Most first-wave digital capabilities helped people access things they already did—shopping, banking, finding information. Consumers must often settle for compromises in their digital experiences. Yet robust programming, data-access, and interface possibilities now available could make every digital interaction an opportunity to deliver something exceptional.

Consider Commonwealth Bank of Australia’s new smartphone app, which changes the house-hunting experience. A prospective home buyer begins by taking a picture of a house he or she likes. Using image-recognition software and location-based technologies, the app identifies the house and provides the list price, taxes, and other information. It then connects with the buyer’s personal financial data and (with further links to lender databases) determines whether the buyer can be preapproved for a mortgage (and, if so, in what amount). This nearly instantaneous series of interactions cuts through the hassle of searching real-estate agents’ sites for houses and then connecting with the agents or with mortgage brokers for financing, which might take a week.

The mortgage app shows how the digital environment is now integrating disparate sources of information, at low cost and at scale, for many new domains. The challenge for companies is to look beyond today’s interfaces and interactions and to see that moving past compromises will require a rethinking of aspects of packaging, pricing, delivery, and products.

For me

Some online marketers already use features in devices such as cameras and touch screens to help consumers see what apparel and accessories may actually look like when worn. Web retailer Warby Parker, for example, offers hundreds of customized views of eyeglasses overlaid on a Webcam picture of the consumer.

In the future, demands for more personalized experiences will intensify. A phone tap, a click, or a stylus jot will instantly personalize offers, using information captured on “likes,” recent travel, income, what friends are doing or like, and much more. With each interaction, the consumer will be creating new data footprints and streams that complement existing digital portraits, sharpening their potential impact. Facebook will eventually be able to mine the world’s largest database of photographs, linking individual people to their activities. Smartphones have rich data on every place where you have traveled with one in your pocket. This is just a start, and the privacy, security, and general trust implications are staggering. Yet consumers consistently show a desire to provide more data when companies use captured information to provide truly helpful feedback (you’re over budget or you are doing well in your exercise program) or to offer recommendations, services, and customization tools rather than just push what might appear to be intrusive (and creepy) messaging.

Simply

The quest for simplicity led Amazon to create a subscriber model for delivering bulky repeat-buy items (such as diapers) and Starbucks to adopt a tap-and-go approach to mobile payments. Yet many interactions remain complex and fragmented: to name just a few, finding, organizing, and redeeming online coupons; turning weekly meal plans into online delivery orders; tracking your monthly cash flow; and staying on top of your health-insurance bills and reimbursements.

Evolving technologies and consumer behavior should make it easier to redesign many complex experiences. For example, companies offering inherently complicated products or services could overlay a game interface on certain Web pages, to let consumers play at trading off different options and prices. Visual-recognition technology could allow you to scan health-care bills, receipts, statements, and appointments into one integrated calendar and cash-management system. Already, start-ups in travel, expense, and sales-force management are experimenting with approaches that streamline processes and make interactions more inviting—using touch and swipe to make changes, gestures to activate large displays, and data in phones to recognize consumers and automatically customize interfaces.

Setting strategies and building capabilities

Consumers will soon make these demands of every interaction they have with companies. Although the marketing function may often be the best conduit to get customer input and to drive decisions about how to distinguish brands, coordinated efforts across the enterprise will be needed on three levels.

Designing interactions across the consumer decision journey

Today, many companies have successfully defined and addressed customer interactions across a few channels. What they need to be designing, however, is the entire story of how individuals encounter a brand and the steps they take to evaluate, purchase, and relate to it across the decision journey. Marketing or customer research can’t do this alone. At one apparel retailer, managers from multiple functions go together into the field to do deep ethnographic research— watching how customers shop, going into their homes, and uncovering the triggers and motivations that drive behavior. These managers look for the compromises that people face as they try to get things done, probing for their higher aspirations. And the managers watch how customers react as they interact with brands.

Among the findings, the managers identified seven key “use cases”—customer situations that lead to satisfaction along different decision journeys. They found a wide range of trigger points for choosing an “outfit solution” for a social occasion, learning that shoppers became frustrated, especially online, when they couldn’t see how items would look together. Customers wanted to drag and drop items on an on-screen model or to see great combinations in advance. But that required different merchants to work collectively and the stores to bring items together on sales floors.

Cross-functional teams also came together in workshops. With third parties such as fashion bloggers and thought leaders from online-media companies, they mapped out new ways to influence the decision journeys of customers with different attitudes toward the retailer’s brand or different kinds of spending behavior. One of the most valuable outcomes was clarity on how the store’s brand positioning could guide the design of new experiences. The teams knew that their story would always be “better value than the shopper expected, delivered in a friendly way.” That meant warm visuals and messaging on the company’s Web site and across various media to reinforce the story of value to the customer. And the teams explored new ways social media could help customers show off the value they received.

Out of the work came not only a shared, company-wide sense of the decision journeys of consumers but also immediate buy-in to a wide range of initiatives that could boost market share. These initiatives are on track to provide an 8 percent sales lift above what the existing plan envisioned and were implemented more quickly because of the management team’s shared sense of engagement.

Making data and discovery a nonstop cycle

To win over on-demand customers, you must know them, what they expect, and what works with them, and then have the ability to reach them with the right kind of interaction. Data lie at the heart of efforts to build that understanding—data to define and contextualize trends, data to measure the effectiveness of activities and investments at key points in the consumer decision journey, and data to understand how and why individuals move along those journeys. To realize that potential, companies need three distinct data lenses.

Telescope. A clear view of the broad trends in your market, category, and brand is essential. Digital sources that track what people are looking for (search), what people are saying (social monitoring), and what people are doing (tracking online, mobile, and in-store activities) represent rivers of input providing constant warning signs of trouble or signals of latent opportunity. Many companies are drowning in reports from vendors providing these types of information tools, yet few have much clarity on which things they need to look for and who needs to know what.

One packaged-goods company got a jump on competitors when it saw a spike in online conversations about the lack of natural ingredients in shampoos and then recognized a corresponding rise in search inquiries on the subject. A new line of natural hair care products, launched at record-breaking speed, has become a successful early mover in a growing segment. A telecommunications company has become similarly plugged in: it now has a war room to track every online comment anywhere. Besides being better able to address—in an open, friendly, and fast way—problems that could escalate, it now has a great frontline source of line-outage signals that trigger repair crews and increases in call-center capacity.

Binoculars. Against this backdrop of market activity, few companies have a complete, integrated picture of where they spend their money, which interactions actually happen, and what their outcomes are. Most direct-sales companies (retailers, banks, travel services) measure the performance of their spending through isolated last-attribution analyses that look narrowly at what consumers do after confronting a search link, an e-mail, or an advertisement. Branded-goods companies try to throw all of their media spending together into an econometric model assessing the effects of their media mix. In the world of on-demand marketing, where multiple interactions take place along multiple journeys, last-action attribution explains only part of the impact of media spending, and media-mix models fail to account for touches and costs outside of paid channels.

What’s next? Deploying tools that rapidly assemble databases of every customer contact with a brand, companies will need to push every customer-facing function to work together and form an integrated view of consumer decision journeys. With longitudinal pictures of customers’ touches and their outcomes, companies can model total costs per action, find the most effective decision-journey patterns, and spot points of leakage. As more contacts become digitized—and they will—the data will gradually get easier to create. Getting a head start can help companies build ongoing test labs where they tune the ability to create and analyze the right data and immediately learn where to add investments. One bank has already realized millions of dollars in added value from the knowledge that weak points in the customer on-boarding process were undermining major marketing programs. Only when branches, call centers, and marketing worked together could the bank find the right fixes, improve customer satisfaction, and raise marketing’s return on investment.

Microscope. Trust is essential, and personalization can show customers they matter. They expect a brand to be a good steward and user of data about them and, increasingly, have high expectations for what a brand should know. In the example described earlier, data about Diane powers the brand’s ability to make it easy for her to share photographs, to buy a headset, to set up and manage a free Spotify subscription, to receive information about a local event, to be recognized at it, and to get additional special offers. Information about Diane is the thread that keeps all of her brand interactions immediate (now), valuable (can I), relevant (for me), and easy (simply).

Yet given the laser focus on getting programs into the market to improve performance, few marketers (or even line executives) have stepped back and pulled their teams together to work through the scenarios and customer-data models they will now need to build. Even fewer have a strong sense of what the current plans of the company’s IT department will deliver in which time frame. One company that addressed these issues has identified over 20 types of consumer decision journeys as archetypes of experiences it must support over the next three years. From those decision journeys, it has derived a core set of information capabilities it will need to build and is well down a tight road map of development that has already enabled it to launch products in breakthrough ways.

Delivering with new skills and processes

To deliver these new experiences, executive teams must rethink the role and structure of the marketing organization and how it engages with other functions. The changes are likely to cut deeply, transforming the way companies manage campaigns and communities, measure performance, provide customer support, and interact with outside agencies. It’s still early days, but consider the breadth of recent efforts.

Raising a consumer-packaged-goods company’s digital game. A European CPG company started by creating a digital-analytics group with worldwide operations. Rather than sprinkle digital experts across the globe, the company developed a unified structure with common standards for roles, common training, and digital career tracks to build an arsenal of future talent. The analytics team is part of a broader digital center of excellence that provides service support to the business units and drives major upgrades in IT capabilities. Defined commitments from managers in finance, legal, and HR help the center deal with challenges that arise as it seeks to offer customers a richer digital experience.

The company also reviewed all of its e-commerce trade accounts and decided that it needed a much more granular approach to serving customers. Says one executive, “It is not just an issue of managing our relationship with pure-play e-commerce sellers versus our traditional channels; it also is an issue of managing the online versus brick-and-mortar sides of the same traditional partner.” A new e-commerce trade team with added digital-analytic support is helping both to enhance the online-merchandising mix and to improve the placement of the company’s products in the search engines of e-commerce providers.

Finally, marketing leaders established a novel customer-relationship-management (CRM) team because they realized that the growth of the company’s mobile services, coupon programs, sampling, and social communities was finally enabling it to gather huge amounts of direct data about how people interacted with its brands. (That information had previously been available only to retailers.) These structural and talent changes led the company to realize that it needed to reshuffle its agency relationships, replacing a single brand-and-ad agency with two agencies—one for brand programs, the other for digital and CRM direct marketing. The company also brought more media and digital analytics in-house.

Reorienting a bank. At one institution, a new understanding of emerging brand challenges led to a radical change in the status of the CMO. Marketing had earlier ranked low in this sales-driven organization, where the function’s leaders focused mostly on corporate communications and brand campaigns. Now, a new CMO, much closer to her peers on the executive board, has been charged with directing the full consumer experience.

Each month, the bank’s business-unit leaders gather to talk about their progress in improving different consumer decision journeys. As new products and campaigns are launched, these executives place a laminated card of such a journey at the center of a conference-room table. They discuss assumptions across the whole flow of the journey for different consumer segments and how various groups across functions should contribute to the campaign. Where should customer data be captured and reused later? How will the campaign flow from mass media to social media and to the bank’s Web site? What is the follow-up experience once a customer sets up an account?

The bank has created a corporate center of excellence for digital marketing to give the strategy a forward tilt and to plan for needed capabilities. It has also appointed a new team of full-time executives who focus on mobile and social technologies—executives who have become evangelists, helping business units to raise their digital game along a range of consumer interactions. The first wave of fixes and new programs has already generated tens of millions of dollars in the first six months, and the bank expects these efforts to add more than $100 million to its annual margins.

The forces enabling consumers to expect fulfillment on demand are unstoppable. Across the entire consumer decision journey, every touch is a brand experience, and those touches just keep multiplying in number. To mobilize for the on-demand challenges ahead, companies must:

  • bring managers together from across the business to understand consumers’ decision journeys, to speculate about where they may lead, and to design experiences that will meet the consumer’s demands (NowCan IFor me, andSimply)
  • align the executive team around an explicit end-to-end data strategy across trends, performance, and people
  • challenge the delivery processes behind every touch point—are the processes making the best use of your data and interaction opportunities and are they appropriately tailored to the speed required and to expectations about your brand?

Executive recruiters tell us that corporate boards are looking for more people who can challenge and improve a company’s approach to social media, big data, and the customer experience. Staying ahead of the design, data, and delivery requirements of on-demand customers is much more than a marketing issue—it will be a crucial basis for future competitive advantage.

Beyond Korean style: Shaping a new growth formula

Beginning in the 1960s, South Korea has set economic-development records with a growth formula that focused on heavy-industry and manufactured exports. GDP has tripled in just the past 20 years, and South Korea became the first nation to go from being a recipient of aid from the Organisation for Economic Co-operation and Development to being a member of its donor committee. South Korea is the leading supplier of LCD screens, memory chips, and mobile phones and is the world’s number-five automaker.

Yet the nation’s GDP growth is increasingly decoupled from the lives of its middle- income citizens. The number of middle-income households—earning 50 to 150 percent of median income—has fallen from 75.4 percent of the population to 67.5 percent since 1990, and more than half of middle-income households are cashflow constrained when the full costs of housing payments are counted. The squeeze contributes to trends that could affect future growth, including a plummeting personal-saving rate and one of the world’s lowest fertility rates. Beyond Korean style: Shaping a new growth formula, a new report from the McKinsey Global Institute (MGI), explores the causes of these economic challenges and makes specific recommendations for combatting them. Among the report’s findings:

  • South Korea’s largest industrial corporations have continued to grow rapidly, but mostly in new global markets; their domestic employment has fallen by 2 percent annually for 15 years, leaving job creation to small and medium-sized enterprises (SMEs) and Korea’s underdeveloped service sector, where wages are just 55 percent of manufacturing pay.
  • Spending on housing and education have soared (exhibit). The median price for a home in South Korea is 7.7 times the median annual income—more than twice the US multiple. South Koreans also pay much more to finance their home purchases because low loan-to-value limits often force homebuyers to seek supplemental, high-interest loans. Spending on private education is extremely high as well (around 9 percent of GDP) because South Koreans believe admission to a top university is the only path to success for their children.

 

Exhibit

Beyond Korean Style - exhibit

 

But South Korea can take specific steps to strengthen its middle-income households, increase domestic demand, and build a more balanced economy. Namely:

  • Reduce housing payments. By switching to mortgages with looser loan-to-value limits, MGI estimates that South Korean homeowners could save $8 billion annually in payments. South Korea can also encourage more investment in rental housing and can consider shared ownership programs.
  • End the education “arms race.” Even though Koreans continue to sacrifice to prepare their children for university, unemployment rates are higher for South Korean college graduates than for graduates of vocational high schools. And when costs are factored in, the net present value of the lifetime earnings of a privately educated college graduate is lower than those for a graduate of vocational high school. To help parents consider alternatives to a university education, MGI suggests higher investment in vocational education and expansion of the Meister school program, in which employers collaborate with schools to create job-relevant curricula. A dual-track system would enable students to continue on to college degrees as they progress in their careers.
  • Build up services and SMEs. South Korean services are dominated by low value-added enterprises, particularly local services (for example, restaurants, real-estate sales, transportation). South Korea can build on the success of sectors that are already globally competitive, such as construction engineering, and help expand sectors such as health care, tourism, and financial services.
  • Create an entrepreneurial SME sector. Most SMEs are very small, and few mid-sized enterprises become large companies. Structural problems are partly to blame, but South Korea also lacks an entrepreneurial tradition and offers limited support for innovative risk-takers. South Korea can work to expand access to capital, increase intellectual-property protections, teach entrepreneurism, and update bankruptcy regulations. These initiatives will take a concerted effort by policy makers, business leaders, and South Korean citizens. But the result could be a new growth formula that complements the current model, reverses the erosion of middle-income households, and builds a sustainable future for all South Koreans.

Printed with permission from McKinsey Global Institute

Manufacturing the future: The next era of global growth and innovation

The global manufacturing sector has undergone a tumultuous decade:

Large developing economies leaped into the first tier of manufacturing nations, a severe recession choked off demand, and manufacturing employment fell at an accelerated rate in advanced economies. Still, manufacturing remains critically important to both the developing and the advanced world. In the former, it continues to provide a pathway from subsistence agriculture to rising incomes and living standards. In the latter, it remains a vital source of innovation and competitiveness, making outsized contributions to research and development, exports, and productivity growth. But the manufacturing sector has changed—bringing both opportunities and challenges—and neither business leaders nor policymakers can rely on old responses in the new manufacturing environment.

Manufacturing the future:

The next era of global growth and innovation, a major report from the McKinsey Global Institute, presents a clear view of how manufacturing contributes to the global economy today and how it will probably evolve over the coming decade. Our findings include the following points:

  • Manufacturing’s role is changing. The way it contributes to the economy shifts as nations mature: in today’s advanced economies, manufacturing promotes innovation, productivity, and trade more than growth and employment. In these countries, manufacturing also has begun to consume more services and to rely more heavily on them to operate.
  • Manufacturing is not monolithic. It is a diverse sector with five distinct groups of industries, each with specific drivers of success.
  • Manufacturing is entering a dynamic new phase. As a new global consuming class emerges in developing nations, and innovations spark additional demand, global manufacturers will have substantial new opportunities—but in a much more uncertain environment.

Manufacturing’s role is changing:

Globally, manufacturing continues to grow. It now accounts for approximately 16 percent of global GDP and 14 percent of employment. But the manufacturing sector’s relative size in an economy varies with its stage of development. We find that when economies industrialize, manufacturing employment and output both rise rapidly, but once manufacturing’s share of GDP peaks—at 20 to 35 percent of GDP—it falls in an inverted U pattern, along with its share of employment. The reason is that as wages rise, consumers have more money to spend on services, and that sector’s growth accelerates, making it more important than manufacturing as a source of growth and employment.

The sector is also evolving in ways that make the traditional view—that manufacturing and services are completely separate and fundamentally different sectors—outdated. Service inputs (everything from logistics to advertising) make up an increasing amount of manufacturing activity. In the United States, every dollar of manufacturing output requires 19 cents of services. And in some manufacturing industries, more than half of all employees work in service roles, such as R&D engineers and office-support staff.

As advanced economies recover from the Great Recession, hiring in manufacturing may accelerate, and some nations may even raise net exports. Manufacturers will continue to hire workers, both in production and nonproduction roles (such as design and after-sales service). But in the long run, manufacturing’s share of employment will remain under pressure as a result of ongoing productivity improvements, faster growth in services, and the force of global competition, which pushes advanced economies to specialize in activities requiring more skill (Exhibit 1).

Exhibit 1

Manufacturing is not monolithic. No two manufacturing industries are exactly alike; some are more labor- or more knowledge-intensive. Some rely heavily on transportation, while for others, proximity to customers is the critical issue. We have identified five broad manufacturing segments and analyzed how different production factors influence where they build factories, carry out R&D, and go to market.

The largest segment by output (gross value added) includes industries such as autos, chemicals, and pharmaceuticals. These industries depend heavily on global innovation for local markets—they are highly R&D intensive—and also require close proximity to markets. The second-largest segment is regional processing, which includes industries such as printing and food and beverages. The smallest segment, with just 7 percent of global manufacturing value-added, produces labor-intensive tradables (Exhibit 2).

Exhibit 2

Manufacturing is diverse: We identify five broad groups with very different characteristics and requirements

Manufacturing is entering a dynamic new phase. By 2025, a new global consuming class will have emerged, and the majority of consumption will take place in developing economies. This will create rich new market opportunities. Meanwhile, in established markets, demand is fragmenting as customers ask for greater variation and more types of after-sales service. A rich pipeline of innovations in materials and processes—from nanomaterials to 3-D printing to advanced robotics—also promises to create fresh demand and drive further productivity gains across manufacturing industries and geographies.

These opportunities arise in an extremely challenging environment. In some low-cost labor markets, wage rates are rising rapidly. Volatile resource prices, a looming shortage of highly skilled talent, and heightened supply-chain and regulatory risks create an environment that is far more uncertain than it was before the Great Recession.

Manufacturers and policy makers need new approaches and capabilities. Companies must develop a highly detailed understanding of specific emerging markets, as well as the needs of their existing customers. They will also require agile approaches to the development of strategy—using scenario planning rather than point forecasts, for example. And they will have to make big bets on long-range opportunities, such as tapping new markets in developing economies or switching to new materials, but must do so in ways that minimize risk.

A critical challenge for manufacturers will be to approach footprint decisions in a more nuanced way. Labor-intensive industries will almost always follow the path of low wages, but others, with more complex needs, must weigh factors such as access to low-cost transportation, to consumer insights, or to skilled employees. The result could very well be a new kind of global manufacturing company—a networked enterprise that uses “big data” and analytics to respond quickly and decisively to changing conditions and can also pursue long-term opportunities.

For policymakers, supporting manufacturing industries and competing globally means that policy must be grounded in a comprehensive understanding of the diverse industry segments in a national or regional economy, as well as the wider trends affecting them. For example, shapers of energy policy need to consider which segments will be affected by higher or lower energy costs, how great the impact is likely to be, and what magnitude of difference will trigger a location decision. Policymakers should also recognize that their long-term goals for growth, innovation, and exports are best served by supporting critical enablers for manufacturers (such as investing in modern infrastructure) and by helping them forge the connections they will need to access rapidly growing emerging markets.

Two key priorities for both governments and businesses are education and the development of skills. Companies have to build their R&D capabilities, as well as expertise in data analytics and product design. They will need qualified, computer-savvy factory workers and agile managers for complex global supply chains. In addition to supporting ongoing efforts to improve public education—particularly the teaching of math and analytical skills—policy makers must work with industry and educational institutions to ensure that skills learned in school fit the needs of employers.

Urban World: A new iPad app for exploring an unprecedented wave of urbanization

The growth of cities in emerging markets is driving the most significant economic transformation in history. The McKinsey Global Institute’s new iPad app, Urban World, offers a sense of how economic power will move as this urban expansion takes place. The app offers previously unavailable data from a proprietary MGI database of more than 2,600 cities around the world.

The app also places urbanization in a historical context, using a view from space of the global nighttime distribution of light as a proxy for the global distribution of economic activity. Users can visualize the world’s shifting center of economic gravity during the past two millennia, to 2025. The app serves a purpose similar to a 16th-century map—a rough but helpful tool to help navigate the evolving urban world.

Corporate strategists, urban planners, economic historians, and geography buffs alike can use the app’s interactive map to compare individual cities on their GDP, population, and income levels in 2010 and one scenario for 2025.

The growth of some urban markets can exceed that of entire nations, which is why cities matter for strategy. Companies can use the data to compare the economic growth from different cities. For example, Vienna had roughly the same GDP in 2010 as Istanbul. By 2025, the scenario presented in the app shows that the GDP of Istanbul will be comparable to the entire country of Austria. Auckland (New Zealand) had roughly the same GDP in 2010 as New Delhi but, by 2025, the GDP of New Delhi will be almost as great as the GDP of the entire country of New Zealand.

MGI research finds that the annual consumption of citizens in emerging markets will reach $30 trillion by 2025, and the GDP of these markets will exceed that of developed countries. Business leaders recognize that emerging markets hold the key to long-term success—but that they also pose daunting challenges. Many companies’ financial results reflect that ambivalence. In 2010, 100 of the world’s largest companies headquartered in developed economies derived just 17 percent of revenue from emerging markets—despite the fact that those markets account for 36 percent of global GDP. Companies that neglect these new markets risk missing out as much as 70 percent of global GDP growth between now and 2025.

iPad screenshot

Urban World: A new iPad app - image3