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Protecting information in the cloud

IT and business executives need to apply a risk-management approach that balances economic value against risks.

The use of highly scaled, shared, and automated IT platforms—known as cloud computing—is growing rapidly. Adopters are driven by the prospects of increasing agility and gaining access to more computing resources for less money. Large institutions are building and managing private-cloud environments internally (and, in some cases, procuring access to external public clouds) for basic infrastructure services, development platforms, and whole applications. Smaller businesses are primarily buying public-cloud offerings, as they generally lack the scale to set up their own clouds.

As attractive as cloud environments can be, they also come with new types of risks. Executives are asking whether external providers can protect sensitive data and also ensure compliance with regulations about where certain data can be stored and who can access the data. CIOs and CROs are also asking whether building private clouds creates a single point of vulnerability by aggregating many different types of sensitive data onto a single platform.

Blanket refusals to make use of private- or public-cloud capabilities leave too much value on the table from savings and improved flexibility. Large institutions, which have many types of sensitive information to protect and many cloud solutions to choose from, must balance potential benefits against, for instance, risks of breaches of data confidentiality, identity and access integrity, and system availability.

Refusing to use cloud capabilities is not a viable option for most institutions. The combination of improved agility and a lower IT cost base is spurring large enterprises to launch concerted programs to use cloud environments. At the same time, departments, work groups, and individuals often take advantage of low-cost, easy-to-buy public-cloud services—even when corporate policies say they should not.

High growth and value expectations

Corporate spending on third-party-managed and public-cloud environments will grow from $28 billion in 2011 to more than $70 billion in 2015, according to IDC. However, total spending on the cloud is much larger than these estimates indicate because the figures do not reflect what enterprises spend on their private-cloud environments. Eighty percent of large North American institutions surveyed by McKinsey are planning or executing programs to make use of cloud environments to host critical applications—mostly by building private-cloud environments. At several of these institutions, executives predict that 70 to 75 percent of their applications will be hosted in cloud environments that will enable savings of 30 to 40 percent compared with current platforms.

Using external cloud offerings can yield even more pronounced savings. Some executives cite examples of 60 to 70 percent savings by replacing custom-developed internal applications with software-as-a-service alternatives sourced from the public cloud. In addition, according to recent McKinsey research, 63 percent of business leaders who responded agreed that the cloud can make their entire organization more business agile and responsive.

The rise of bottom-up adoption

Truly cloud-free organizations are extremely rare—and in fact may not exist at all. If you think you are the exception, you are probably wrong. Regardless of any “no cloud” policy, the democratized nature of cloud purchasing reduces the middleman role played by traditional IT departments and makes central control difficult. Users are subscribing directly to cloud services, from online storage and backup to media services and customer-relationship management solutions, paying via credit card. Developers are using infrastructure-as-a-service and platform-as-a-service solutions for testing code and sometimes for hosting applications.

Ironically, forbidding cloud offerings may lead to users subscribing to less secure solutions. An employee using a credit card may not be sufficiently security inclined or aware to purchase the enterprise-class version of cloud software. That same individual might have been perfectly willing to use cloud service providers endorsed by his or her organization had they been available.

Risks and opportunities

Using the cloud creates data-protection challenges in public-cloud services as well as private-cloud environments. However, traditional platforms at most organizations have significant information risks that actually can be mitigated by moving to a more highly scaled and automated environment.

Risk of contracting for public cloud

Decades of experience matured the practice of writing contracts for telecommunications network services and traditional outsourcing arrangements. Terms and conditions exist for allocating liability for security breaches, downtime, and noncompliance events between providers and enterprises. They may be unwieldy, but they are well understood by providers, law firms, and—in many cases—CIOs and CROs.

Contracting for the cloud is different in many ways. Highly scaled, shared, and automated IT platforms, for example, can obscure the geographic location of data from both the provider and customer. This is a problem for institutions dealing in personally identifiable information because often they must keep some customer data in certain jurisdictions and face regulatory action if they do not. At this point, banking CIOs and CROs that we have interviewed largely do not believe that most public-cloud providers can give them the guarantees they require to protect their institutions from this type of regulatory action. Another novel challenge presented by the cloud is how to conform to regulatory and industry standards that have not yet been updated to reflect cloud architectures.

At some level, for the cloud, we are simply in the early days of contracting for enterprise-class services. How to draft the required terms and conditions will remain an open question until litigation has identified the critical issues and legal precedent has been established for resolving those issues.

Risk of aggregation in private-cloud environments

The current state of data fragmentation at many enterprises provides a peculiar kind of risk-management benefit. Dispersing sensitive customer data across many platforms means that a problem in one platform will affect only a subset of a company’s information. Fragmentation may also limit the impact of a security breach, as different platforms often have varying security protocols.

In contrast, consolidating applications and data in shared, highly scaled private-cloud environments increases the honeypot for malevolent actors. There’s much more valuable data in one place, which raises the stakes for being able to protect data.

Risk-management advantages of the public and private cloud

Both public- and private-cloud solutions can provide data-protection advantages compared with traditional, subscale technology environments. Cloud solutions improve transparency—for example, the centralized and virtualized nature of the cloud can simplify log and event management, allowing IT managers to see emerging security or resiliency problems earlier than might otherwise be possible. Likewise, in cloud environments, operators can solve problems once and apply the solutions universally by using robust automation tools.

Perhaps more important, technology organizations can focus investments in security capabilities on a small number of highly scaled environments.

A risk-management approach to exploiting the cloud

In many large institutions, information security traditionally has been a control function that used policies limiting what IT managers and end users could do in order to reduce the likelihood of data loss, privacy breaches, or noncompliance with regulations. We believe that IT organizations must now adopt a business-focused risk-management approach that engages business leaders in making trade-offs between the economic gains that cloud solutions promise and the risks they entail. It is still the early days of cloud computing, and risk-management decisions are highly dependent on the specifics of the situation, so there are no hard-and-fast rules. However, some rough principles for managing cloud-information risk are emerging.

Consider the full range of cloud contracting models

“Public cloud” and “private cloud” are useful simplifications, but there are other models that may provide attractive combinations of control and opportunities to tap vendor capabilities:

  • One option is on-premises managed private-cloud services, in which third-party vendors provide a service that operates like an external cloud offering but is located in an enterprise’s own facility and is dedicated to the organization.
  • Some flavors of virtual private clouds can be used; these are similar to public clouds in that the solution is externally managed, but like private clouds, they offer dedicated capacity, such as resource pools, that are reserved for each client.
  • Community clouds feature infrastructure that is shared by several organizations and meets the needs of a specific community of users. Community clouds may, for example, provide industry-specific solutions that ensure compliance with relevant regulations.

To complicate things further, the maturity of technological and organizational solutions varies by deployment type and by application, vendor, and specific configuration.

Pursue a mixed-cloud strategy

Different workloads and data sets have vastly different stakes when it comes to data protection, depending on the nature of the application and which phase of the software life cycle it supports—for instance, development and test versus live production. The public cloud can be a good option for developing and testing software, since this usually does not involve sensitive data. Any workload that includes personally identifiable customer information will require careful consideration before it could be hosted in a public-cloud environment. Control of data access is also important in order to protect confidential business information and intellectual property. Essentially, any data that has business value or is covered by regulation needs appropriate management and protection (for more on the types of information to manage.

In addition, benefits from cloud migration can vary widely by workload. For example, consumer-commerce sites, where capacity demand spikes during major promotions or at certain times of the year, will benefit from taking advantage of the variable pricing available through highly scalable public clouds.

Sophisticated IT shops are developing tools to map workloads to cloud-based hosting options using criteria like mission criticality, sensitivity of data, migration complexity, and peak processing requirements. This will make it possible for IT staff to pursue a mixed-cloud strategy and drive workloads to the hosting options that best balance risk and economic value.

Implement a business-focused approach

Organizations that have mature risk-management functions—for example, large companies in heavily regulated industries such as banking—should establish a comprehensive risk-management approach for cloud computing that extends beyond technology solutions and the IT department. Design and implementation should cover the policies, skills, capabilities, and mind-sets required of the IT and risk-management organizations, as well as the operating units. The risk-management methodology should address several elements, including transparency, risk appetite and strategy, risk-enabled business processes and decisions, risk organization and governance, and risk culture.

Transparency about the risks of breaches of confidential business information, intellectual property, and regulated information is essential to protecting sensitive data. Fortunately, centralized cloud platforms and expanded operational data available from these platforms allow managers to assess risks, discover breaches, design guidelines based on trade-offs between risk and value, and in many cases automate the enforcement of these guidelines.

To a large extent, the rules for the data that certain groups of employees are authorized to access and the data that must remain in the private cloud can be enforced by the cloud platform itself. Data on the company’s quarterly financial results, for instance, can be automatically blocked from leaving the secure environment of its private cloud until results have been officially released.

For organizations engaged in wholesale cloud migrations, roles and responsibilities will require significant changes—moving from specialized roles, such as server or network managers, to broader roles for integrated service managers. These service managers will be well positioned to steward business risks because their perspective is more comprehensive than that of specialized managers, for example, when making judgments on when to use private- or public-cloud resources.

Nonetheless, the democratized nature of cloud purchasing and usage constitutes risks that automated guidelines cannot fully address. The proliferation of wireless devices that can access cloud computing anytime and anywhere, for instance, extends the reach of the company’s information infrastructure, but by doing so, the information also becomes more vulnerable to breaches. Among the risks: lost or stolen devices with sensitive data stored on them. This means that the mind-sets and behaviors of line staff and managers can have great impact on cybersecurity. As a result, companies must drive risk awareness across the organization and provide risk orientation for new and lateral hires. Linking compliance to compensation through clear metrics reinforces the culture shift.

The cloud in its many forms is an exciting development for enterprise IT, but it also creates new types of challenges in protecting sensitive information assets. A business-focused risk-management approach enables large institutions to strike the right balance between protecting data and taking advantage of more efficient and flexible technology environments.

Printed with permission from McKinsey Quarterly.

What’s in store for China in 2013?

The year ahead could be a time of significant change for everything from banks, retailers, and infrastructure projects to pork prices, soccer, and “compulsory” vacation time.

How might China surprise us in 2013? Read the ten predictions of Gordon Orr, a McKinsey director based in Shanghai, and tell us what you would add.

1. Banks underperform

Mainland banks have undergone a remarkable financial recovery over the past decade, thanks to the sector’s initial recapitalization and China’s rapid economic growth. As the economy slows, however, two issues are of immediate concern: the scale of nonperforming loans left behind after the 2009 economic stimulus and the volume of wealth-management products recently snapped up by retail investors in search of decent returns. The latter may come back to haunt Chinese banks in the same way that structured products plagued Western ones in the early stages of the global financial crisis.

This year could mark the start of a more fundamental transformation that will last several years. Most banks, after all, realize they need to find a different economic and business model, given growth rates that comfortably exceed returns on equity and unsustainable rates of capital consumption. In view of current trends, banks must find 1.3 trillion renminbi ($208 billion) in additional capital over the coming five years.

The challenge, which many banks are ill-equipped to manage, will be to shift from customer-acquisition and “growth at all costs” strategies to more differentiated ones focused on profits. The winners will be institutions that serve the customer well and improve their operational capabilities—among other things, by taking a more robust approach to risk. Complying with decisions of the China Banking Regulatory Commission, for example, must become a much more strategic exercise in future.

2. Pork or chicken prices rise 100 percent

China’s domestic food supply has been strained for years. The country consumes 50 percent of all pork globally, and rising demand for protein, especially pork, is pushing the system beyond its limits. In July 2011, pork prices surged 57 percent for a number of reasons, including the steady exit of swine farmers from the market beginning in 2010 and an outbreak of disease among pigs in late 2010 and early 2011. That could easily happen again, and on a much larger scale, because of failures in farms or in the extremely rudimentary cold supply chain. Imports could not increase on a scale sufficient to fill the gap. The psychological scars from recent food-safety scandals could lead to panic hoarding of substitute products and drive up their prices, too. Although a better food chain will develop over time, this may take several years.

3. Local protests intensify—and succeed more often

In June 2007, local protesters successfully forced the authorities to withdraw plans to build a chemical plant in Xiamen. Since then, a growing number of planned incineration and chemical projects have been withdrawn, postponed, or modified following protests, whose number doubled in the second half of 2012. A “not in my backyard” mentality is becoming common. Since there is no formal process for legitimizing proposed investments in a community, people are willing to protest noisily for an extended period, harnessing the power of social media. They realize that the government has little choice but to intervene with force or to compromise or back down.

In 2013, local protests against both new construction of polluting facilities and the operation of existing ones are likely to intensify. The fear of further damage to health and the environment will increasingly trump the desire for economic growth. Local governments will back down more often.

4. China spends more on infrastructure

Beijing’s airport welcomed more than 80 million passengers last year, and China has the world’s largest network of toll roads and high-speed trains, as well as six of the ten busiest container ports. Yet the high cost of logistics is just one indicator that China needs to build a much more extensive transport infrastructure. Many in government not only recognize this reality but also believe profoundly that it is better to build sooner rather than later.

China lags furthest behind other nations in the number of airports with paved runways: the world’s most populous country has 452 airports, Brazil 713 and the United States 5,194. Forty-four Chinese cities with more than a million people still have no mass-transit system other than buses. The supply chain for agricultural products remains rudimentary.

Most significantly, much of the urban population in all but the top-tier cities lacks modern accommodations, and the rehousing of China’s existing urban residents is considerably less than half complete. The scale of the construction task is all the greater, since many of the residential buildings China put up in the 1980s were of relatively poor quality and will reach the end of their useful lives much sooner than might have been expected at the time.

Manufacturing investment will be strong this year. Capital-intensive Chinese manufacturing continues to earn good returns, and investment in technology across all sectors is boosting productivity, although this is perhaps not such good news for employment.

Infrastructure spending will continue to drive economic growth in 2013, and the vast majority of it will be put to good use. Yet the capital efficiency of many projects lags behind that of global leaders.

5. Online competition bankrupts a major main-street retailer

Online competition has yet to put major retailers in China out of business. Historically, economic growth has been sufficient to support all players, but that is about to change. In third- and fourth-tier Chinese cities, where modern retailing still isn’t well established, online retailers have the biggest edge in product range and prices. But thanks to low-cost distribution and very small markups on consumer-electronics products such as mobile phones, China’s e-retailers are increasingly penetrating “time poor” middle-income households in all cities. The appeal of these players lies not just in low prices but also in convenient home delivery, a trusted payment system, and the ability to return goods quickly and without administrative barriers. Physical retailers are moving online as fast as they can, but for most of them this is a very different business model and one that requires execution skills and a sophisticated online presence they currently lack.

The scale of the Alibaba companies—with $150 billion-plus 2012 sales, up by more than 60 percent—is overwhelming. This year will represent a tipping point for growth in the share of online sales of clothes and electronics. Many Chinese physical retailers, as owners of their own real estate and part of broader conglomerates, may be able to hide their underperformance for a while. But further exits from China by multinationals (following the path of Home Depot, Mattel, and OBI) seem likely.

6. Even the middle classes hedge their bets

It has long been common knowledge that many of the offspring of China’s leaders study outside the country. More and more upwardly mobile people are now following suit. In the past four years, the number of Chinese students applying to boarding schools in the United Kingdom and the United States appears to have tripled; many of these institutions could fill their classes entirely with students from mainland China. Parents are not motivated only by a desire to give their children an alternative to the rote learning that still characterizes much of Chinese education; they are also creating additional options for their children should there be a discontinuity in China.

Private-business owners have an opportunity to give themselves such options by making international investments and acquisitions outside China. With permanent residence on offer in countries such as Australia, Canada, and Singapore in return for an investment of up to a few million dollars, many are taking advantage. Vancouver, in particular, has had a new influx of the kind it experienced from Hong Kong in 1997. Individuals may have fewer options for diversifying their asset base outside the country, but buying real estate is one of them: by some reckonings, the Chinese are now the second-largest acquirers of luxury property in London. Like other forms of “groupthink,” this wave will probably get a lot larger before it subsides.

7. European soccer teams invest in the Chinese Super League

The government-owned Chinese Super League of soccer became a lot more glamorous last year when the star player Didier Drogba joined Nicolas Anelka at Shanghai Shenhua, an ambitious but underperforming team. Yet the Chinese Super League will never fulfill its potential until fans have confidence that the games are clean and that coaches and players are improving. In many other (generally Olympic) sports, China has imported the best coaches and operating models. But not in soccer.

A new leadership intends to privatize the Chinese Super League and welcome international investment as part of an ongoing program of reform. This will allow team owners to develop and retain the full range of revenue streams at a modern sports club’s disposal. International teams from many European countries will invest in leading Chinese teams and rotate players between Europe and China.

8. Investment in overseas agriculture is the “next big thing”

In China, a trend that starts as a trickle often becomes an overnight flood. Outbound investment in commodities and premium agricultural products, for instance, will reach a tipping point in 2013: China has shifted rapidly from a trade balance on agricultural goods to a deficit that’s currently around $40 billion and growing at 50 percent a year. This transformation reflects increased demand in China for basic cereals to feed its expanding livestock populations and a slow-to-restructure domestic industry that can’t supply the need. China is now the second-largest importer of rice and barley and a top-ten buyer of corn. Chinese companies lease hundreds of thousands of hectares from Argentina to Kazakhstan to grow soybeans.

Outbound investors also eye a growing opportunity for premium fruits and vegetables of the kind sorely lacking in China. I don’t mean only state-owned enterprises spending their spare cash. Many private Chinese entrepreneurs, who have been wildly successful in areas from real estate to technology, have identified the food chain as their next big thing. Investing outside rather than inside China is attractive not only for the reasons already mentioned but also to diversify assets geographically and to avoid the high prices paid recently for assets in the domestic food chain. In the last few months, for example, the Shanghai Zhongfu Group diversified from real estate in Shanghai by investing around $728 million in a sugar-cane project in Western Australia. And at a major conference in Beijing in December, Chinese private-equity firms met with senior executives of US food companies and representatives of US state agricultural bureaus to discuss ways of increasing China’s investment in US agriculture.

9. A third-tier city goes bankrupt

Chinese cities still depend on land sales—in many cases, for 30 percent of gross revenue and, in some, for more than 50 percent. However, the supply of attractively located land for sale to developers is not inexhaustible. Some cities, especially those located in areas where manufacturing is in decline, now find that land values are on the slide. The financing vehicles these cities have been using to build projects will no longer work. Recent cases of trust companies bailing out troubled local real-estate concerns represent warning signals that municipalities are in difficulty. Without a bailout from the central government, they will no longer be able to meet their bills. Continuing to roll over loans to state-owned enterprises just pushes the problem a short way into the future.

10. National holiday weeks are abolished (please)

Perhaps this is more a hope than an expectation. Fifteen years ago, when the current structure of mandated vacation weeks was put in place, China’s economy was very different. There was a real belief that, without mandated vacations, most workers would never get a holiday or have an opportunity to spend the income they were saving. Yes, many hundreds of millions did travel during the Chinese New Year period, but far fewer people had migrated from their home towns to new urban environments than have done so today, and far fewer could afford to travel. In this respect, China was not that different from those European countries that mandated vacation weeks in the 1970s.

Today, these compulsory holiday weeks merely serve to saturate and overload the country’s infrastructure—if anything, reducing the amount of money that people spend on travel and related services as more and more choose to stay at home. The growing middle classes can schedule their own vacations when they want to much more readily than they could in the past. Formerly, large numbers of state-owned and private-sector enterprises did not meet the legal requirements for vacations. But in the age of social media, even factory workers can now name and shame offending employers.

Mandated vacation weeks will either gradually decline into irrelevance—starting in first-tier cities—or, better still, they will be formally abolished as an idea that has outlived its purpose.

Printed with permission from McKinsey Quarterly.

Investing in growth: Europe’s next challenge

Although the decline in Europe’s level of private investment from 2007 to 2011 is rarely highlighted as a feature of the region’s financial crisis, it was unprecedented. In fact, during that period, private investment in the European Union’s 27 member states (the EU-27) plunged by a combined total of €354 billion—20 and 4 times the fall in private consumption and real GDP, respectively.

Investment in European Union

Research by the McKinsey Global Institute (MGI) finds that while private investment was the hardest-hit component of GDP, it is also vital for recovery. Even in the face of weak demand and high uncertainty, some investors would start spending again if governments took bold measures to remove barriers that now stand in the way. And companies need not rely exclusively on regulatory changes to take a more fine-grained look at their own investment approaches.

In the past, private consumption has been the driving force behind most economic recoveries. But high rates of unemployment and personal debt have made consumers cautious about spending. Governments are feeling the weight of large debts and pressure to deleverage, so they cannot fill Europe’s private-investment hole themselves by investing or consuming. And while exports have played a significant role in the recovery thus far, they now face headwinds, not least because Europe is its own biggest export market and its overall growth has been anemic.

In contrast, publicly traded European companies had excess cash holdings of €750 billion in 2011, close to their highest real level in two decades. By removing regulatory barriers, European governments could, at a relatively low cost, unlock short-term private investment that would contribute to growth—and inspire confidence in firms that have hesitated to launch their own dormant investment plans.

Skeptics might argue that governments can make a difference only at the margins of the private sector’s investment decisions. But the largest investment potential for private companies lies in capital-intensive sectors such as energy and transportation, where government policy has a significant impact. MGI’s latest research finds that closing only 10 percent of the current subsector variation between countries in capital stock per worker would involve more than €360 billion in additional investment—more than what was lost during the financial crisis.

Such government intervention has a poor track record. “Picking winners” has too often been ineffective and a drain on public money. Instead, governments should consider a new policy for investment: prioritizing sectors in which it is most likely to help renew GDP growth, identifying barriers in those sectors, executing cost–benefit analyses, and building the skills necessary to implement these new policies effectively.

Regulatory change often involves difficult, time-consuming political trade-offs, so businesses looking to invest shouldn’t rely exclusively on regulatory changes, however great the imperative and opportunity. Companies need to examine their own approaches to investment. That might mean taking a more granular perspective on market opportunities (for example, by focusing on “micromarkets,” at the city rather than country level), engineering a step change in capital productivity, or ensuring that the bitter experience of recent years does not screen out potentially attractive opportunities by creating a bias against risk.

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The global gender agenda

Women continue to be underrepresented at senior-management levels in Asia, Europe, and North America. McKinsey research suggests some answers.

The progress of women toward the upper echelons of business, government, and academia continues to provoke media attention and lively debate. Look, for instance, at the coverage of Marissa Mayer’s July appointment as CEO of Yahoo! and the diverse reactions to an article (“Why women still can’t have it all”) published in the July/August issue of the Atlantic magazine.

Coincidentally, this summer also marked the moment when we released the latest phase of a global research initiative on women in senior management across Asia, Europe, and North America. This effort involved assembling fresh data on the gender composition of boards, executive committees, and talent pipelines, as well as detailed surveys of leading businesses in each region.

Encouragingly, the research shows that a growing number of women, both in senior roles and among the rank and file, are finding their voices and inspiring others to achieve progress. It also demonstrates that more companies are enjoying the benefits of gender diversity and that some have found ways to boost the representation of women at the highest levels of their organizations. From an admittedly low base, for instance, more women sit on European corporate boards (though not executive committees) than did so five years ago. Countries with a clear political commitment to change, in the form of specific quotas or targets, are achieving significant results. Several major corporations are emerging as inspirational role models.

Yet while the vast majority of organizations in developed economies are striving to unlock the potential of women in the workforce, many executives remain frustrated that they have not made more immediate and substantial progress. Firmly entrenched barriers continue to hinder the progress of high-potential women: many of those who start out with high ambitions, for instance, leave for greener pastures, settle for less demanding staff roles, or simply opt out of the workforce. In Asia, cultural attitudes toward child care and household tasks further complicate the challenges for corporate pioneers. And everywhere we look, despite numerous gender diversity initiatives, too few women reach the executive committee, and too few boards have more than a token number of women.

Our research also offered some clues about the characteristics of companies that make the greatest advances in gender diversity. Much depends on the stage of the journey companies have reached. The regional and cultural context matters, too. Still, we were struck by the global applicability of some core principles. Across geographies, we find that a wholly committed senior leadership, active talent management, and more effective efforts to shift mind-sets and change behavior can transform the gender agenda (see sidebar, ‘We’re at a tipping point’).

Global challenges

Women hold 15 percent of the seats on corporate boards and 14 percent of those on executive committees in the United States; 16 percent and 3 percent, respectively, in Germany; 20 percent and 8 percent, respectively, in France; and less than 10 percent on both boards and executive committees in China, India, and Japan. In Scandinavia, the numbers are higher: Norway’s representation is currently at 35 percent and 15 percent, respectively; Sweden’s at 25 percent and 21 percent, respectively.

The representation of women in all regions, moreover, diminishes markedly at each higher management level. Some female executives, of course, leak out of the talent pipeline because they are headed for other or better jobs; others voluntarily draw back from promotions as part of conscious work–life decisions. But a significant number run into a succession of seemingly immovable barriers at key career intersections.

We have long noted the combination of structural obstacles, lifestyle choices, and institutional and individual mind-sets that hinder the advancement of women. But only recently have we started to understand how deeply entwined they are. Men and women tend to be evenly distributed across line and staff roles early in their careers, for example, but women begin a steady and disproportionate shift into staff roles by the time they reach the director level. Lacking the sorts of networks that come more easily to men, many women miss out on discussions with sponsors who might encourage them to stay in the line. Line jobs tend to involve more pressure and less flexibility—less appealing to women forming families or opting for greater control over their lives. Some male executives, with good intent, do not even ask mothers to consider line assignments that involve travel and long hours.

Natural advantages or disadvantages do characterize some sectors, but the situation varies markedly even within them, and contradictions abound. In European financial services, for instance, the rate of attrition is particularly severe by the time women reach middle management. In contrast, our research indicated that some of the top US gender diversity performers were in financial services.

Finally, Asia stands out. The relatively low overall rate of female labor force participation in many Asian countries—though not all of them, for China is a notable exception—means that it is harder to fill the pipeline at the outset. Next, the double burden of Asia’s working women, who must juggle families and jobs, is not only reinforced by cultural factors but also compounded by a lack of government support in areas such as childcare. In many markets, women wait until their children are older before returning to work or (in Taiwan, for example) drop out in their late 20s never to return. Exacerbating matters in much of Asia is an absence of urgency to change the equation. In our recent survey of the region’s senior executives, just 30 percent of respondents said that gender diversity was currently a top priority for their corporations, and only a third saw it as being one of the top ten priorities on the corporate agenda in coming years.

From good to great

These challenges persist at a time when many companies, particularly in North America and Europe, are pursuing an arsenal of measures aimed at easing women’s progress through the organization. Such measures include efforts to make appraisals objective and unbiased; the adoption of diversity targets; greater flexibility in remote working; smoother transitions before, during, and after maternity leave; and executive coaching for high-potential vice presidents. Of the 235 European companies we surveyed recently, for instance, more than 60 percent told us they have at least 20 gender diversity initiatives in place.

Motivations vary. A number of studies find a correlation between high-performing companies and those with strong female representation at the top,3 though correlation does not prove causality. Many CEOs are convinced that mixed boards and mixed executive teams perform better than those dominated by men. As one corporate leader put it, just about every company wants to “get the best brains to work on the problem.” That said, successfully transforming gender attitudes and performance requires much greater leadership attention and dedication than even committed CEOs and top teams are currently giving to it. These goals also call for integrated management and monitoring of women in the talent pipeline from early on to the point when they become eligible to join the C-suite and for intervention to shift widely held beliefs holding back talented women.

Leadership ‘obsession’

Every major cultural, operational, or strategic change in a business requires personal passion, “skin in the game,” and role modeling from senior leaders, and gender diversity is no exception. When a CEO is the chief advocate and “storyteller,” more people (including the often less committed male middle managers) believe that the story matters and begin to adopt the CEO’s mind-set and behavior. Intensely committed CEOs make their goals clear and specific, tell everyone about them, get other leaders involved, and manage talent to help make things happen. CEOs who do not see gender diversity as a top issue fold “gender” into “diversity” and “diversity” into “talent,” thereby losing focus as leadership of initiatives is delegated to others further down the line. CEOs who champion gender diversity, for example, participate in women’s events and multiday talent discussions; less committed CEOs introduce them and leave, inadvertently signaling that other priorities take precedence.

In Europe, many executives tell us that the momentum for change took hold only when the top team made its commitment visible—for example, by appointing women to senior positions or taking measures to ensure that they were considered for certain jobs. Sponsorship is (and always has been) a critical part of an executive’s path to the top. HR leaders tell us that these relationships are hard to institutionalize and that formal programs have mixed success. But we find it significant that one company did much better when the CEO and the diversity leader personally took charge of the sponsorship program, selected a group of high-potential women, and invited them to spend significant time with the top team. Women in the program really got to know the CEO and senior-team members, and vice versa, and most have since moved up the management ladder.

Managing—and cultivating—the pipeline

McKinsey’s more general work on transforming the performance of companies shows that those with a clear understanding of their starting point are more than twice as likely to succeed as those that are less well prepared.4 In a gender diversity context, this understanding means knowing the gender balance at every level of the organization; comprehending the numbers by level, function, business unit, and region; and then monitoring metrics such as pay levels, attrition rates, reasons women drop out, and the ratio between women promoted and women eligible for promotion.

Why go to this expense? Establishing the facts is the first step toward awareness, understanding, and dedication to improvement. Using a diagnostic tool, one company simulated how much hiring, promoting, and retaining of women it would require to increase the number of senior women managers. That approach helped it set an achievable and, just as important, sustainable target that would not compromise a highly meritocratic corporate culture. With an overall target—that 25 percent of managing directors and directors should be women by 2018—and a clear understanding that the bar for promotion could not be lowered, managers now look harder for high-potential women and start working with them earlier to develop that potential.

Incentives tied to managers’ bonuses can help, though some companies fear that targets may undermine the credibility of women at the top. Those in favor of such targets believe that a radical mandate is required for substantial change and worth the backlash from women who ascended “the hard way.” Where targets are rejected, other mechanisms “with teeth” are necessary—almost all the top US performers on gender diversity have goals, if not targets. In Europe, we identified a gap between the measures companies now have in place and how carefully these companies apply and monitor them. Some have targets for women in senior positions, for example, but no plans for implementation; others have targets and plans but fail to communicate them. Companies with cultures inimical to top-down diktats should consider adopting a regular report that candidly evaluates progress and prompts senior management to brainstorm for new ideas.

Shifting mind-sets and behavior

Leaders with the best of intentions may still fall short unless they can change the way they and their organizations think. So if, for example, the prevailing view is that truly committed executives work 24/7 and travel at the drop of a hat, many talented women will turn their backs on further advancement. Such prevailing attitudes are hard to shift: in our experience, that can be done only by role models who challenge them through their actions and by a learning environment that cultivates self-awareness. More women at the top should help, though of course women can be as responsible as men for promoting a culture of nonstop work.

The top performers on gender diversity value and promote inclusiveness. Their leaders firmly believe that mutual respect drives better customer service and hence sales. When such beliefs take hold, they are powerful. One global cosmetics company we know, which operates in 88 countries and has a customer base that’s 90 percent female, now cites gender diversity as one of its key strengths. Another consumer-based business, headquartered in Europe, makes mostly products for men but learned through research that women usually make the buying decision. Increasingly, the company looks to female employees to refine its marketing and product-development approach.

Certain institutional biases are subtle—for example, a reluctance on the part of men to give women the tough feedback everyone needs on their way to the top. Many men, fearing that sponsoring women might seem inappropriate, find it difficult to do so. Most people feel more comfortable promoting those who behave and think as they do. A willingness to question can make a difference. When one company discovered, through an audit of its recruiting processes, that recruiters were more critical of female than male candidates, it devised a training course for the critics. One of them was asked to lead a session and has since become among the company’s most vocal supporters of diversity and inclusion.

The mind-sets—and aspirations—of women themselves are as important as those of the companies that employ them. Interviews with 200 successful middle-management and more senior women in 60 large companies across the United States highlighted some common threads: early career acceleration coupled with significant sponsorship, a willingness to change employers to gain greater opportunities, and a propensity to stay in line jobs for much of their advancement. These women remained optimistic even in the face of significant challenges.

Early-tenure women want to move to the next level as much as men do. Yet we found that only 18 percent of entry- and midlevel women have a long-term eye on the C suite, against 36 percent of men. That finding reinforces our belief that inspirational leaders should intervene with talented female middle managers to discuss their aspirations, build their confidence, embolden them to aim higher, and seek ways to make line roles more palatable for them. In particular, we would emphasize the need for women’s leadership-development programs to focus on personal mastery of thoughts, feelings, and actions and thus to make women accountable for their own future.5 In the average Fortune 500 company, a 10 percent boost in the odds that women will advance from manager to director and then to vice president would yield an additional 90 female executives, including five senior vice presidents and one member of the executive committee.

Four priorities for committed leaders

The widespread applicability of the principles above suggests a short list of actions that should be on every committed leader’s priority list:

1. Treat gender diversity like any other strategic business initiative, with a goal and a plan that your company monitors and follows up at the highest levels over many years. Build in a “report or explain” process and articulate a well-supported point of view on the value women bring to your organization and the case for or against explicit targets. If greater representation of women in the talent pipeline promises a competitive advantage, successful leaders will work hard to include them. If greater female representation better serves the company’s customers, those leaders will make that happen.

2. Ask for—and talk about—the data, sliced and diced to identify ‘pain points’ in the pipeline by business, geography, and function. Go well beyond measuring success by the number of women at the top. Discuss the percentage of talented women at each stage of the pipeline, their odds of advancement versus men’s, and the mix of women between line and staff jobs compared with that of their male counterparts. Make sure your entire top team and those who report to its members are accountable for the numbers, and brainstorm about what it will take to improve them.

3. Establish a culture of sponsorship, encouraging each top executive to sponsor two to three future leaders, including women. Instill a mind-set of “paying it forward,” so that every woman sponsored will in turn sponsor two or three others. Embed effective sponsorship of women into the profile of successful leaders at your company and raise the issue in performance dialogues with your own direct reports. Show your wider commitment by talking with top female talent when you visit regional divisions and business units or participate in external events.

4. Raise awareness of what a diverse work environment looks like, celebrating successes to reinforce the mind-set shifts you desire. Use frequent personal blogs, top-team meetings, and town hall gatherings to communicate what you are doing to drive change. To increase awareness of the new mind-sets, question your own personnel choices, and think about whom you tend to work with and why. Top executives who work hard to encourage diversity of thought across a company will increase everyone’s determination to bring the best to work—ending up not only with what they set out to achieve but with even more: an engaged community that corrects itself when things go off track.

A wide range of global companies made real advances in gender diversity over the past five years. They know that this is hard work—a journey measured in years rather than months. But they also know that improving the pipeline of female talent is possible, with rewards that include tapping the best brains, improving customer service, increasing employee engagement, and everything that comes with these benefits.

Africa: 2008 vs 2020

Africa at work: Job creation and inclusive growth

African economies are on the move. The continent has been the second-fastest-growing region in the world over the past decade. GDP is on course to expand by 4.8% in 2012. The acceleration in Africa’s growth over the past ten years reflects fundamental improvements in the macroeconomic landscape, political stability, and the business environment. MGI’s 2010 report Lions on the move: T he progress and potential of African economies found that Africa is harnessing its natural wealth, and that sectors across the economy are growing rapidly. These sectors include agriculture, manufacturing, and local services such as retail, banking, and transportation and communications, in addition to the  natural resources sector, which was the largest single contributor to growth.

Africa today …..

  • 382 million in Africa’s workforce
  • 42% of workforce employed outside agriculture
  • 28% of workers earn a wage vs 24% in 2000
  • Retail and hospitality accounted for 18% of new wage-paying jobs since 2002 vs 11% from manufacturing
  • 32% of African businesses surveyed cite access to finance as a major constraint on growth

….. and in 2020

  • 122 million more workers, more than any other region
  • 72 million new wage-paying jobs could be created by 2020
  • 36% of workforce in wage-paying jobs if this potential is realized
  • 128  million consumer households, up from 90 million in 2011
  • 48% of Africans with secondary of tertiary education

Read the full report at http://www.epictranslations.com/download/MGI_Africa_at_work_August_2012_Full_Report.pdf

Corporate Espionage

Foreign spies stealing U.S. economic secrets in cyberspace

Executive Summary:
Foreign economic collection and industrial espionage against the United States represent significant and growing
threats to the nation’s prosperity and security. Cyberspace—where most business activity and development of
new ideas now takes place—amplifies these threats by making it possible for malicious actors, whether they are
corrupted insiders or foreign intelligence services (FIS), to quickly steal and transfer massive quantities of data
while remaining anonymous and hard to detect.

Read the entire report at http://www.ncix.gov/publications/reports/fecie_all/Foreign_Economic_Collection_2011.pdf

Beyond the boom: Australia’s productivity imperative

Australia has been riding the wave of Asia’s economic growth, supplying coal, iron ore, and minerals to meet unprecedented demand in China and other emerging markets. As commodity prices spiked in recent years, the country has attracted a flood of investment into its mines, processing plants, pipelines, and ports. More money has been invested in Australian resource projects in the past 5 years than in the previous 20.

Asia’s economic and demographic trends point to sustained demand in the decades ahead, but growth fuelled by demand for natural resources carries risk. The McKinsey Global Institute (MGI) report Beyond the boom: Australia’s productivity imperative finds that “one-off” factors—including favorable terms of trade and an investment surge—have driven half of the country’s recent growth, obscuring the truth about its overall economic health.

The magnitude of Australia’s resource boom belies some weakening fundamentals. Since 2005, the country has enjoyed 4.1 percent annual gains in income. But growth in labor productivity has fallen to just 0.3 percent. Capital productivity is now the biggest drag on income growth.

MGI outlines four potential scenarios for the future and finds that growth is likely to slow down, even in the best possible outcome. But in the worst-case scenario—if terms of trade move back toward their long-term average, some capital projects stall, and productivity growth remains low—income growth could stagnate at just 0.5 percent a year until 2017.

Australia can’t control commodity prices and global demand for resources, but by reversing its slide in productivity, it can take steps to create a softer landing when the boom eventually subsides. The report identifies four sectors—defined by their proximity to the resource boom and their exposure to trade competition—and pinpoints the major challenges for each of them. Successfully addressing these areas could raise national income by up to AU $90 billion (about US $95 billion) a year by 2017.

  • Resource sectors: Getting capital productivity right. Australia is less than halfway through the capital boom, with AU $443 billion in investment still to come in the resource sector. Major capital projects are prone to inefficiencies and overruns, but the country has an opportunity to boost its capital productivity by up to 30 percent if firms emphasize a top-level focus on value, adopt a best-practice “tool kit,” and assemble project teams with superior execution skills.
  • Resource-rider sectors: Improving efficiency. Transport, utilities, professional services, and other resource-related sectors have grown dramatically because of their links with the mining and energy boom. Yet at the same time, their labor productivity has fallen dramatically as well. Stakeholders must find ways to develop new infrastructure more cost effectively. Additionally, a more integrated cross-sector approach to resource productivity can reduce the need for some expensive new projects.
  • Local services: Implementing microeconomic reform. Sectors such as retail trade and telecommunications have been largely unaffected by the resource boom. They have posted solid productivity gains but tend to lag behind international benchmarks. Australia can close the gap through a renewed focus on microeconomic reforms that streamline regulations, encourage innovation, and promote competitive markets.
  • Manufacturing: Creating a foundation for long-term competitiveness. Like other developed economies, Australia has seen its manufacturing base erode. Improvement will depend on cost efficiencies, particularly the neglected area of management quality; higher labor mobility; and a shift to innovative manufacturing, which offers the best long-term potential for competitiveness.

Download Executive Summary

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Printed with permission from McKinsey Global Institute

Playing war games to prepare for a cyberattack

A poor response can be far more damaging than the attack itself.

“Can it happen to us?” All over the world, technology executives have been fielding this question from boards of directors and CEOs in the wake of highly publicized cyberattacks on large, well-respected companies and public institutions.

“Yes” is the only honest answer at a time when ever more value is migrating online, when business strategies require more open and interconnected technology environments, when attackers have always-expanding capabilities, and when attacks take advantage of limited security awareness among employees and customers. In fact, it may already have happened to you—but you may not know it.

Although political “hacktivists,” such as Anonymous and LulzSec, certainly delight in announcing their exploits to the world and causing embarrassment to their targets, other sophisticated attackers seek to cover their tracks. Organized-crime rings engaging in cyberfraud have no interest in letting their targets know they have been infiltrated.

We believe that boards and senior business leaders should be asking the technology team a different question—namely, “Are we ready to respond to a cyberattack?”

An ill-thought-out response can be far more damaging than the attack itself. Whether customers cancel their accounts in the wake of a successful cyberattack depends as much on the quality of a company’s communications as on the gravity of the breach. How much value is destroyed by the loss of sensitive business plans depends on the ability to adjust tactics quickly.

Testing readiness with cyberwar games

The armed forces have long conducted war games to test capabilities, surface gaps in plans, and build their leaders’ abilities to make decisions in real time. Some companies—3 percent, according to a recent McKinsey survey of digital business practices—have conducted cyberwar games to help ensure they are ready to manage a cyberattack. In fact, many corporate cyberwar-gaming efforts have been directly inspired by national-defense-oriented cyberwar games.

A cyberwar game is very different from traditional penetration testing, in which companies employ or contract with “white hat” hackers to identify technical vulnerabilities, such as unsecured network ports or externally facing programs that share too much information in the browser bar.

A cyberwar game is organized around a business scenario (such as cybercriminals using “spear phishing” attacks to target high-net-worth customers for fraud). It is structured to simulate the experience of a real attack. Participants receive incomplete information, and their objectives may not be 100 percent aligned. The simulation is cross-functional, involving participants from not only information security but also application development, technology infrastructure, customer care, operations, marketing, legal, government affairs, and corporate communications.

The cyberwar game occurs over a few days but requires up-front analysis of business-information assets and potential security vulnerabilities to make the scenario relevant and the game play realistic. The exercises usually do not affect live production systems; many cyberwar games are “tabletop” exercises.

Most important, a cyberwar game tests for flaws in a company’s ability to react to an attack by answering key questions about the capabilities required for a successful response:

  • Will the security team identify and assess the breach quickly? One organization found that the processes its security team used to address a breach were entirely dependent on e-mail and instant messaging; the organization would have limited ability to respond to an attack that compromised those systems.
  • Will the team make effective decisions in containing the breach? One corporation discovered that it did not have functional guidelines for deciding when to shut down parts of its technology environment. It found that senior executives would have ordered the technology team to sever external connectivity unnecessarily, thereby preventing customers from accessing their accounts.
  • Will the team effectively communicate the breach to the full set of stakeholders? At one financial institution, a war game demonstrated that guidelines had not been differentiated for communicating with customers whose data had been breached. As a result, high-net-worth customers would have received an impersonal e-mail.
  • Can the company adjust business strategies and tactics in the wake of a breach? At one manufacturer, a war game revealed that business managers had never thought through what they would do if competitors or counterparties gained access to sensitive information, and so would be unable to change negotiation strategies quickly after the disclosure of proprietary information about their cost structure.
Gaining insights from gaming

Cyberwar games yield insights into information assets that require protection, security vulnerabilities that attackers can exploit, and flaws (or “failure modes”) in a corporation’s ability to respond to an attack.

The analysis required to develop relevant scenarios for the war game also facilitates a discussion between business and security managers about which risks and types of information assets are most important, who would want to compromise these information assets, and what the implications of an attack could be with regard to loss of intellectual property, loss of reputation, business disruption, or fraud. This information is not always clear before such a discussion. For example, one public institution found out that most of its IT-security processes were geared toward preventing online fraud, even though the biggest risk was the loss of confidence associated with a public breach. Likewise, the analysis required to ensure that scenarios used in the game are realistic can, in turn, highlight important security risks. For instance, one retail brokerage discovered that most of its most sensitive information assets were hosted on applications that had not undergone security reviews and used out-of-date controls for authenticating users.

Conducting a cyberwar game

Most corporations can plan and conduct a game in 6 to 12 weeks, with a manageable impact on security, technology, and business managers’ time.

Aligning the scope and objectives of the war game is the first step. This includes deciding how many scenarios to incorporate into the game, how sophisticated those exercises will be, and how much participation will be required of the representatives of each business function who help design the game. These “trusted agents” develop potential scenarios that take into account critical information assets, attackers who would want to compromise them, and any existing security vulnerabilities they might exploit.

fter selecting the scenarios to be deployed in the game, the agents identify the failure modes they need to test for and create the step-by-step script that a facilitator—an internal or external war-gaming expert—uses when running the game. The simulation or game itself can last anywhere from a day to a week or more, depending on the complexity of the scenarios. Throughout the course of the simulation, the facilitator will provide participants with intermittent updates or new information on which they can act. At each turn, the data that the players representing functions like security, marketing, and legal receive depend on the actions they have just taken.

The last and most important phase takes the insights generated by the simulation and converts them into actionable steps that will improve a corporation’s ability to respond to an attack. These steps typically include everything from implementing tools that increase an organization’s ability to foresee attacks, clarify responsibilities, and develop guidelines for making high-stakes decisions under pressure to creating communications protocols that can be pulled “off the shelf” when required.

Conducting a war game to test a corporation’s ability to manage a cyberattack requires genuine effort and planning. However, it is one of the most effective mechanisms for prioritizing which assets to protect, surfacing vulnerabilities, identifying flaws in a company’s ability to respond, and building the type of “muscle memory” required to make appropriate decisions in real time with limited information.

Printed with permission from McKinsey Global Institute.

The great rebalancing

Posted with permission from McKinsey Quarterly

The great rebalancing

As the center of economic growth shifts from developed to developing countries, global companies should focus on innovation to win in low-cost, high-growth countries. Their survival elsewhere may depend on it.

As the center of economic growth shifts from developed to developing countries, global companies should focus on innovation to win in low-cost, high-growth countries. Their survival elsewhere may depend on it.

The vibrancy of emerging-market growth will not be the only major disruption reshaping the global economy in the next ten years, but it may prove the most profound. This decade will mark the tipping point in a fundamental long-term economic rebalancing that will likely leave traditional Western economies with a lower share of global GDP in 2050 than they had in 1700.

Two socioeconomic movements are under way.

  • Declining dependency ratios. Virtually all major emerging markets are undergoing demographic shifts that historically have unleashed dynamic economic change: simultaneous labor force growth and rapidly declining birthrates. Simply put, there will be more workers, with fewer mouths to feed, leaving more disposable income.
  • The largest urban migration in history. Each week, nearly one-and-a-half-million people move to cities, almost all in developing markets. The economic impact: dramatic gains in output per worker as people move off subsistence farms and into urban jobs. China and India are seeing labor productivity grow at more than five times the rate of most Western countries as traditionally agrarian economies become manufacturing and service powerhouses.
These same factors powered Western economic growth for the better part of two centuries. (And they should last well into the next decade—at least until China’s population, finally seeing the full effects of the one-child policy, begins to go gray.)

In the next decade, emerging-market economies will rapidly evolve from being peripheral players, largely reacting to events set in motion by wealthy Western nations, into powerful economic actors in their own right. They will shed their role as suppliers of low-cost goods and services—the world’s factory—to become large-scale providers of capital, talent, and innovation. (One hint of what’s to come: the number of BRIC1 companies on the Fortune 500 has more than doubled in the past four years alone.)

Nor is this trend just about China and India. To varying degrees, ASEAN,2 Latin American, and Eastern European nations, as well as portions of the Middle East and North Africa, are taking part in this economic renaissance. Even pockets of sub-Saharan Africa now demonstrate vigor after decades of stagnation.

For all companies—both established multinationals and emerging-market challengers—this great rebalancing will force major adjustments in strategic focus. No longer can established companies treat emerging markets as a sideshow. Emerging markets will increasingly become the locus of growth in consumption, production, and—most of all—innovation. More and more, global leadership will depend on winning in the emerging markets first.

Opportunity and adversity are the mothers of invention—emerging markets will be the world’s next fount of innovation

Consider that more than 70 million people are crossing the threshold to the middle class each year, virtually all in emerging economies. By the end of the decade, roughly 40 percent of the world’s population will have achieved middle-class status by global standards, up from less than 20 percent today. This means opportunity in consumer markets: P&G, for example, hopes to add a billion new customers to its ranks in the next decade, adding to the nearly four billion the company touches today. In recent quarterly earnings reports, nearly every global consumer products company—from Kraft to Nestlé—noted upticks in profits, driven primarily by unexpected gains in emerging markets.

Seizing that opportunity won’t be easy. These new consumers come from a bewildering array of ethnic and cultural backgrounds. They have little loyalty to—or even knowledge of—established global brands. Their tastes and preferences will evolve just as rapidly, if not more so, than those of consumers in developed markets, and they will demand products with every bit as much quality. Yet, on average, they will wield just 15 percent of the spending power, in real dollars, of their developed-world counterparts.

Companies that can reduce cost structures to 20 or 30 percent of developed-world levels, or lower, will be in position to ride a swelling wave of unmet demand. While much has been made of the Nano, Tata’s $2,200 car, the truth is that hundreds of products now being developed promise to reinvent price and cost structures radically—from Hindustan Lever’s $43 water purifier, in use in more than three million Indian homes, to the Zero, a proxy ATM that costs less than $50 a month to operate (essentially a revamped cell phone with an attached fingerprint scanner, used by local merchants).

To tap the riches rising from these new markets, established organizations must reinvent business models. Hindustan Lever, for example, unable to find reliable distribution in large reaches of India, uses everything from bicycles to bullock carts to deliver products to market. When the Indian refrigerator manufacturer Godrej decided to release a refrigerator for the rural market, it worked with villagers to codesign a product that worked for their needs. The result: the ChotuKool, a $69 fridge that not only shattered price barriers but also included features that allow it to work in an environment where consumers cannot depend on their electricity to stay on.

Today’s unit share leaders will be tomorrow’s revenue winners—ignore them at your peril

Thanks to a low price structure, such innovations capture massive unit share long before they generate meaningful revenue share. This distinction matters. CEOs who miss it risk being overtaken by low-cost innovators that race up the value chain until they have a commanding lead.

Caterpillar, for example, is the world’s largest construction-equipment manufacturer. Its revenues are twice those of the next-largest player. No Chinese company makes the top ten by this measure, so China might appear to be a distant threat. But unit sales numbers tell a different story. Ranked by the number of vehicles sold, 9 of the industry’s 12 largest manufacturers of wheel loaders—the second-largest-selling piece of construction equipment—are Chinese. Nor do these players have an advantage only in their home market: Chinese manufacturers now supply a third of the wheel-loader volume in emerging markets outside China and are beginning to hit their stride in developed markets too. No wonder traditional industry leaders, including Cat, have raced to get a piece of the action, rushing to forge joint ventures with Chinese competitors.

Significantly, while emerging-market upstarts often gain market share by trading away margin to build position, that is not always the case. The best, forced to innovate by the harsh conditions of their home markets, are developing leaner business models that both boost low-cost demand and deliver enviable financial returns.

Consider Bharti Airtel, India’s leading wireless provider. In 2003, Bharti founder Sunil Mittal, struggling to hire telecommunications engineers and build out a network fast enough to keep pace with exploding demand for mobile services, made a controversial decision to outsource the construction and management of Bharti’s wireless network to Ericsson and Siemens. The result, a fundamentally new approach to managing a mobile-services company, allows Bharti to reap profit margins higher than most Western telecommunications companies do—despite average revenues per user just 10 to 15 percent of those of its developed-world counterparts.

The allure of emerging-market consumers touches even luxury companies. The privately held French beauty products company L’Occitane, for example, is floating its upcoming IPO not on the Euronext, in Paris, but rather on the exchange in Hong Kong. The reason: emerging-market consumers are the fastest-growing segment for this affordable luxury brand.

Don’t assume that emerging markets are just a cost play—technological innovation will be the next frontier

Last year marked the first ever when an emerging-market company—the Chinese telecom manufacturer Huawei—led the world in patent applications. No US company made the top ten. An imperfect measure? Perhaps, but it captures a deep underlying trend. Today, India supplies more technology workers than any other country, and China is on track to pass the United States as the home of the world’s largest R&D workforce. As more and more talent centers spring up across emerging markets and skills deepen, new innovation ecosystems will emerge. Already, more than 1,000 multinational companies operate R&D facilities in China, five times the level a decade ago.

In electronics, computing, and clean energy, among other fields, emerging-market companies increasingly define the future. Huawei, long dismissed as a perennially weak upstart to the likes of Cisco Systems or Ericsson, is now the world’s third-largest telecom-equipment manufacturer and builds some of the most sophisticated network equipment anywhere. It counts nearly every leading telecom operator as a customer.

Learn to manage multiple business models—or why the West still matters

For established Western multinationals, the biggest dilemma will be figuring out how to thrive while competing across highly different types of markets. Since both developed and emerging markets require innovation at breakneck speed, many companies may be tempted to underinvest in potential long-term revenue growth in new markets in order to pursue here-and-now profit gains in established ones. That’s understandable: while more than 50 percent of future global growth will occur in emerging markets—and in many industries much more than that—the lion’s share of profits so far remains in the OECD. But that’s shortsighted. Companies need to figure out how to win in both.

The mobile-phone handset market epitomizes the paradox: cutting-edge smartphones make up just 6 percent of global handset volumes, yet Apple, Research in Motion (RIM), and HTC now earn more than 50 percent of total industry profits. On the lower end, ultra-low-cost handsets from OEM manufacturers such as TCL and ZTE are capturing significant volume share in emerging markets. Traditional players such as Motorola, Nokia, and Samsung find themselves squeezed in the middle, fending off assaults on both top and bottom—largely from competitors that barely registered less than five years ago. Managing multiple business models is hard.

Blowback is real—so why not drive it yourself?

A few innovative companies are starting to get it right. GE, for example, has devised an electrocardiograph machine for the Indian market that can be sold profitably for $1,500, less than a fifth of the price of traditional ECG monitors in Europe and the United States. The new model has helped GE not only to extend a new level of health care to millions of Indians but also to figure out how to create a monitor it could sell for $2,500 in developed markets. Based on this experience and others like it, GE is now developing more than 25 percent of its new health care products in India—with explicit plans to deploy them both in emerging and advanced economies.

The prospect of this innovation wave unleashed by the great rebalancing should serve as a wake-up call to any CEO. Emerging markets are more than enormous growth opportunities; they are where tomorrow’s champions will hone their long-term competitiveness. Pursuing incremental product line extensions in developed markets, though profitable in the short run, will not suffice to build the critical muscle required. Innovation “blowback” is coming as lower-priced, high-quality products created for the mass markets of tomorrow move from the developing to the developed world. Buoyed by strengthening currencies and improved balance sheets, emerging-market challengers will move further up the value chain by acquiring more Western companies. Learning to win in low-cost, high-growth countries means winning not just there but everywhere.