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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.

How multinationals can attract the talent they need

Printed with permission from McKinsey Global Institute.

Competition for talent in emerging markets is heating up. Global companies should groom local highfliers—and actively encourage more managers to leave home.

Global organizations appear to be well armed in the war for talent. They can tap sources of suitably qualified people around the world and attract them with stimulating jobs in different countries, the promise of powerful positions early on, and a share of the rewards earned by deploying world-class people to build global businesses. However, these traditional sources of strength are coming under pressure from intensifying competition for talent in emerging markets.

  • Talent in emerging economies is scarce, expensive, and hard to retain. In China, for example, barely two million local managers have the managerial and English-language skills multinationals need.1 One leading bank reports paying top people in Brazil, China, and India almost double what it pays their peers in the United Kingdom. And a recent McKinsey survey in China found that senior managers in global organizations switch companies at a rate of 30 to 40 percent a year—five times the global average.
  • Fast-moving, ambitious local companies are competing more strongly: in 2006, the top-ten ideal employers in China included only two locals—China Mobile and Bank of China (BOC)—among the well-known global names. By 2010, seven of the top ten were Chinese companies. As one executive told us, “local competitors’ brands are now stronger, and they can offer more senior roles.”
  • Executives from developed markets, by no means eagerly seizing plum jobs abroad, appear disinclined to move: a recent Manpower report suggests that in Canada, France, Germany, the United Kingdom, and the United States, the proportion of staff ready to relocate for a job has declined substantially,2 perhaps partly because people prefer to stay close to home in uncertain times.

How can global organizations best renew and redeploy their strengths to address these challenges? Our experience suggests they should start by getting their business and talent strategies better aligned as they rebalance toward emerging markets. This is a perennial challenge, made more acute by extending farther afield. But the core principles for estimating the skills a company will need in each location to achieve its business goals, and for planning ahead to meet those needs, are similar enough across geographies not to be our focus here. Rather, we focus on two additional questions. How can global organizations attract, retain, and excite the kinds of people required to execute a winning business strategy in emerging markets? And what can these companies do to persuade more executives trained in home markets to develop businesses in emerging ones, thereby broadening the senior-leadership team’s experience base?

Becoming more attractive to locals

A big historic advantage global companies have over local competitors is the ability to offer recruits opportunities to work elsewhere in the world. A small number of executives, in fact, have moved from leading positions in emerging markets to a global-leadership role, including Ajay Banga, president and CEO of MasterCard Worldwide; Indra Nooyi, chairman and CEO of PepsiCo; and Harish Manwani, COO of Unilever.

But big global companies need a lot more role models like these if they are to persuade highly talented local people to join and stay. A recent McKinsey survey of senior multinational executives from India found that few companies were providing opportunities overseas in line with the aspirations and capabilities of ambitious managers.3 We’ve also heard this concern voiced in many interviews. A senior executive at a global company in Asia told us, “In our top-100-executive meetings, we spend more than half of our time speaking about Asia. But if I look around the room I hardly see anybody with an Asian background.” Another put the problem more bluntly: “Leaders tend to promote and hire in their own image.”

The makeup of most multinational boards provides further evidence: in the United States, less than 10 percent of directors of the largest 200 companies are non-US nationals, up from 6 percent in 2005 but still low considering the global interests of such companies. Western ones can start working on these numbers by refining their approach to developing top talent in emerging markets. Many also need to rethink their brands to win in a fast-changing talent marketplace.

Prepare your highfliers for top roles

There’s no silver bullet for developing or retaining emerging-market talent. Examples such as the ones below present different paths, but each company will need to find its own.

Global-development experiences at Bertelsmann. The German media giant tries to develop—and retain—top managers through specialized training programs. In India, for example, its high-potential employees can apply for an INSEAD Global Executive MBA; over the three years this benefit has been available, motivation and retention rates among alumni of the program have sharply increased for less than it would have cost to give them salary hikes. In addition, Bertelsmann’s CEO program brings local-market employees to the corporate center, where they gain exposure to the range of functional and geographical issues they can expect to encounter as leaders. Having spent a couple of years at the center, recruits then compete for senior roles in local or regional markets. They return with a solid understanding of the organization and its strategy, as well as an extended network based on trust gained from working intensively with leaders across the company.

Breaking cultural barriers at Goldman Sachs. The global bank is one of many firms that have designed special programs to tackle cultural and linguistic barriers impeding local executives from taking jobs at the global level. In 2009, for example, Goldman Sachs launched a program in Japan to help local employees interact more comfortably and effectively with their counterparts around the world, with a focus on improving cross-cultural communication skills. The firm has extended this “culture dojo,” named after Japan’s martial-arts training halls, to China and South Korea and plans to launch programs in Bangalore and Singapore.4

Local-leadership development at Diageo. Nick Blazquez, the drinks company Diageo’s president for Africa, questions whether leadership training today must include experience in a developed economy. “I used to think that to optimize the impact, a general manager should work in a developed market for a period of time, because that’s where you see well-developed competencies. But I’m just not seeing that now. If I think about marketing competencies, for example, some of Diageo’s most innovative marketing solutions are in Africa.” In fact, he notes, “we in Africa have developed some of Diageo’s leading digital-marketing programs. So I don’t think that there’s a need anymore for somebody to have worked in a developed market for them to be a really good manager. That said, I do feel that a good leader of a global organization would be better equipped having experienced both developed and developing markets.” For global companies in a similar position, acknowledging that local highfliers can drive global innovation without first serving a long apprenticeship in a developed economy could unlock massive reserves of creative energy.

Enhance your brand as an employer

While there’s no substitute for development programs that will help emerging-market recruits rise, global organizations need to strengthen other aspects of their employer brands to succeed in the talent marketplace in these countries. Historically, globally recognized companies have enjoyed significant advantages: they knew they were more attractive to potential local employees than any local competitor. “We still have the attitude that someone is lucky to be hired by us,” one executive told us. But today, many local fast-growing and ambitious companies have more pulling power. And multinationals based in emerging markets are conscious of the work they must do to sustain their levels of recruitment. As Santrupt Misra, Aditya Birla’s HR director, says: “We are growing as a company more rapidly than people grow, so we need to develop more peer leaders. Simultaneously, we need to [maintain] a very strong employer brand so that if we do not manage to develop enough people, we can hire.”

Established global companies should consider the same strategy. In any market, the basic ingredients of a strong employer brand will be competitive compensation; attractive working conditions; managers who develop, engage, and support their staff; and good communication. One challenge for global companies is to manage the tension between being globally consistent and, at the same time, responsive to very diverse local needs. Some degree of local tailoring is often necessary—for example, to accommodate the preference for near- over long-term rewards in Russia. However, any tailoring must sit within a broadly applied set of employment principles. Tata sets out to “make it a point to understand employees’ wants, not just in India, but wherever Tata operates,” according to its group vice president of HR. It has a tailored employee value proposition for each of its major markets; for example, it stresses its managers’ quality to employees in India, development opportunities in China, and interesting jobs in the United States.

In some markets, particularly in Asia, global organizations are extending awareness of their brands as employers by building a relationship between themselves and their employees’ families. For example, Motorola and Nestlé have tried to strengthen these links in China through their family visits and family day initiatives. Aditya Birla webcasts its annual employee award ceremony to all employees and their families around their world. And in all markets, companies are likely to find that many young, aspiring managers view being part of a broader cause and contributing to their countries’ overall economic development as increasingly important. Articulating a company’s contribution to that development is likewise an increasingly important component of any employer brand.

Encouraging homebodies to venture abroad

Even if a global company can find, keep, and develop all the local leaders it wants, it still may need more executives from its home market to work at length in diverse emerging ones so they learn how these markets function and forge networks to support the company’s future growth. To that end, some leading firms are replacing fixed short-term expatriate jobs with open-ended international roles. This not only deepens the expertise of the executives who hold them but also eliminates a problem cited by a European car executive we interviewed in South America: expat leaders become lame ducks toward the end of their overseas terms, progressively ignored by local managers.5

Developed-country operations have much to gain from executives versed in emerging-market management. “Leaders’ mind-sets are very different,” says Johnson & Johnson’s worldwide consumer group chairman Jesse Wu. “When you’re running an emerging market, you always operate under an austerity model. When you’ve been operating in emerging markets and come to the United States, you become aware of the little things, like how much people use color printers for internal documents. All these little things add up. Everybody’s happy with emerging-market growth,” but he adds that it “necessitates a lot of changes worldwide, not only in emerging markets.”

Global organizations’ growing need for managers willing to work for long stretches overseas is coinciding with a decrease in their willingness to go. “US talent over time seems to have become less mobile than executives from Europe, Asia, or Latin America,” says Wu. “We need this to change.”

Reversing the trend will take time. In firms where long-term success depends on moving across businesses, functions, and regions, that expectation should be crystal clear to all managers. Schlumberger requires managers to rotate jobs every two to three years across business units and corporate functions: the company expects that executives will spend 70 percent of their total careers working outside their home countries. Similarly, a leading mining company expects its people to have experience in at least two different geographic regions, two different businesses or functions, and even two different economic environments (high and low growth, say) before they can move into senior-leadership roles. Of course, it’s crucial to help managers abroad maintain their connections and influence back home and to provide close senior-executive mentorship—as HSBC does for participants in its International Management program, who are sent to an initial location, far from home, and can expect to rotate again after 18 to 24 months.

Making sure that new executives can contribute strongly and avoid mistakes when they arrive in new markets also is important. In 2010, IBM began sending executives to emerging markets as consultants, with the goal of investing time helping long-standing customers and other stakeholders. This way, the executives not only developed business in new geographies but also got to know the new markets and developed their personal skills. Dow Corning and FedEx have realized similar benefits by providing free services in emerging markets.

We have presented some snapshots here of how companies are getting better at attracting talent and developing leaders in emerging markets and of what it takes to cross-fertilize talent between different geographies. As the world’s economic center of gravity continues to shift from developed to emerging markets, more companies will wrestle with these issues, and some definitive best practices may well appear. For now, though, the global talent market is in flux, just like the global economy.

Understanding Mexico’s evolving consumers

Printed with permission from McKinsey Global Institute.

Their behavior since the downturn contrasts sharply with that of their US neighbors. As the country’s economy rebounds, many of these differences will probably persist.

Mexican consumers have been hit harder than their US counterparts by the downturn since 2008, but they are more optimistic about their country’s prospects than their neighbors to the north are. Far fewer Mexican consumers than US ones have traded down to less expensive products: instead, they have remained loyal to their brands but cut back on spending. Those who have traded down are much happier with less expensive brands than their northern neighbors are. These key insights from a new McKinsey survey1 of Mexican consumers have important implications for consumer-packaged-goods (CPG) and retailing companies that compete in Mexico, a market vying with China as the number-two US trade partner. As the country’s economy continues to recover, CPG companies have an opportunity to design strategies that fit well with the Mexican consumer’s brand loyalty preferences, while retailers could tap into the potential for growth in private-label sales.

Our survey shows that consumers in Mexico have responded more actively to the downturn than their US counterparts have: over 70 percent of Mexicans said they have cut spending, compared with 45 percent of Americans. Mexican consumers reported that they had changed their purchasing habits and, in particular, had significantly reduced their outlays in the leisure and travel categories. When it comes to eating habits, 66 percent of Mexican consumers said they were eating out less, 63 percent ordering in less, and 60 percent picking up prepared food less. For US consumers, the corresponding changes were 47 percent, 43 percent, and 34 percent. Education is one important exception in Mexico: over two-thirds of the country’s consumers have increased their spending on school supplies, and significant minorities are spending more on extracurricular activities (45 percent) and remedial classes (39 percent).

The food category exemplifies how Mexican consumers have, overall, remained loyal to their brands. About 25 percent of the respondents said they would buy less food rather than trade down to save money and buy what they saw as inferior products. Just 4 percent of these respondents reported switching to less expensive brands during the previous 12 months. And the way Mexicans trade down contrasts sharply with the approach of their US counterparts: only 2 percent of Mexican consumers did so in food-related categories, compared with 11 percent of US ones.

Mexican consumers who do trade down, however, may very well never go back to their original brands. They almost always report that the new one is better than expected and that they are quite satisfied with it: their expectations are exceeded in 90 to 100 percent of trade-downs, in contrast to 54 percent of those US consumers report. Not surprisingly, almost half (46 percent) of Mexican respondents say they have no intention of trading back up when their economic situation improves; a similar percentage say they no longer prefer the previous brand. While this subset of respondents is relatively small, such a high level of consumer satisfaction with lower-cost substitutes could indicate that more expensive brands are vulnerable.

Among consumers who traded down, about 20 percent selected private-label alternatives to their former brands—an intriguing finding since private labels have been slow to catch on in Mexico, where they account for about 5 percent of retail sales, compared with 43 percent in Britain, 31 percent in Spain, and 17 percent in the United States. In Mexico, private labels are relatively strong in some categories, such as frozen foods and pasta, but quite weak in others, such as milk and biscuits. This suggests that there is considerable potential to build awareness of and recognition for private-label goods.

The relatively low percentage of private-label business highlights two aspects of the Mexican retail landscape. First, consumers typically have relatively few options. Second, housewives generally have limited disposable income and are risk averse when making purchases, since they cannot afford to buy something to replace a product they do not like or that does not do the job. Faced with such choices, consumers tend to stay with what they know—a phenomenon also reflected in the Mexican consumer’s preference for staying with trusted brands but reducing the level of purchases.

Yet the choice of places to shop is changing significantly. Fifteen percent of Mexico’s consumers, citing the desire for lower prices and greater convenience, say they have changed where they buy groceries. That hurts traditional and informal grocers; think of the corner mom-and-pop shop. But burgeoning modern-trade retailers—supermarkets, hypermarkets, and price clubs—benefit from the change.

While the shift to modern trade has been under way for the past 30 years in Mexico, the recession has accelerated this trend. Between 2009 and 2011, mom-and-pop shops lost 5 percent of their market share, which fell to 32 percent. This rate of decline was more than twice what they had lost in the previous several years: their share fell from nearly half of the market in 2000 to 37 percent in 2009. From 2009 to 2011, however, 825 new discounters and more than 3,000 convenience stores opened for business. The survey clearly reflects these trends—Mexican consumers say they are shopping more in modern retail channels, less in traditional ones. In the United States, by contrast, consumers report shopping less in all brick-and-mortar retail channels except dollar stores.

How should companies serving Mexican consumers respond? First, given the conservative nature of these consumers and their resistance to changing brands, CPG companies could strengthen their complaints departments and offer better product or money-back guarantees to give consumers the confidence to try out new products.

Second, when CPG companies are determining their strategy, they should keep in mind the brand loyalty of Mexican consumers, on the one hand, and signs that they may be satisfied trading down to cheaper brands, on the other. Companies should consider strategies that encompass both premium and cheaper brands.

Third, CPG companies ought to think about how they should respond to the potential for private-label business to grow in Mexico. The fear of many retailers that conservative Mexican shoppers wouldn’t want to try new private-label offerings has discouraged companies from even launching them. That, in turn, limits consumers’ opportunities to become familiar with such products, a problem reflected in their small market share in Mexico. Some retailers, however, have succeeded in giving their private-label store brands a reputation for quality and affordability and made inroads in local markets. Since Mexican consumers who trade down tend to be pleased with the experience, other retailers will probably want to explore the private-label opportunity further. CPG companies should know about these emerging trends and adjust their strategies accordingly.

 

Winning the $30 trillion decathlon: Going for gold in emerging markets

Printed with permission from McKinsey Global Institute.

By 2025, annual consumption in emerging markets will reach $30 trillion—the biggest growth opportunity in the history of capitalism. To compete for the prize, companies must master ten key disciplines.

The Industrial Revolution is widely recognized as one of the most important events in economic history. Yet by many measures, the significance of that transformation pales in comparison with the defining megatrend of our age: the advent of a new consuming class in emerging countries long relegated to the periphery of the global economy.

The two shifts bear comparison. The original Industrial Revolution, hatched in the mid-1700s, took two centuries to gain full force. Britain, the revolution’s birthplace, required 150 years to double its economic output per person; in the United States, locus of the revolution’s second stage, doubling GDP per capita took more than 50 years. A century later, when China and India industrialized, the two nations doubled their GDP per capita in 12 and 16 years, respectively. Moreover, Britain and the United States began industrialization with populations of about ten million, whereas China and India began their economic takeoffs with populations of roughly one billion. Thus the two leading emerging economies are experiencing roughly ten times the economic acceleration of the Industrial Revolution, on 100 times the scale—resulting in an economic force that is over 1,000 times as big.

CEOs at most large multinational firms say they are well aware that emerging markets hold the key to long-term success. Yet those same executives tell us they are vexed by the complexity of seizing this opportunity. Many acknowledge that despite greater size, larger capital bases, superior product technology, and more sophisticated marketing tools, they are struggling to hold their own against local upstarts. That anxiety is reflected in their companies’ performance in emerging markets. In 2010, 100 of the world’s largest companies headquartered in developed economies derived just 17 percent of their total revenue from emerging markets—though those markets accounted for 36 percent of global GDP (Exhibit 1) and are likely to contribute more than 70 percent of global GDP growth between now and 2025.

This essay and the compendium of articles it introduces (PDF-6,017 KB) describe, for senior executives, the most important priorities in emerging markets. It builds on an extraordinary foundation of research and experience. For more than a decade—starting with the 2001 McKinsey Global Institute (MGI) study of India’s economy—McKinsey has put emerging markets at the forefront of its research agenda. Special issues of McKinsey Quarterly have focused on Africa, China, India, and Latin America. We have created more than 60 databases and conducted longitudinal studies on the behavior of consumers in Africa, Brazil, China, India, and Indonesia. McKinsey consultants also have been deeply engaged in helping clients address the business implications of the emerging markets’ rapid rise.

We wish there were a secret formula or key capability that could easily transform a company’s emerging-market efforts. In fact, our experience suggests the challenge in emerging markets more closely resembles a decathlon, where success comes from all-around excellence across multiple sports. Sitting out an event isn’t an option; competing effectively means mastering a variety of different capabilities in a balanced way. As with a decathlon, there’s no single path to victory. In emerging markets, companies, like athletes, must learn to make trade-offs, taking into account their own capabilities and those of competitors. They must choose where it makes sense to differentiate themselves through world-class performance and where it is wiser to run with— or, ideally, a little ahead of—the pack. Both the rewards for success and the costs of failure will be large.

The $30 trillion opportunity

For centuries, less than 1 percent of the world’s population enjoyed sufficient income to spend it on anything beyond basic daily needs. As recently as 1990, the number of people earning more than $10 a day, the level at which households can contemplate discretionary purchases of products such as refrigerators or televisions, was around one billion, out of a total world population of roughly five billion. The vast majority of those consumers were based in developed countries in North America, Western Europe, or Japan.

But over the past two decades, the urbanization of emerging markets—supported by long-term trends such as the integration of peripheral nations into the global economy, the removal of trade barriers, and the spread of market-oriented economic policies—has powered growth in emerging economies and more than doubled the ranks of the consuming class, to 2.4 billion people. By 2025, MGI research suggests, that number will nearly double again, to 4.2 billion consumers out of a global population of 7.9 billion people. For the first time in world history, the number of people in the consuming class will exceed the number still struggling to meet their most basic needs.

By 2025, MGI estimates, annual consumption in emerging markets will rise to $30 trillion, up from $12 trillion in 2010, and account for nearly 50 percent of the world’s total, up from 32 percent in 2010 (Exhibit 2). As a result, emerging-market consumers will become the dominant force in the global economy. In 15 years’ time, almost 60 percent of the roughly one billion households with earnings greater than $20,000 a year will live in the developing world. In many product categories, such as white goods and electronics, emerging-market consumers will account for the overwhelming majority of global demand. China already has overtaken the United States as the world’s largest market for auto sales. Even under the most pessimistic scenarios for global growth, emerging markets are likely to outperform developed economies significantly for decades.

Leading the way is a generation of consumers, in their 20s and early 30s, who are confident their incomes will rise, have high aspirations, and are willing to spend to realize them. These new consumers have come of age in the digital era. Already, more than half of all global Internet users are in emerging markets. Brazilian social-network penetration, as early as 2010, was the second highest in the world. And a recent McKinsey survey of urban African consumers in 15 cities in ten different countries found that almost 60 percent owned Internet-capable phones or smartphones. As e-commerce and mobile-payment systems spread to even the most remote hamlets, emerging consumers are shaping, not just participating in, the digital revolution and leapfrogging developed-market norms, creating new champions like Baidu, mPesa, and Tencent.

The preferences of emerging-market consumers also will drive global innovation in product design, manufacturing, distribution channels, and supply chain management, to name just a few areas. Companies failing to pursue consumers in these new markets will squander crucial opportunities to build positions of strength that, history suggests, could be long lasting. In 17 major product categories in the United States, the market leader in 1925 remained the number-one or number-two player for the rest of the century.

Ten crucial capabilities

For developed-market companies, winning consumers in these new high-growth markets requires a radical change in mind-set, capabilities, and allocation of resources. The value consciousness of emerging-market consumers, the diversity of their preferences, and their sheer numbers mean companies must rethink every aspect of operations, including product portfolios, research and development, marketing, supply chain management, and talent development. They must learn to place big bets on new markets and technologies, invest with speed and at scale, and manage risk and cultural diversity at a whole new level.

Changes of such magnitude must be implemented in a thoughtful, systematic way. With the help of colleagues who, in aggregate, have spent centuries applying their diverse expertise to the challenges of emerging-market competition, we’ve distilled a set of ten capabilities global corporations need in emerging markets. Just as winning a decathlon requires an athlete to master ten events, we believe winning in emerging markets requires companies to master these ten capabilities. Like the events in a decathlon, they can be grouped into three types of activities:

  • Throwing accurately. Companies must aim their emerging-market activities at the right opportunities. That involves surgically targeting urban growth clusters, anticipating moments of explosive growth, and carefully balancing local relevance and global scale. The digitization of the emerging world is generating increasingly rich data sources that can guide such efforts.
  • Jumping in. As multinationals leap into action in the emerging world, they face the potential for big gains or losses. The next four capabilities reflect these moments of truth: aggressively redeploying resources to seize nascent opportunities, creating product portfolios, crafting brands, and building a go-to-market system that delivers what emerging-market consumers need, where they want it. Success in these markets demands cutting-edge technology and aggressive investment in processes tailored to local conditions.
  • Running the distance. The final three capabilities underscore the fact that competing effectively in emerging markets is a long-term challenge. Global organizations must rethink structures and management processes to move nimbly in unfamiliar environments while retaining scale advantages. They must fashion new models to attract, retain, and develop scarce emerging-market talent and forge new relationships with stakeholders to build sustainable businesses.

Finally, as in a decathlon, companies must sharpen their skills in all these areas at the same time.

1. Surgically target urban growth clusters.

The scale of the modern exodus from farms to cities has no precedent. In emerging-market economies today, the population of cities grows by 65 million people a year—the equivalent of seven cities the size of Chicago. Over the next 15 years, just 440 emerging-market cities will generate nearly half of global GDP growth and 40 percent of global consumption growth.

Most of those are midsize cities with unfamiliar names, like Ahmedabad, Huambo, Medan, or Viña del Mar. These “middleweights,” as opposed to tier-one megacities, frequently offer the best opportunities. In Brazil, the big metro market is São Paulo state, with a GDP larger than Argentina’s. But competition in São Paulo is brutal and retail margins razor thin. For new entrants to the Brazilian market, there might be better options in the northeast, Brazil’s populous but historically poorest region, where boomtowns like Parauapebas are growing by as much as 20 percent a year.

The notion that smaller cities can offer bigger opportunities isn’t new. Fifty years ago, Wal-Mart opened its first store, in Rogers, Arkansas, and proceeded to build one of the world’s largest businesses by avoiding highly competitive metropolitan markets. Yet four out of five executives queried in a recent McKinsey survey of major multinational firms said that, in emerging markets, their companies make decisions at the country rather than the city level. Three in five said their companies perceive cities as “an irrelevant unit of strategic planning.”

Given the diversity of consumer preferences, purchasing power, and market conditions in emerging societies, this failure to acknowledge the importance of cities in business planning is a fundamental strategic error. China has 56 different ethnic groups, who speak 292 distinct languages; India embraces about 20 official languages, hundreds of dialects, and four major religious traditions; Brazil’s citizens are among the world’s most ethnically and culturally diverse; the residents of Africa’s 53 countries speak an estimated 2,000 different languages and dialects. Even geographically proximate tier-one cities can be radically different. Consider Guangzhou and Shenzhen, two southern Chinese metropolitan centers of comparable size, separated by a distance of just 100 kilometers. In the former, the majority of consumers are locally born Cantonese speakers. In the latter, more than 80 percent are migrants who communicate in Mandarin and, reflecting their disparate regional origins, have far more diverse tastes in consumer electronics, fashion, and food.

Many multinationals nonetheless pursue country-based approaches or hybrid ones that include tweaks for megacities. They assume that efforts to develop local strategies for middleweight cities can come only at the expense of economies of scale. To minimize that trade-off, global companies should group multiple smaller cities into clusters with common demographics, income distributions, cultural characteristics, media regions, and transportation links (Exhibit 3). By running operations through a common management hub and pursuing a strategy of gradual, cluster-by-cluster expansion, companies can gain scale efficiencies in all aspects of their operations, including marketing, logistics, supply chain management, and distribution. For all but a handful of high-end product and service categories, the emphasis should be on “going deep” before “going wide.”

In our experience, cluster-based strategies are far more effective than attempts to achieve blanket coverage of an entire country or region or to chase growth in scattered individual cities. The results of switching to a cluster focus can be dramatic: in India, one leading consumer goods company recently cut costs in half by concentrating on eight large urban clusters rather than attempting to plot strategy for 200 different cities.

2. Anticipate moments of explosive growth.

In emerging markets, timing matters as much as geography in choosing where to compete. Demand for a particular product or category of products typically follows an S-curve rather than a straight line: there is a “warm-up zone” as growth gathers steam and consumer incomes begin to rise, a “hot zone” where consumers have enough money to buy a product, and a “chill-out zone” in which demand eases.

Predicting when and where consumers will move into the hot zone also requires a granular understanding of technological, demographic, cultural, geographic, and regulatory trends, as well as a thorough knowledge of local distribution networks. Because many of India’s households are vegetarian, for example, meat consumption in that country is much lower than the global average. In Nigeria, where more than one-third of the population is 14 years of age or younger, sales of baby food are far above the global average at similar income levels.

3. Devise segmentation strategies for local relevance and global scale.

Identifying high-growth hot spots and anticipating when consumers there will be ready to buy isn’t enough. Multinationals also must determine how to refine their product or service offerings so that they will appeal to (or even shape) local tastes, be affordable, and give the company an opportunity to achieve reasonable scale in a timely way.

Deciding how and how much to cater to local preferences requires a deep understanding of consumer demographics, preferences, and behavior within target segments. In some segments—for instance, many kinds of breakfast cereal in China and India—companies may find that their core offerings aren’t even relevant. In others, they will discover opportunities to realize economies of scale by leveraging products across markets. Too often, multinationals attempt to make sense of the diversity of emerging-market consumers by ordering them in polar caricatures: at one extreme, the “nouveau riche,” eager to flaunt their wealth and emulate the West; at the other, the “penny-pinching” poor at the “bottom of the pyramid,” for whom the overriding purchase criterion is getting the lowest price. Marketers who succumb to this false dichotomy are drawn into debating flawed strategic alternatives. Should they pursue a niche strategy, targeting rich customers with essentially the same products they sell to developed-market consumers? Or should they go for the mass market by offering cheap products that would never sell back home?

With the number of mainstream consumers on the rise in emerging markets—more than half of all Chinese urban households, for example, will be solidly middle class by 2020, up from 6 percent in 2010—companies are learning to craft more nuanced product strategies that balance scale and local relevance.

A careful segmentation strategy helped Frito-Lay capture more than 40 percent of the Indian branded-snacks market. The company tailored global products, such as Lays and Cheetos, to local tastes. Frito-Lay also created Kurkure, a cross between traditional Indian-style street food and Western-style potato chips that represented a new category in India and is now being sold in other countries. Critical to Kurkure’s success: attractive pricing and combining local feel with scalable international packaging. In China, Audi introduced A6 models with a longer wheelbase for extra legroom, while adding backseat entertainment systems and extendable tray tables.

Leading companies also look for opportunities to scale ideas across emerging markets. Unilever, for example, has begun marketing its Pureit water filter, first launched in India in 2005, to consumers in Asia, Eastern Europe, and South Africa. Telecommunications providers operating in emerging markets have learned to replicate successful marketing programs across multiple geographies.

4. Radically redeploy resources for the long term.

To win in emerging markets, developed-market companies must be willing to embrace big changes fast; those unable to reallocate resources radically risk a drubbing by local competitors. Our research shows that emerging-market companies redeploy investment across business units at much higher rates than companies domiciled in developed markets. Emerging-market firms are growing faster than their developed-market counterparts, even when both operate in neutral third markets where neither is based. The emerging players’ growth advantage persists even after controlling for the smaller base from which they start, and it also exists in developed markets.

In part, the agility of emerging-market companies reflects the fact that majority shareholders tend to have more power in them than in their developed-market counterparts. But it also reflects different management mind-sets. Emerging-market companies are built for speed. They are designed to serve the rapidly changing needs of middle-class consumers in their home markets and other emerging societies. They know that they must innovate or die. It helps too that these upstarts aren’t burdened by legacy issues; they can focus on what works in emerging markets without having to straddle both the rich and developing worlds. By contrast, CEOs at many developed-market companies, who live in fear that even a fleeting dip in domestic earnings, market shares, or stock prices could put their jobs at risk, must protect their flank at home as they are pursuing emerging markets that carry significant near-term risks.

Yet there’s no escaping the importance in emerging markets of making big bets and riding them for the long term. The investment profile of global consumer products giants that have established a successful presence in emerging markets indicates an interval of approximately four or five years until investments pay off. M&A can accelerate progress. Consider Danone’s purchase in Russia of Unimilk, which allowed the French food giant to offer more competitive products at a wider variety of prices. Similarly, Diageo’s acquisition of a majority stake in China’s Shuijing-fang boosted the British beverage company’s distribution reach and ability to supply Chinese consumers with the white liquor that is so popular there.

5. Innovate to deliver value across the price spectrum.

Emerging markets offer greenfield opportunities to design and build products and services with innovative twists on best-in-class equivalents in established markets. South Korea’s LG Electronics, for instance, struggled in India until the 1990s, when a change in foreign-investment rules enabled the company to invest in local design and manufacturing facilities. Local developers, recognizing that many Indians used their TVs to listen to music, urged LG to introduce new models with better speakers. To keep prices competitive, the company swapped expensive flat-panel displays for less costly conventional cathode tubes. Today, LG markets many other original products in India, including appliances with programming menus in local languages, refrigerators with brighter colors and smaller freezers, large washing machines for India’s big families, and microwaves with one-touch “Indian menu” functions. LG’s product innovation center in Bangalore is its largest outside South Korea, and the company is India’s market leader in air conditioners, refrigerators, TVs, and washing machines. Other global firms are following LG’s lead, in India and elsewhere; over the past 12 years, the number of multinational firms with major research centers in China has risen to nearly 1,000, from less than 20.

Local players too are proving nimble innovators. For rural customers, China’s Haier makes extra-durable washing machines that can wash vegetables as well as clothes, and refrigerators with protective metal plates and bite-proof wiring to ward off mice. The company is no less ingenious in developing products for urban users, such as smaller washing machines and refrigerators designed for tiny, cramped apartments. Dabur, an Indian consumer health company, is combining Western science with Indian Ayurvedic medicine to offer innovative consumer health products in India and Africa. Meanwhile Tanishq, part of the Tata Group, has built a fast-growing jewelry business with heavily localized design and payment options that cater to the needs of different Indian communities and regions.

Whether a company sells basic products or services to challenge low-cost local players or seeks to entice consumers to adopt new products and services comparable to global offerings, competing effectively often requires innovating and localizing, while redesigning product lines, service operations, and supply chains.

6. Build brands that resonate and inspire trust.

The outlook of consumers in emerging markets differs from those in developed ones in many ways. On average, emerging consumers are younger—with 63 percent aged 35 or under in 2010, versus 43 percent in developed countries—and more optimistic than their more affluent counterparts. And unlike developed-market consumers, whose purchases are informed by a lifetime of exposure to products and brands, emerging consumers are novice shoppers for whom buying a car, a television, or even a box of diapers may be a first-time experience. Emerging consumers wrestle with these new choices in a cluttered marketing environment and highly fragmented retail landscape offering little consistency in how products are presented or promoted. As emerging consumers move from rural villages to cities, they embrace new ideas and ways of living, placing in flux not just their buying preferences but also their very identities. They are highly receptive to effective branding efforts, but also far more likely than developed-market consumers to dump one brand for the next new thing.

These characteristics have significant implications for brand and marketing strategies. In emerging markets, it is critical for products to be included in the initial consideration sets of consumers—the short list of brands they might purchase. Our research indicates that Chinese consumers, for example, consider an average of three brands and end up purchasing one of them about 60 percent of the time. In the United States and Europe, by contrast, consumers consider at least four brands and end up selecting one from their initial consideration sets only 30 to 40 percent of the time. The intensity of emerging consumers’ focus on the initial consideration set favors brands with high visibility and an aura of trust. Multinationals can build visibility with a cluster-by-cluster strategy that achieves top-of-mind recognition in a handful of selected cities before moving to the next batch. Locally focused campaigns have the added advantage of accelerating network effects and making it easier for firms to generate positive word of mouth—a critical prerequisite for emerging-market success. McKinsey surveys find that positive product recommendations from friends or family are twice as important for consumers in China and nearly three times as important for consumers in Egypt as for those in the United States or Britain.

Building trust also requires careful scrutiny of brand messages and delivery. Acer, the Taiwanese computer maker, tested messages emphasizing simplicity with Chinese customers. This theme had resonated with consumers in Taiwan and other affluent markets, but the company discovered that it risked causing mainland buyers to question the quality of Acer products. A new campaign emphasizing reliability proved highly effective.

Mobile and digital channels, including e-commerce, offer additional opportunities to build trust and brand awareness and to engage with customers. In China, more than half the urban population is online, and surveys indicate Chinese consumers are more likely to trust online recommendations than television advertisements. By 2010, a quarter of Brazilians using the Internet had opened Twitter accounts, making Brazilians the world’s most enthusiastic tweeters. In India, consumers are leapfrogging traditional media and the PC to embrace mobile devices, while low literacy rates spur the development of voice-activated Web sites and services. Of course, digital-marketing efforts must be part of integrated campaigns across a range of channels, including, for reasons we examine below, in-store promotions and educational campaigns.

7. Control the route to market.

Our research underscores the importance in emerging markets of managing how consumers encounter products at the point of sale. In China, 45 percent of consumers make purchasing decisions inside shops, compared with just 24 percent in the United States. Almost a quarter of the Chinese consumers we surveyed said in-store promoters or salespeople greatly influence their decisions. In one study, we found that Chinese who purchased high-end consumer electronics items visited stores up to ten times before deciding what to buy.

Managing the consumer’s in-store experience is an enormous challenge, especially in middleweight cities where the biggest growth opportunities lie. Part of the problem is the fragmented nature of the retail landscape in emerging markets; e-commerce penetration currently lags behind Western levels, supermarkets remain a relative novelty, and consumers still make most purchases from ubiquitous mom-and-pop shops. In China, the 50 largest retailers have only a tenth of the market share of the 50 largest US retailers. Reaching these small outlets often means negotiating bad roads and a byzantine, multitiered network of distributors and wholesalers. In these locations, local champions have clear advantages, including long-standing alliances with distributors and armies of low-paid salesmen. Multinationals—many of which now struggle just to get products into emerging-market stores—should be prepared to build a much larger in-house sales operation in these countries. They should also devote far more time and energy than they do in their home markets to categorizing and segmenting sales outlets and to devising precise routines and checklists for monitoring the quality of the in-store experience.

In India, Unilever distributes directly to more than 1.5 million stores by deploying thousands of people for sales and in-store merchandising, many equipped with handheld devices to book replenishment orders anywhere, anytime. For priority outlets, it is often essential to deploy a heavy-control model, using supervisors, “mystery shoppers,” and sophisticated IT support to maximize margins while ensuring enough visibility to assess the performance of stores.

Coca-Cola, long active throughout the developing world, goes to great lengths in those markets to analyze the range of retail outlets, identify the highest-priority stores, and understand differences in service requirements by outlet type. For each category of outlet, Coca-Cola generates a “picture of success”—a detailed description of what the outlet should look like and how Coke products should be placed, displayed, promoted, and priced. The company employs a direct-sales delivery model to serve high-priority outlets, while relying on distributors and wholesalers when direct delivery isn’t cost effective. It scrutinizes everything from service levels and delivery frequencies to the positioning of coolers.

In China, Coca-Cola sells directly to over 40 percent of its two million retail outlets and monitors execution in an additional 20 to 30 percent through regular visits by Coca-Cola salesmen and merchandisers. In Africa, where infrastructure is less developed, Coca-Cola has built a network of 3,200 “microdistributors” by recruiting thousands of small entrepreneurs who use pushcarts and bicycles to deliver Coke products to hard-to-reach outlets. There’s no substitute in emerging markets for this sort of hands-on approach to managing distributors and key accounts.

8. Organize today for the markets of tomorrow.

In a series of surveys and structured interviews with more than 300 executives at 17 of the world’s leading multinationals, chosen from a range of sectors and geographies, we learned that local companies struggle with a host of problems. Strategy planning, risk management, talent development, and operating efficiency frequently disappoint global leaders. In related research, we also found that high-performing companies often suffered from a “globalization penalty”: they consistently scored lower than more locally focused ones on key dimensions of organizational health.

In theory, global players should enjoy substantial advantages over local rivals in emerging markets, including shared infrastructure and the protection that a more geographically diverse business portfolio offers against country and currency risks. In practice, however, we found that as global companies grow bigger and more diverse, the costs of coping with complexity rise sharply. Less than 40 percent of the executives at the firms we surveyed said they were better than local competitors at understanding the operating environment and customers’ needs. Furthermore, the need to adhere to globally standard policies and risk-management practices sometimes hinders managers of global companies in emerging markets from moving quickly to lock in early opportunities.

Large multinationals can reduce their globalization penalty by rethinking organizational structures and processes. IBM, for instance, radically revamped its functions in Asia, moving human resources to Manila, accounts receivable to Shanghai, accounting to Kuala Lumpur, procurement to Shenzhen, and customer service to Brisbane. Other global firms have moved core activities closer to priority markets. ABB shifted the global base of its robotics business from Detroit to Shanghai. Dell created regionwide functional centers in Singapore.

Underpinning these moves are some important principles. For example, we’ve found that multinationals can boost their effectiveness by focusing on a few key management processes for which global consistency is advantageous, while allowing variability and local tailoring in others. It may be useful to group high-growth countries together (even when not geographically proximate) to help top management assess their needs. Clarifying the role of the corporate center is critical; too often headquarters assumes functions that add complexity but little value. New communication technologies can help, but management must ensure that they do not ensnare employees in an ever-expanding web of teleconferences in disorienting time slots, with hazy agendas and ill-defined decision rights. The farther flung the organization, the greater the virtue of simplicity.

9. Turbocharge the drive for emerging-market talent.

Unskilled workers may be plentiful in emerging societies, but skilled managers are scarce and hard to retain. In China, barely two million local managers have the managerial and English-language capabilities multinationals need. A recent McKinsey survey found that senior managers working for the China divisions of multinational firms switch companies at a rate of 30 to 40 percent a year—five times the global average. Increasingly, local stars prefer working for local employers that can offer them more senior roles. In 2006, the top-ten ideal employers in China included only two locals— China Mobile and Bank of China—among the well-known global names. By 2010, seven of the top ten were Chinese firms.

Barely half of the executives at the 17 global companies we studied thought their organizations effectively tailored recruiting, training, and development processes across geographies. In a recent survey of leading global companies, we found that just 2 percent of their top 200 employees hailed from key Asian emerging markets. Some global companies have tried to address their emerging-market talent problem by throwing money at it; one leading bank reports paying senior staff in Brazil, China, and India almost double what it does in the United Kingdom.

But beefing up salaries is, at best, a partial solution. In emerging markets, global firms must develop clear talent value propositions—an employer brand, if you will—to differentiate themselves from local competitors. In South Korea, L’Oréal established itself as the top choice for female sales and marketing talent by creating greater opportunities for brand managers, improving working hours, expanding the child care infrastructure, and adopting a more open communications style. Other Western firms, such as Motorola and Nestlé, have burnished their employer brands by building relationships with employees’ families.

Deepening ties between key corporate functions and emerging markets can create opportunities for local talent while enhancing organizational effectiveness. Western firms, including Cisco, HSBC, and Schneider Electric, have benefited from strengthening links between headquarters and high-growth regions and offering emerging-market managers global career paths and mobility programs. Similarly, in 2010, about 200 managers from Unilever’s Indian subsidiary were assigned global roles with the parent company; indeed, two former senior executives in the company’s Indian operations now are members of the global parent company’s core leadership team. At Yum Brands, the India head reports directly to the global CEO.

Given the leadership requirements of emerging markets, global companies need bold talent-development targets. We think many players should aspire to multiply the number of leaders in emerging markets tenfold—and to do that in one-tenth of the time they would take back home. The strategies of emerging-market players merit careful study. In India, Reliance Group, the largest private employer, addressed a leadership gap—a need for as many as 200 new functional leaders to support growth initiatives—by recruiting a new wave of 28- to 34-year-old managers and enlisting help from local business schools and management experts to design new development programs.

10. Lock in the support of key stakeholders.

No matter where successful businesses operate, they need the support of key stakeholders in government, civil society, and the local media (increasingly shaped by online commentators). Managing these relationships effectively can have a huge impact on a company’s market access, ability to engage in merger or acquisition activity, and broader reputation. We believe global companies must devote far more time and effort to building such support in emerging markets than they would in developed ones. Such efforts should include cultivating relationships with local business allies—customers, joint-venture partners, investors, and suppliers.

Such recommendations may sound like common sense, yet it is surprising how few multinationals take them seriously. Companies must set and monitor rigorous performance targets to measure their commitment to relationship building in emerging markets. Senior executives should make a systematic effort to identify key regulators, community leaders, and business partners and to understand their needs. They should attend meetings and events in which key stakeholders participate, and seek inclusion in government advisory bodies. They must also ensure that public-affairs and external-relations teams in emerging markets are as well staffed as operations back home.

Amway’s success in China illustrates the benefits of effective stakeholder management. In the early 2000s, the US-based direct-sales giant was almost declared an illegal business in China for violating a 1998 ban on direct selling. Amway’s senior executives made numerous visits to Beijing to get to know senior leaders and explain the company’s business model. The company also demonstrated its commitment to China by opening stores countrywide, while investing more than $200 million in China-based manufacturing and R&D centers. In 2006, the Chinese government reshaped the regulation of direct sales. Today Amway is China’s second-largest consumer product business.

Finally, don’t neglect financial stakeholders. Domestic shareholders must be persuaded that the pursuit of long-term growth in emerging markets is worth short-term reductions in returns on capital and won’t necessarily weaken performance in core markets. Furthermore, as emerging markets contribute a greater proportion of the global savings pool, investors there could offer a crucial new source of funding.

Over the last 100 years, the title of “world’s greatest athlete” has been given to the winner of the Olympic decathlon. This has been true since the Stockholm Olympics, in 1912, when King Gustav V of Sweden used those words to describe Jim Thorpe, winner of the newly reintroduced decathlon competition. The rise of the emerging world’s new consumer class is the greatest competition of our age for businesses—one no truly global company can ignore. For all the complexity of emerging markets, they offer multinationals and their shareholders the best hope for future prosperity. Consumers in those markets hold the key to a $30 trillion prize that lies just over the horizon. During the next 100 years, the title of “world’s greatest companies” will surely be given to those that win in emerging markets. Business leaders and their boards need to ask themselves whether they are making the changes required to win or risk being overtaken by competitors with bolder ambitions.

 

The global company’s challenge

Printed with permission from McKinsey Quarterly.

As the economic spotlight shifts to developing markets, global companies need new ways to manage their strategies, people, costs, and risks.

Managing global organizations has been a business challenge for centuries. But the nature of the task is changing with the accelerating shift of economic activity from Europe and North America to markets in Africa, Asia, and Latin America. McKinsey Global Institute research suggests that 400 midsize emerging-market cities, many unfamiliar in the West, will generate nearly 40 percent of global growth over the next 15 years. The International Monetary Fund confirms that the ten fastest-growing economies during the years ahead will all be in emerging markets. Against this backdrop, continuing advances in information and communications technology have made possible new forms of international coordination within global companies and potential new ways for them to flourish in these fast-growing markets.

There are individual success stories. IBM expects to earn 30 percent of its revenues in emerging markets by 2015, up from 17 percent in 2009. At Unilever, emerging markets make up 56 percent of the business already. And Aditya Birla Group, a multinational conglomerate based in India, now has operations in 40 countries and earns more than half its revenue outside India.

But, overall, global organizations are struggling to adapt. A year ago, we uncovered a “globalization penalty”: high-performing global companies consistently scored lower than more locally focused ones on several dimensions of organizational health.1 For example, the former were less effective at establishing a shared vision, encouraging innovation, executing “on the ground,” and building relationships with governments and business partners. Equally arresting was evidence from colleagues in McKinsey’s strategy practice showing that global companies headquartered in emerging markets have been growing faster than counterparts headquartered in developed ones, even when both are operating on “neutral turf”: emerging markets where neither is based (see “Parsing the growth advantage of emerging-market companies”).

Over the past year, we’ve tried to understand more clearly the challenges facing global organizations, as well as approaches that are helping some to thrive. Our work has included surveys and structured interviews with more than 300 executives at 17 of the world’s leading global organizations spanning a diverse range of sectors and geographies, a broader survey of more than 4,600 executives, and time spent working directly with the leaders of dozens of global organizations trying to address these issues.2

Clearly, no single organizational model is best for all companies handling the realities of rapid growth in emerging markets and round-the-clock global communications. That’s partly because the opportunities and challenges facing companies vary, depending on their business models. R&D-intensive companies, for example, are working to staff new research centers in the emerging world and to integrate them with existing operations. Firms focused on extracting natural resources are adapting to regulatory regimes that are evolving rapidly and sometimes becoming more interventionist. Consumer-oriented firms are facing sometimes-conflicting imperatives to tailor their businesses to local needs while maintaining consistent global processes.

Another reason no single model fits all global companies is that their individual histories are so different. Those that have grown organically often operate relatively consistently across countries but find it hard to adjust their products and services to local needs, given their fairly standardized business models. Companies that have mainly grown through M&A, in contrast, may find it easier to tailor operations to local markets but harder to integrate their various parts so they can achieve the potential of scale and scope and align a dispersed workforce behind a single set of strategies and values.

Although individual companies are necessarily responding differently to the new opportunities abroad, our work suggests that most face a common set of four tensions in managing strategy, people, costs, and risk on a global scale. The importance of each of these four tensions will vary from company to company, depending on its particular operating model, history, and global footprint. (For more on the implications of these uneven globalization efforts, see “Developing global leaders,” forthcoming on mckinseyquarterly.com.) Taking stock of the status of all four tensions can be a useful starting point for a senior-management team aiming to boost an organization’s global performance.

Strategic confidence and stretch

Being global brings clear strategic benefits: the ability to access new customer markets, new suppliers, and new partners. These immediate benefits can also create secondary ones. Building a customer base

in a new market, for example, provides familiarity and relationships that may enable additional investments—say, in a research center.

But being global also brings strategic challenges. Many companies find it increasingly difficult to be locally flexible and adaptable as they broaden their global footprint. In particular, processes for developing strategy and allocating resources can struggle to cope with the increasing diversity of markets, customers, and channels. These issues were clear in our research: fewer than 40 percent of the 300 senior executives at global companies we interviewed and surveyed believed that their employers were better than local competitors at understanding the operating environment and customers’ needs. And barely half of the respondents to our broader survey thought that their companies communicated strategy clearly to the workforce in all markets where they operate.

People as an asset and a challenge

Many of the executives we interviewed believed strongly that the vast reserves of skills, knowledge, and experience within the global workforce of their companies represented an invaluable asset. But making the most of that asset is difficult: for example, few surveyed executives felt that their companies were good at transferring lessons learned in one emerging market to another.

At the same time, many companies find deploying and developing talent in emerging markets to be a major challenge. Barely half the executives at the 17 global companies we studied in depth thought they were effective at tailoring recruiting, retention, training, and development processes for different geographies. An emerging-market leader in one global company told us that “our current process favors candidates who have been to a US school, understand the US culture, and can conduct themselves effectively on a call with head office in the middle of the night. The process is not designed to select for people who understand our market.”

One of our recent surveys showed how hard it is to develop talent for emerging markets at a pace that matches their expected growth. Executives reported that just 2 percent of their top 200 employees were located in Asian emerging markets that would, in the years ahead, account for more than one-third of total sales. Complicating matters is the fact that local highfliers in some key markets increasingly prefer to work for local employers (see “How multinationals can attract the talent they need,” forthcoming on mckinseyquarterly.com). Global companies are conscious of this change. “Local competitors’ brands are now stronger, and they can offer more senior roles in the home market,” noted one multinational executive we interviewed.

Scale and scope benefits, complexity costs

Large global companies still enjoy economic leverage from being able to invest in shared infrastructure ranging from R&D centers to procurement functions. Economies of scale in shared services also are significant, though no longer uniquely available to global companies, as even very local ones can outsource business services and manufacturing and avail themselves of cloud-based computing.

But as global companies grow bigger and more diverse, complexity costs inevitably rise. Efforts to standardize the common elements of essential functions, such as sales or legal services, can clash with local needs. And emerging markets complicate matters, as operations located there sometimes chafe at the costs they must bear as part of a group centered in the developed world: their share of the expense of distant (and perhaps not visibly helpful) corporate and regional centers, the cost of complying with global standards and of coordinating managers across far-flung geographies, and the loss of market agility imposed by adhering to rigid global processes.

Risk diversification and the loss of familiarity

A global company benefits from a geographically diverse business portfolio that provides a natural hedge against the volatility of local growth, country risk, and currency risk. But pursuing so many emerging-market opportunities is taking global companies deep into areas with unfamiliar risks that many find difficult to evaluate. Less than half of the respondents to our 2011 survey thought these organizations had the right risk-management infrastructure and skills to support the global scale and diversity of their operations.

Furthermore, globally standard, exhaustive risk-management processes may not be the best way to deal with risk in markets where global organizations must move fast to lock in early opportunities. One executive in an emerging-market outpost of a global company told us “a mind-set that ‘this is the way that we do things around here’ is very strongly embedded in our risk process. When combined with the fact that the organization does not fully understand emerging markets, it means that our risk process might reject opportunities that [the global] CEO would approve.”

Understanding these tensions is just a starting point. Capturing the benefits and mitigating the challenges associated with each will require global companies to explore new ways of organizing and operating.

Shifting gears: Where the Russian car market is headed

Printed with permission from McKinsey Quarterly

The Russian car market is on track to recover from the financial crisis shortly. Where is the growth coming from? And who will benefit?

In 2008, the passenger car market in Russia hit a historic high, with more than 2.7 million units sold. Then came the worldwide financial crisis, and sales braked sharply, to half that level in 2009. The market, however, is recovering quickly—to 1.8 million in 2010 and 2.5 million in 2011. Experts predict sales will return to pre-crisis levels by 2014, with sales increasing 3 percent a year. One reason for the rebound is that Russian household income is rising strongly. By 2015, the number of households making more than $15,000 a year—the level at which car ownership becomes plausible—will be a third higher than in 2005, accounting for more than 40 million households.

What will they buy? Russian car consumers will diversify away from what have traditionally been the most popular models—the B and C sedan-type cars that currently account for 62 percent of sales. Between now and 2021, the sales of auto types such as smaller sport-utility vehicles (SUVs) and multi-purpose vehicles (MPVs), are expected to grow significantly. Sales of MPVs are growing fastest of all—24 percent a year, though from a very low base, while SUVs account for a quarter of the market.

Who will the big winners be? And how will the market shape up?

Download “Shifting gears: Where the Russian car market is headed” (PDF–.99 MB) to find out.

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.

Daniel Yergin on the future of global energy

Reprinted with permission from McKinsey Quarterly

The Pulitzer Prize–winning author and global energy expert sees rising demand from the East spurring innovation.

 

The recent rise of emerging markets as voracious consumers of energy has established a price point for oil at more than $100 a barrel, injected volatility into energy markets, and changed the economics of massive, complex energy projects such as oil sands, “tight oil” trapped in shale formations, and offshore drilling. Daniel Yergin, chairman of the energy research consultancy IHS Cambridge Energy Research Associates (IHS CERA), sees the tilt in demand from West to East continuing to reshape the global energy landscape. By 2030, he says, the world will be using a lot more energy than it does today, but the mix will still be dominated by oil, natural gas, and coal. In this video interview, Yergin explains how in the years ahead higher oil prices will produce “a great bubbling of innovation” across the energy spectrum, and shares his perspectives on three geopolitical trends that he sees influencing this transformation. McKinsey Publishing’s Rik Kirkland conducted the interview at the World Economic Forum, in Davos, in January 2012. Yergin is the author of The Quest: Energy, Security, and the Remaking of the Modern World (Penguin, September 2011).

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