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    Talent tensions ahead: A CEO briefing

    Looming imbalances in global labor pools could make it harder for some companies to find enough skilled workers and for some less-skilled workers to find jobs.

    Technological advances, industrialization, and liberalized trade have created a staggering 900 million nonfarm jobs in developing countries since 1980, lifting hundreds of millions of people out of poverty. As global companies have tapped (and helped fuel the growth of) low-cost labor sources, they also have created high-wage jobs for more than 50 million high-skill workers, while boosting productivity in developed and emerging markets alike.

    This virtuous cycle appears to be reaching its limits, however, and there is a growing sense that something has gone wrong with the machinery that, for decades, delivered GDP growth, higher productivity, rising wages, and better standards of living. Indeed, new research from the McKinsey Global Institute (MGI) suggests that by 2020, the world could have 40 million too few college-educated workers and that developing economies may face a shortfall of 45 million workers with secondary-school educations and vocational training. In advanced economies, up to 95 million workers could lack the skills needed for employment.

    The projected gaps we identified are notional, and global labor markets will adjust in response to them. But their consequences would be serious: higher levels of unemployment (even as companies struggle to fill select vacancies), rising income inequality, and heightened social tensions testing political stability in countries around the world.

    Senior executives and policy makers should study these imbalances closely because together they outline where dangers and opportunities will arise, and they provide a framework that business leaders and policy makers can use to guide their decisions. In this article, we’ll look at the most significant labor imbalances by geography and then discuss the moves companies can begin making now to prepare for the talent tensions to come.

    A new world for work

    To better understand the evolving global labor market, we analyzed 70 countries, representing 87 percent of global population and 96 percent of GDP. Segmenting these countries by educational achievement (a rough proxy for skill), median age, and GDP per capita highlighted clusters of countries sharing similar attributes (Exhibit 1). Using these clusters as a starting-off point, we modeled a “momentum” base case that combines current trajectories in demographics, GDP, educational attainment, and the supply of and demand for labor by skill level, all with the intention of highlighting potential labor imbalances that companies around the world might soon face. Four areas deserve close scrutiny from senior executives.

    China’s high-skill gap

    In recent decades, China’s industrialization has moved hundreds of millions of workers from farms into urban manufacturing and services. These changes boosted the country’s GDP per capita and productivity, while providing the developed world with a massive source of low-cost labor. More recently, China has expanded beyond its role as “workshop to the world” and become a vital growth market for global companies operating there.

    Yet a confluence of factors—including China’s aging population, the rapid growth of the country’s service sectors, and the move into more skill-intensive manufacturing—means that by 2020 the economy will probably need 23 million more college-educated workers than it can supply (Exhibit 2). This gap, equivalent to 16 percent of estimated labor demand, will probably emerge despite massive investments, already made or planned, in education. (China, for example, is already on track to add more than 50 million workers with a college education by 2020.) The implications of the gap are huge, as an adequate supply of highly educated workers will be critical to securing the growth of higher-value-added industries and the productivity gains needed to sustain China’s GDP trajectory, not to mention realizing the growth aspirations of companies around the world.

    Boosting the share of college graduates in the labor force would help—it currently stands at 11 percent—but that will be tough. Getting to 17 percent by 2020 would require more than 85 percent of China’s secondary-school graduates to complete a college education, compared with about 50 percent at present.

    What’s more, the country already has one of the world’s highest female labor-participation rates, at 82 percent; increasing that level won’t be easy.

    India’s missing middle

    India is a much younger country than China, and its shift out of agriculture and up the value curve is proceeding more slowly. From 2000 to 2010, India created just enough nonfarm jobs (about 67 million) to keep pace with the growth of its labor force, but not enough to move workers out of agriculture in substantial numbers. Consequently, India faces a unique set of labor market imbalances. In fact, it could be among the few countries with a surplus of highly skilled workers: in our momentum case, 36 million college graduates will join its labor force in the coming decade, about 6 million more than its domestic industries can employ.

    Nonetheless, the share of India’s working-age population with a secondary education is less than half that of China and many other developing economies. Further, India’s relatively low secondary-school graduation rate could mean a shortage of medium-skill workers, such as plumbers and welders, to fill the jobs created by the country’s burgeoning construction, manufacturing, retail- and wholesale-trade, and service sectors. All told, we project a gap in medium-skill workers of 13 million, or about 10 percent of demand in 2020 (Exhibit 3). India already faces a shortage of medium-skill workers, a fact reflected in high wage growth for vocationally trained people in sectors such as construction and mining.

    Finally, if current population and education trends persist, India could have 27 million too many low-skill workers by 2020. This growing surplus of low-skill workers implies adverse social outcomes: millions of people trapped in low-productivity, low-income jobs. India would need an unprecedented increase in job creation and education levels (including vocational education) to address these labor market challenges.

    From surplus to shortage

    As China’s labor force growth slows in coming decades, the young developing countries we studied, a group that includes Bangladesh, Kenya, Morocco, and Nigeria,3 will contribute about one-third of the growth in the global labor force. Today, these countries have ample numbers of college-educated workers—often more than their industries are ready to employ. In North African countries, for example, unemployment among highly educated workers is 20 percent, which is worse than the 8 percent rate for workers with only a primary education. (This difference reflects the fact that lower-skill workers engage in subsistence activities to survive in the absence of social safety nets.)

    The labor surplus many of these countries have won’t last forever, because their economies are growing much faster than those of the developed world and represent important markets for multinational companies. African countries, in particular, have garnered significant attention in recent years as destinations for investment, and new research from MGI finds the continent has large untapped job potential in agriculture, manufacturing, and the retail and hospitality industries.4

    Nonetheless, if current growth, population, and education trends persist, we conservatively project that the countries of sub-Saharan Africa and South Asia (excluding India) could have a shortage of 31 million workers with a secondary education by 2030 (Exhibit 4). Furthermore, young developing countries will need to find work for about 30 million low-skill workers with no education or only primary schooling. By 2020, the surpluses will represent 14 percent of the supply of such workers in these countries.

    Addressing such imbalances will require young developing economies to more than double the growth of educational attainment and to raise their secondary-enrollment and -completion rates.

    High-skill shortage, low-skill surplus

    Advanced economies, including those in Europe and North America, face daunting challenges, too. Trends in educational attainment and projected employment needs indicate that employers there will require 16 million to 18 million more college-educated workers than will be available in 2020, a gap representing 11 percent of demand.

    The skill gap will be widest in Southern Europe, where educational attainment is lowest and populations are relatively old. These countries could have 3.5 million too few college graduates in 2020. Other advanced economies with high median ages—such as Germany—could face a shortage of college-educated workers equivalent to 10 to 11 percent of demand, despite relatively high college completion rates. In the United States, a demographically younger economy, the gaps will be less severe: perhaps 1.5 million too few workers with college or graduate degrees by 2020.

    Meanwhile, the advanced economies are likely to face an excess supply of low- and medium-skill workers. Our analysis of demand patterns indicates that in 2020, there could be 32 million to 35 million more workers without post secondary education than employers will need—a surplus equivalent to 10 percent of the supply of these workers. That surplus implies a range of adverse social and economic outcomes: higher unemployment rates (even during periods of economic expansion), rising numbers of discouraged workers who opt out of the labor force permanently, and more workers forced to accept marginal jobs, resulting in downward pressure on wages.

    The oversupply of low-skill labor will be most acute where educational attainment is lowest. Current demand trends suggest that in 2020, as many as 16 percent of Southern Europe’s roughly 50 million workers without a post secondary education could be unable to find employment.

    Bridging the high-skill-worker gap would require raising young people’s rate of college completion by 2.5 times the historical rate of increase, and simultaneously raising participation rates of college-educated women and older workers at over twice the historical rate of increase. Even this won’t suffice to deal with the surplus of low-skill workers: the rate of job creation for them would need to be at least five times higher than it was in the past to create enough job opportunities.

    What business can do

    As we’ve said, labor markets are dynamic: wages will adjust in the face of imbalances; workers will relocate; and the nature of work itself will continue to evolve. Technology has a critical role to play—both helping workers perform higher-skill jobs than they otherwise could and serving as a powerful aggregator of skills. (Consider how 20,000 low-skill workers in southern India are using smartcards, mobile phones, and kiosks to disburse microloans or how Amazon’s Internet marketplace, Mechanical Turk, enables businesses to outsource simple tasks, such as writing product descriptions.)

    The uneven distribution of skills and needs means that business leaders must develop a finer-grained view of shifting labor dynamics. By anticipating trends in education, aging, and incomes, executives can better tune their recruitment, offshoring, and investment strategies. In addition to sizing pools of appropriately skilled workers, companies will need to assess the quality of educational systems and the market forces that determine—often at the level of individual cities—the wage differentials among employees.

    And then companies will need to take action. For those competing at the high end of the labor market, a deficit of high-skill workers implies an intensifying global war for talent. Companies worried about losing the skills and institutional knowledge of older employees as they retire may need to provide them with more flexible options. In Japan, for example, Toyota Motor aggressively recruits among its retiring employees to bring workers back in half-time roles at the company or its affiliates.

    Of course, business leaders will be establishing their labor strategies in an environment set by policy makers, who should focus on raising the output of educational systems and eliminating barriers to creating jobs for less-skilled workers. Looming labor market tensions suggest it would be unwise to take that context for granted. Particularly in high-demand STEM (science, technology, engineering, and math) disciplines, companies can play a larger role in shaping the educational content of colleges. The Great Minds in STEM initiative, for example, is committed to increasing attainment in these subjects among Hispanic students through an extensive community and school outreach program facilitated by corporate partners such as Boeing, Lockheed Martin, and Northrup Grumman. Some companies may even want to participate directly in the large and fast-growing market for education and training.

    Companies also can influence the context by focusing their corporate-social-responsibility efforts on youth unemployment and helping to bring the long-term unemployed back into the workforce. Beverage-maker Diageo, for instance, set up Tomorrow’s People, a UK-based charity that has helped more than 400,000 of the long-term unemployed find jobs, education, or training. Three-quarters of the people it helps to place remain employed after a year. Diageo supported the charity, now an independent entity, with operational and financial help, as well as access to jobs in businesses it owns.

    By taking decisive action now, companies and policy makers can help ensure that over the next two decades a growing global labor market continues to provide the opportunities and benefits it did over the past 30 years. Companies would continue to access the talent they need to sustain growth and create opportunities. Workers, in advanced and developing economies alike, would enjoy clearer paths out of poverty, along with improved—and improving—living standards.

    Printed with permission from McKinsey Global Institute

    A CEO’s guide to innovation in China

    Dynamic domestic players and focused multinationals are helping China churn out a growing number of innovative products and services. Intensifying competition lies ahead; here’s a road map for navigating it.

    China is innovating. Some of its achievements are visible: a doubling of the global percentage of patents granted to Chinese inventors since 2005, for example, and the growing role of Chinese companies in the wind- and solar-power industries. Other developments—such as advances by local companies in domestically oriented consumer electronics, instant messaging, and online gaming—may well be escaping the notice of executives who aren’t on the ground in China.

    As innovation gains steam there, the stakes are rising for domestic and multinational companies alike. Prowess in innovation will not only become an increasingly important differentiator inside China but should also yield ideas and products that become serious competitors on the international stage.

    Chinese companies and multinationals bring different strengths and weaknesses to this competition. The Chinese have traditionally had a bias toward innovation through commercialization—they are more comfortable than many Western companies are with putting a new product or service into the market quickly and improving its performance through subsequent generations. It is common for products to launch in a fraction of the time that it would take in more developed markets. While the quality of these early versions may be variable, subsequent ones improve rapidly.1

    Chinese companies also benefit from their government’s emphasis on indigenous innovation, underlined in the latest five-year plan. Chinese authorities view innovation as critical both to the domestic economy’s long-term health and to the global competitiveness of Chinese companies. China has already created the seeds of 22 Silicon Valley–like innovation hubs within the life sciences and biotech industries. In semiconductors, the government has been consolidating innovation clusters to create centers of manufacturing excellence.

    But progress isn’t uniform across industries, and innovation capabilities vary significantly: several basic skills are at best nascent within a typical Chinese enterprise. Pain points include an absence of advanced techniques for understanding—analytically, not just intuitively—what customers really want, corporate cultures that don’t support risk taking, and a scarcity of the sort of internal collaboration that’s essential for developing new ideas.

    Multinationals are far stronger in these areas but face other challenges, such as high attrition among talented Chinese nationals that can slow efforts to create local innovation centers. Indeed, the contrasting capabilities of domestic and multinational players, along with the still-unsettled state of intellectual-property protection (see sidebar, “Improving the patent process”), create the potential for topsy-turvy competition, creative partnerships, and rapid change. This article seeks to lay out the current landscape for would-be innovators and to describe some of the priorities for domestic and multinational companies that hope to thrive in it.

    China’s innovation landscape

    Considerable innovation is occurring in China in both the business-to-consumer and business-to-business sectors. Although breakthroughs in either space generally go unrecognized by the broader global public, many multinational B2B competitors are acutely aware of the innovative strides the Chinese are making in sectors such as communications equipment and alternative energy. Interestingly, even as multinationals struggle to cope with Chinese innovation in some areas, they seem to be holding their own in others.

    The business-to-consumer visibility gap

    When European and US consumers think about what China makes, they reflexively turn to basic items such as textiles and toys, not necessarily the most innovative products and rarely associated with brand names.

    In fact, though, much product innovation in China stays there. A visit to a shop of the Suning Appliance chain, the large Chinese consumer electronics retailer, is telling. There, you might find an Android-enabled television complete with an integrated Internet-browsing capability and preloaded apps that take users straight to some of the most popular Chinese Web sites and digital movie-streaming services. Even the picture quality and industrial design are comparable to those of high-end televisions from South Korean competitors.

    We observe the same home-grown innovation in business models. Look, for example, at the online sector, especially Tencent’s QQ instant-messaging service and the Sina Corporation’s microblog, Weibo. These models, unique to China, are generating revenue and growing in ways that have not been duplicated anywhere in the world. QQ’s low, flat-rate pricing and active marketplace for online games generate tremendous value from hundreds of millions of Chinese users.

    What’s keeping innovative products and business models confined to China? In general, its market is so large that domestic companies have little incentive to adapt successful products for sale abroad. In many cases, the skills and capabilities of these companies are oriented toward the domestic market, so even if they want to expand globally, they face high hurdles. Many senior executives, for example, are uncomfortable doing business outside their own geography and language. Furthermore, the success of many Chinese models depends on local resources—for example, lower-cost labor, inexpensive land, and access to capital or intellectual property—that are difficult to replicate elsewhere. Take the case of mobile handsets: most Chinese manufacturers would be subject to significant intellectual property–driven licensing fees if they sold their products outside China.

    Successes in business to business

    Several Chinese B2B sectors are establishing a track record of innovation domestically and globally. The Chinese communications equipment industry, for instance, is a peer of developed-world companies in quality. Market acceptance has expanded well beyond the historical presence in emerging markets to include Europe’s most demanding customers, such as France Télécom and Vodafone.

    Pharmaceuticals are another area where China has made big strides. In the 1980s and 1990s, the country was a bit player in the discovery of new chemical entities. By the next decade, however, China’s sophistication had grown dramatically. More than 20 chemical compounds discovered and developed in China are currently undergoing clinical trials.

    China’s solar- and wind-power industries are also taking center stage. The country will become the world’s largest market for renewable-energy technology, and it already has some of the sector’s biggest companies, providing critical components for the industry globally. Chinese companies not only enjoy scale advantages but also, in the case of solar, use new manufacturing techniques to improve the efficiency of solar panels.

    Success in B2B innovation has benefited greatly from friendly government policies, such as establishing market access barriers; influencing the nature of cross-border collaborations by setting intellectual-property requirements in electric vehicles, high-speed trains, and other segments; and creating domestic-purchasing policies that favor Chinese-made goods and services. Many view these policies as loading the dice in favor of Chinese companies, but multinationals should be prepared for their continued enforcement.

    Despite recent setbacks, an interesting example of how the Chinese government has moved to build an industry comes from high-speed rail. Before 2004, China’s efforts to develop it had limited success. Since then, a mix of two policies—encouraging technology transfer from multinationals (in return for market access) and a coordinated R&D-investment effort—has helped China Railways’ high-speed trains to dominate the local industry. The multinationals’ revenue in this sector has remained largely unchanged since the early 2000s.

    But it is too simplistic to claim that government support is the only reason China has had some B2B success. The strength of the country’s scientific and technical talent is growing, and local companies increasingly bring real capabilities to the table. What’s more, a number of government-supported innovation efforts have not been successful. Some notable examples include attempts to develop an indigenous 3G telecommunications protocol called TDS-CDMA and to replace the global Wi-Fi standard with a China-only Internet security protocol, WAPI.

    Advantage, multinationals?

    Simultaneously, multinationals have been shaping China’s innovation landscape by leveraging global assets. Consider, for example, the joint venture between General Motors and the Shanghai Automotive Industry Corporation, which adapted a US minivan (Buick’s GL8) for use in the Chinese market and more recently introduced a version developed in China, for China. The model has proved hugely popular among executives.

    In fact, the market for vehicles powered by internal-combustion engines remains dominated by multinationals, despite significant incentives and encouragement from the Chinese government, which had hoped that some domestic automakers would emerge as leaders by now. The continued strength of multinationals indicates how hard it is to break through in industries with 40 or 50 years of intellectual capital. Transferring the skills needed to design and manufacture complex engineering systems has proved a significant challenge requiring mentorship, the right culture, and time.

    We are seeing the emergence of similar challenges in electric vehicles, where early indications suggest that the balance is swinging toward the multinationals because of superior product quality. By relying less on purely indigenous innovation, China is trying to make sure the electric-vehicle story has an ending different from that of its telecommunications protocol efforts. The government’s stated aspiration of having more than five million plug-in hybrid and battery electric vehicles on the road by 2020 is heavily supported by a mix of extensive subsidies and tax incentives for local companies, combined with strict market access rules for foreign companies and the creation of new revenue pools through government and public fleet-purchase programs. But the subsidies and incentives may not be enough to overcome the technical challenges of learning to build these vehicles, particularly if multinationals decline to invest with local companies.

    Four priorities for innovators in China

    There’s no magic formula for innovation—and that goes doubly for China, where the challenges and opportunities facing domestic and multinational players are so different. Some of the priorities we describe here, such as instilling a culture of risk taking and learning, are more pressing for Chinese companies. Others, such as retaining local talent, may be harder for multinationals. Collectively, these priorities include some of the critical variables that will influence which companies lead China’s innovation revolution and how far it goes.

    Deeply understanding Chinese customers

    Alibaba’s Web-based trading platform, Taobao, is a great example of a product that emerged from deep insights into how customers were underserved and their inability to connect with suppliers, as well as a sophisticated understanding of the Chinese banking system. This dominant marketplace enables thousands of Chinese manufacturers to find and transact with potential customers directly. What looks like a straightforward eBay-like trading platform actually embeds numerous significant innovations to support these transactions, such as an ability to facilitate electronic fund transfers and to account for idiosyncrasies in the national banking system. Taobao wouldn’t have happened without Alibaba’s deep, analytically driven understanding of customers.

    Few Chinese companies have the systematic ability to develop a deep understanding of customers’ problems. Domestic players have traditionally had a manufacturing-led focus on reapplying existing business models to deliver products for fast-growing markets. These “push” models will find it increasingly hard to unlock pockets of profitable growth. Shifting from delivery to creation requires more local research and development, as well as the nurturing of more market-driven organizations that can combine insights into detailed Chinese customer preferences with a clear sense of how the local business environment is evolving. Requirements include both research techniques relevant to China and people with the experience to draw out actionable customer insights.

    Many multinationals have these capabilities, but unless they have been operating in China for some years, they may well lack the domestic-market knowledge or relationships needed to apply them effectively. The solution—building a true domestic Chinese presence rather than an outpost—sounds obvious, but it’s difficult to carry out without commitment from the top. Too many companies fail by using “fly over” management. But some multinationals appear to be investing the necessary resources; for example, we recently met (separately) with top executives of two big industrial companies who were being transferred from the West to run global R&D organizations from Shanghai. The idea is to be closer to Chinese customers and the network of institutions and universities from which multinationals source talent.

    Retaining local talent

    China’s universities graduate more than 10,000 science PhDs each year, and increasing numbers of Chinese scientists working overseas are returning home. Multinationals in particular are struggling to tap this inflow of researchers and managers. A recent survey by the executive-recruiting firm Heidrick & Struggles found that 77 percent of the senior executives from multinational companies responding say they have difficulty attracting managers in China, while 91 percent regard employee turnover as their top talent challenge.

    Retention is more of an issue for multinationals than for domestic companies, but as big foreign players raise their game, so must local ones. Chinese companies, for example, excel at creating a community-like environment to build loyalty to the institution. That helps keep some employees in place when competing offers arise, but it may not always be enough.

    Talented Chinese employees increasingly recognize the benefits of being associated with a well-known foreign brand and like the mentorship and training that foreign companies can provide. So multinationals that commit themselves to developing meaningful career paths for Chinese employees should have a chance in the growing fight with their Chinese competitors for R&D talent. Initiatives might include in-house training courses or apprenticeship programs, perhaps with local universities. General Motors sponsors projects in which professors and engineering departments at leading universities research issues of interest to the automaker. That helps it to develop closer relations with the institutions from which it recruits and to train students before they graduate.

    Some multinationals energize Chinese engineers by shifting their roles from serving as capacity in a support of existing global programs to contributing significantly to new innovation thrusts, often aimed at the local market. This approach, increasingly common in the pharma industry, may hold lessons for other kinds of multinationals that have established R&D or innovation centers in China in recent years. The keys to success include a clear objective— for instance, will activity support global programs or develop China-for-China innovations?—and a clear plan for attracting and retaining the talent needed to staff such centers. Too often, we visit impressive R&D facilities, stocked with the latest equipment, that are almost empty because staffing them has proved difficult.

    Instilling a culture of risk taking

    Failure is a required element of innovation, but it isn’t the norm in China, where a culture of obedience and adherence to rules prevails in most companies. Breaking or even bending them is not expected and rarely tolerated. To combat these attitudes, companies must find ways to make initiative taking more acceptable and better rewarded.

    One approach we found, in a leading solar company, was to transfer risk from individual innovators to teams. Shared accountability and community support made increased risk taking and experimentation safer. The company has used these “innovation work groups” to develop everything from more efficient battery technology to new manufacturing processes. Team-based approaches also have proved effective for some multinationals trying to stimulate initiative taking.

    How fast a culture of innovation takes off varies by industry. We see a much more rapid evolution toward the approach of Western companies in the way Chinese high-tech enterprises learn from their customers and how they apply that learning to create new products made for China. That approach is much less common at state-owned enterprises, since they are held back by hierarchical, benchmark-driven cultures.

    Promoting collaboration

    One area where multinationals currently have an edge is promoting collaboration and the internal collision of ideas, which can yield surprising new insights and business opportunities. In many Chinese companies, traditional organizational and cultural barriers inhibit such exchanges.

    Although a lot of these companies have become more professional and adept at delivering products in large volumes, their ability to scale up an organization that can work collaboratively has not kept pace. Their rigorous, linear processes for bringing new products to market ensure rapid commercialization but create too many hand-offs where insights are lost and trade-offs for efficiency are promoted.

    One Chinese consumer electronics company has repeatedly tried to improve the way it innovates. Senior management has called for new ideas and sponsored efforts to create new best-in-class processes, while junior engineers have designed high-quality prototypes. Yet the end result continues to be largely undifferentiated, incremental improvements. The biggest reason appears to be a lack of cross-company collaboration and a reliance on processes designed to build and reinforce scale in manufacturing. In effect, the technical and commercial sides of the business don’t cooperate in a way that would allow some potentially winning ideas to reach the market. As Chinese organizations mature, stories like this one may become rarer.

    China hasn’t yet experienced a true innovation revolution. It will need time to evolve from a country of incremental innovation based on technology transfers to one where breakthrough innovation is common. The government will play a powerful role in that process, but ultimately it will be the actions of domestic companies and multinationals that dictate the pace of change—and determine who leads it.

    Printed with permission from McKinsey Global Institute

    The archipelago economy: Unleashing Indonesia’s potential

    Most international businesses and investors know that modern Indonesia boasts a substantial population and a wealth of natural resources. But far fewer understand how rapidly the nation is growing. Home to the world’s 16th-largest economy, Indonesia is booming thanks largely to a combination of domestic consumption and productivity growth. By 2030, the country could have the world’s 7th-largest economy, overtaking Germany and the United Kingdom. But to meet its ambitious growth targets and attract international investment, it must do more.

    Indonesia has an attractive value proposition. Over the past 20 years, labor productivity improvements, largely from specific sectors rather than a general shift out of agriculture, have accounted for more than 60 percent of the country’s economic growth. Productivity and employment have risen in tandem in 35 of the past 51 years. And unlike typical Asian “tiger” economies, Indonesia’s has grown as a result of consumption, not exports and manufacturing. The archipelago nation is also urbanizing rapidly, boosting incomes. By 2030, Indonesia will have added 90 million people to its consuming class—more than any other country except China and India.

    Nevertheless, to meet the government’s goal of 7 percent a year growth by 2030, the economy must grow faster. Given current trends, the McKinsey Global Institute estimates that Indonesia has to boost productivity growth to 4.6 percent a year—60 percent higher than it has been during the past decade. Amid rising concern about inequality, the country must also ensure that growth is inclusive and manage the strains that the rapidly expanding consumer classes will place on its infrastructure and resources.

    Of course, Indonesia should tackle well-known problems such as excessive bureaucracy and corruption, access to capital, and infrastructure bottlenecks. But in addition it must address its impending skills gap; the country could, for example, develop a private-education market that might quadruple, to $40 billion, by 2030. If at the same time Indonesia took action in the three key sectors below, it could create a $1.8 trillion private-sector business opportunity by 2030:

    • Consumer services. Indonesia faces a range of challenges to productivity growth—including complex regulation of financial services, poor transportation infrastructure, and barriers to entry for new retail players and expansion limits for existing ones. If Indonesia overcame these problems, consumer spending could rise by 7.7 percent a year, to $1.1 trillion, by 2030.
    • Agriculture and fisheries. Indonesia needs to raise productivity per farmer by 60 percent just to meet domestic demand. If the country can boost yields, reduce postharvest waste, and shift to higher-value crops, it could become a net exporter of agricultural products, supplying more than 130 million tons to the international market. Revenue from these sectors, together with the related upstream and downstream revenues, could increase by 6 percent a year, to $450 billion, by 2030.
    • Energy. Demand not only for energy but also for other key resources, such as materials and water, is likely to increase rapidly through 2030. Indonesia could meet up to 20 percent of its energy needs by turning to unconventional sources, such as coal-bed methane, next-generation biofuels, geothermal power, and biomass. This approach could also help boost resource productivity—for example, improving the country’s energy efficiency could reduce energy demand by as much as 15 percent. By 2030, Indonesia’s energy market could be worth $210 billion.

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    Printed  from McKinsey Global Institute


    Africa: 2008 vs 2020

    Africa at work: Job creation and inclusive growth

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

    Africa today …..

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

    ….. and in 2020

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

    Read the full report at

    Corporate Espionage

    Foreign spies stealing U.S. economic secrets in cyberspace

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

    Read the entire report at

    Beyond the boom: Australia’s productivity imperative

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

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

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

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

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

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

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    Printed with permission from McKinsey Global Institute

    Playing war games to prepare for a cyberattack

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

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

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

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

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

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

    Testing readiness with cyberwar games

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

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

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

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

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

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

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

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

    Conducting a cyberwar game

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

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

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

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

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

    Printed with permission from McKinsey Global Institute.

    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.