NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Businesspeople tend to prefer predictable business environments to work in. However, in developing countries, business environments tend to be more unstable than in Western markets because of various unpredictable social, economic and political changes.

Since business plans depend on predictions about the future and the certainty of that prediction, the financial equation by which BOP firms decide where and how to invest will change fundamentally with respect to OECD markets. In this post I want to explore the dichotomy between market growth and innovation in relatively large BOP firms.

Thanks to scalable business models, pursuing market growth strategies is a short- term decision (1-3 years approximately).? On the other hand, devoting resources to innovation efforts or research and development, is a more long term decision (3-5 years depending on the industry).? Additionally, most BOP firms are especially constrained in capital due to illiquid capital markets.? Inefficient and corrupt bureaucracies and unpredictable law regimes do not help either.? How do they make a decision when assigning resources to innovation and growth strategies?

Measuring growth in BOP and OECD markets is relatively straightforward.? On the other hand, innovation tends to be a trickier concept.
The Economist published a ?Special report on Technology in India and China? on November 10th in which this was discussed. It concluded that “India and China’s precocious economies have done more piggybacking than leapfrogging.”

What does this statement exactly mean?
In the BOP, innovation often entails an unusual combination of technologies and other components that generates value for the consumer. It does not normally involve capital intensive research (like that which may be done in western pharmaceutical or technological corporations) or complex supply chains.? BOP innovations are, for example, adding a torch light to mobile phones or developing wider washing machine pipes (for cleaning vegetables, you see).? Rebecca Henderson of MIT and Kim Clark of Harvard have coined the phrase “architectural innovation” to describe these kind of innovations.?

A recent report by the World Bank called “Unleashing India’s Innovation” (do excuse me for not having read it all yet, but it is 224 pages) found that for each industry there was a big group of underperforming companies operating far behind the industry’s vanguard. It calculates that India’s national output could be 4.8 times bigger if only that lagging group of companies were to absorb the existing industry knowledge. Moreover, it found that the recent growth in India (and, by extension, China and other developing economies) has involved in most cases piggybacking or catching up to the frontrunners rather than leapfrogging.

Innovation, because it involves catching up instead of pushing the industry’s boundaries, is shorter term in developing economies than in western economies. As a consequence, it only allows for shorter term and comparatively smaller extraordinary profits.

Furthermore, innovation at the BOP level involves a greater degree of experimentation and interaction with the customer than it does in Western markets. After all, as Tsinghua University’s Mr. von Zedwitz says in the Economist report, Chinese companies “can afford to waste some customers with an imperfect product, because there are always another 100m out there to whom you can sell version 2.0.”? Although this may be an exaggeration, especially if the product is perceived to be toxic or useless (remember the Nestl? boycott?), the case does apply to BOP markets.

Anyhow, innovation is more closely connected to the market and is still being developed even as it is sold (like a computing beta version of sorts). This creates a strong link between the company’s market access and the innovative products. Therefore, additional profits from the new product will be more tightly dependent on successful growth strategies.

Finally, most BOP markets, like the developing countries they are in, are experiencing very strong growth. It must also be noted that volume is a crucial factor in achieving sustainable profits at the BOP level, since sales margins tend to be very thin.

Companies that decide to take advantage of current economic growth (which will tend to stabilize in the future) without innovating at all will have a competitive advantage over those companies that are currently setting aside a portion of their profits for research. In economic terms, other things equal and taking into account decreasing marginal returns, the opportunity cost of innovation will tend to be higher in BOP markets because foregone growth is greater here than in OECD economies.

In non-economic terms, a company will tend to get a bigger ?bang for the buck? if it chooses to spend more of its resources on growth strategies than on innovative products or processes. Even if an abnormally innovative firm strikes gold, due to its smaller volume, it would tend to be bought or absorbed by more growth oriented firms when they recognize the value of that innovation (this is also what happens with plenty of successful Silicon Valley start-ups).

To summarize, in the BOP:

1. The innovation process is less complex and closer to the market.
2. Innovation currently entails piggybacking, not leapfrogging, so profits are smaller and shorter-lived.
3. The final outcomes tend to be easier to copy by competitors because they are simpler and easier to understand (and also due to non-enforced property rights, but that’s another story!). Innovations therefore entail competitive advantages for shorter periods.
4. The opportunity costs of innovating are higher because the foregone growth is bigger.

As a result, innovating in BOP markets tends to be less profitable.

This does not mean that BOP firms should not innovate. It does mean that if two identical firms are doing business in, for example the US and the other in India, the American firm will tend to spend more on innovation than the Indian one, because that is what makes more financial sense. The innovation process will tend to be diluted operationally within the BOP firm and will involve greater contact with customers. BOP companies will be more time-constrained with their innovation investments and will want them manufactured and sold as fast as possible. Ideally, they will involve a variation or addition on a product they sell already.

Anywhere in the word, the best innovation will be the one that involves short development periods, less invested resources and brings additional benefits as fast as possible. However, at the BOP level, we are talking about probably more intuitive, more spontaneous and open innovations. They have a stronger anthropological bent, being dependent on customer observation and with more “obvious” innovations, rather than the more scientifically advanced research western markets are used to.