APPENDIX 12
Memorandum submitted by Deloitte &
Touche
WHY UK MANUFACTURING
NEEDS TO
PURSUE AN
EXPORT STRATEGY
Executive summary
This paper is based on research by Deloitte—"Innovation
in emerging markets—strategies for achieving commercial
success" which was published in 2006, where global companies
were surveyed to provide feedback on activities being undertaken
by them with regard to the emerging markets.
Global manufacturers increasingly regard competing
successfully in emerging markets as key to their corporate strategy.
There is little doubt that emerging markets present a tremendous
opportunity for global manufacturers. Today, many global manufacturers
believe they must have a strategy for the major emerging markets
of China and India. For many, China is seen as the place to produce
or procure goods where India is the place to procure business
and IT services. Yet in the future this discrete division of labour
might not be so clear or even relevant. Moreover , both countries
are seen as burgeoning markets in their own right. Many more UK
manufacturers see opportunities for growth in India but over a
longer term than China.
The question is why does this all matter? China
and India account for nearly 40% of the world's population. When
GDP is measured using PPP (purchasing power parity) exchange rates
which reflect the actual purchasing power of a country's currency,
China has the world's second largest economy after the US and
India , fourth after US, China and Japan. Moreover, China and
India accounted for roughly half of the global GDP growth in 2005.
Not only do countries such as China, India,
Russia and Brazil offer lower operating costs, but they are also
home to rapidly growing middle classes that are potentially huge
markets for the products and services of global manufacturers.
There will be approximately 500million people in the middle classes
in the next 5 years in China and India alone.
What will the future bring for India and China?
— Both will grow rapidly, taking a
much larger share of global GDP yet in the foreseeable future,
it is more likely that China will continue to grow more rapidly
than India. In both countries, the domestic market will be increasingly
attractive to investment.
— The division of labour between India
and China will become blurred as both countries excel in services
and manufacturing.
— Trade between India and China will
expand, enabling companies in both countries to achieve critical
mass. For global companies selling in these markets, this means
more local competition.
— Both countries will create new world-class
companies that will be competitive with companies based in the
UK this will create new challenges for both UK companies but also
UK Government in ensuring that the UK receives its fair share
of inward investment.
— Both countries, while remaining relatively
poor, will experience rapid growth of the middle class, creating
vast opportunities for Western companies to sell in those markets.
Research by Deloitte shows that UK manufacturers
have a challenge to improve their emerging market strategies and
business performance. Most UK companies expected to expand sales
revenues with a quarter of those surveyed expecting to increase
substantially in the next three years. This compares with 30%
in the US, France and Japan and 40% in Germany. (See Exhibits
1 and 2 show the global results).
Exhibit 1
BULLISH ON EMERGING MARKETS
Percentage of executive responses expecting
a substantial increase in sales revenues over the next three years.
Emerging markets = Argentina, Brazil, China, Czech
Republic, India, Indonesia, Mexico, Poland, Russia and South Korea.
Source: one or more member
firms of Deloitte Touche Tohmatsu
Exhibit 2
CHINA EXPECTED TO LEAD THE PACK
Percentage of executive responses expecting
a substantial increase in sales revenues in each location over
the next three years.
Other Asian markets = India, Indonesia, and South
Korea; Latin America = Ergentina, Brazil and Mexico; Eastern Europe
= Czech Republic and Poland
Source: one or more member
firms of Deloitte Touche Tohmatsu
Identifying the opportunity these markets represent,
however, is the easy part. The much more difficult task is determining
what it takes to sustain profitable growth in these markets. Setting
and executing the right strategy for profitable growth is so critical
when exporting. Deloitte research identified and analysed the
strategic initiatives that global manufacturers must take to thrive
in emerging markets. Our research showed that far too many manufacturers
simply made minor adjustments to existing products, reduced prices
and replicated existing distribution channels, this leads to margin
erosion and over the long term, this strategy just doesn't work.
Our research also highlighted that to achieve
sustainable commercial success in emerging markets, global manufacturers
must develop a strategy based around innovation. This means that
global manufacturers must essentially acquire an entirely new
set of skills and organisational structures that address the special
requirements of both consumer and industrial buyers in these markets.
We also believe that this means more focus at the local market
level and development of advanced management expertise. Most significantly,
it means that global manufacturers must offer products at dramatically
lower prices to match the special needs and lower purchasing power
of most emerging market buyers.
The business opportunity cannot be overstated.
When differences in the relative prices of goods and services
are taken into account (purchasing power parity), the aggregate
gross domestic product of the 10 largest emerging economies was
almost. US$18 trillion in 2004 and growing rapidly.
Leveraging the full commercial potential of
emerging markets is not easy. Many manufacturers have attempted
to serve these markets by offering their existing products, often
selling older product models at somewhat lower prices. Half of
executives surveyed said their company's products sold in emerging
markets were similar to those sold in their home market, and only
12% said that their products in emerging markets were very different.
UK manufacturers have the opportunity to achieve
even greater market share and profitable growth by developing
innovative products and services tailored to local customer needs.
Indeed manufacturers can use emerging markets to drive commercially
viable innovation. For example, only 5% of UK manufacturers sell
products that are significantly different as compared to 14% in
US.
Given the size of the opportunity why aren't
more UK manufacturers developing new products for the emerging
markets in which they compete. Simply put, it is a daunting challenge
to design an array of profitable products that meet the specific
needs of customers in each emerging market, and do so at prices
that match the purchasing power of relevant consumer and business
segments of the local economy. Emerging markets offer opportunities
to forge innovations that create entirely new markets, often among
middle and lower income consumers who are not being served well,
or perhaps at all, by available products.
To add to the challenge, most UK manufacturers
have built their capabilities and products on understanding the
preferences, technical requirements, and acceptance pricing for
consumers and businesses in developed markets. Now, they need
to "unlearn" much of what has made them successful an
order to develop and profitably commercialise far less expensive
products and services that meet the very different needs of consumers
and businesses in emerging markets. Making the case for an entirely
new approach to emerging markets is not easy. Companies will need
to go beyond traditional financial metrics to also employ non-
financial metrics of an operation's health and growth prospects
that address such issues as product innovation and customer satisfaction.
Each emerging market will have its own unique
profile, and the right strategy for a company will depend on the
nature of its industry and its capabilities, among other factors.
Our research reveals that many UK manufacturers often lack the
expertise and resources to work through the following five critical
challenges.
1. Rethinking value propositions
Manufacturers will need to design products tailored
to meet the special needs of emerging market customers, often
priced far below their offerings in developed markets. Three-
quarters of the executives surveyed who said that their company
offered very different product features in emerging markets anticipated
a substantial increase in revenues over the next three years,
compared to half of those who said the product features were the
same in emerging markets.
Tailored products are also more likely to be
associated with higher margins. Manufacturers that develop new
product offerings aligned to the unique needs of individual emerging
markets will be likely to achieve the greatest success.
2. Globalising research and development
Many manufacturers are locating research and
development (R&D) facilities in emerging markets not only
to reduce the costs of product development, through lower wages
as well as tax credits, and other government incentives, but more
importantly, to better incorporate local needs and expertise in
product design. Currently this applies mostly to major companies
but our research showed that most of the executives at companies
that did not yet have R&D operations in emerging markets said
their company planned to establish them.
The challenge is to effectively integrate and
leverage R&D teams around the world. To build these connections,
leading companies are combining traditional face-to -face team
building with technology solutions such as databases of innovative
ideas and global project teams that collaborate online.
3. Tailoring talent management
Manufacturing executives will need to rethink
how they recruit, develop, deploy and connect the skilled employees
on who they rely. Once seen as an inexhaustible supply of low-cost
labour, many emerging markets are now facing the same shortages
of skilled labour that are all too familiar here in the UK. Understanding
the local expectations and cultural norms to develop human resource
policies is vital. These could range from providing more holidays
and sick leave in Russia and Eastern Europe to adding softer,
less quantifiable factors to performance evaluations in India.
4. Mastering the complexities of global value
chains
Delivering commercially viable products that
meet the needs of emerging markets will depend on global companies
leveraging their expertise in governance, business processes,
and management while providing autonomy to their local operations.
Global supply chains also need to be adjusted to local realities,
whether sub zero temperatures of a Russian winter or the inadequate
distribution in China.
While the challenges can be formidable, some
companies are using theses obstacles as a catalyst to reinvent
their operations.
5. Managing risks
Emerging markets present a unique profile of
risks—geopolitical, regulatory, financial, currency and
governance risks among others. However, on the greatest concerns
to UK manufacturers in emerging markets are potential threats
to intellectual property rights, whether through outright theft
of proprietary know-how or counterfeiting of products.
Companies must not only protect themselves from
these unrewarded risks , they also need to guard against the risk
of failing to capture the upside of these markets. The goal is
to achieve risk intelligence by systematically identifying, evaluating
and managing all the risks faced by a company across all the markets
in which it operates.
A key aspect of this comprehensive approach
is to manage explicitly the interdependencies that inevitably
exist among the different types of risk that a company faces.
In the Annex we have expanded on each of the
above areas.
FUTURE POLICY
UK companies are clearly on a journey when approaching
the challenges of the emerging markets. We see this journey in
three phases:
— emerging markets have been a low
cost producer of product with many UK manufacturers moving production
from the UK to Eastern Europe or China;
— emerging markets are developing as
markets in their own right with increasing numbers of middle income
consumers who demand products and services that meet their special
needs;
— emerging market headquartered companies
are establishing themselves as global companies and are looking
to expand overseas particularly into Europe;
In developing an emerging market strategy there
are key questions which companies need to answer:
— Is your company developing fundamentally
new products with cost structures that meet the unique requirements
of consumers and industrial buyers in emerging markets?
— Is your company developing innovations
in emerging markets that can be brought back to change the competitive
landscape in developed economies?
— Has your company evaluated the benefits
and challenges of locating R&D capabilities in emerging markets?
Are your R&D operations integrated into a global infrastructure
that takes advantage of common governance, business processes,
and expertise?
— How effectively does your company
manage regulatory risks in emerging markets in such areas as intellectual
property protection, labour laws, and taxes?
— Is your company able to attract,
develop and retain the key employees it needs in emerging markets
and integrate the into its global network?
The landscape is, therefore, complex and support
by UK Government will need to reflect the changing demands of
business. The areas that Government needs to be addressing can
be summarised as follows:
MACROPOLICIES
1. small and medium sized businesses will
still need support in determining their export strategy. Particularly
medium sized businesses have "fallen through" the network
of existing support;
2. product design to meet the regulatory
requirements of emerging markets is a particular area where companies
need help. The investment in new product designs can be very expensive
for small and medium sized companies and Government should review
whether there are incentives that could be introduced in this
area. In addition, the understanding and navigation through laws
and regulations in emerging markets can be onerous and practical,
on the ground advice and support is needed to help companies gain
the relevant product approval;
3. protecting intellectual property rights
is a key challenge in emerging markets and companies struggle
to ensure that their products are not being replicated. More importantly,
companies need help, advice and support to fight intellectual
property challenges in the courts. Again, medium sized companies
are particularly vulnerable in this area;
4. medium sized companies often lack the
expertise to develop market entry strategies and as the emerging
markets cannot be seen as one population but require specific
different tactics and knowledge. In depth customer knowledge is
vital to developing market winning strategies and practical help
in research and knowledge management in this area is essential;
MICROPOLICIES
5. the geo-political landscape in the emerging
markets is sometimes unstable and companies look to the government
to provide guidance and timely advice on key issues. For example,
the current coup in Thailand and how businesses need to react;
6. emerging market headquartered companies
are looking to invest overseas, it is vital that a substantial
part of this investment comes to the UK. The Government must devise
a strong marketing UK plan and invest in building relationships
with these new emerging global companies. One area that needs
immediate action is to ensure that the UK initially is one voice.
It is very confusing to companies to be approached in the first
instance by 9 separate RDAs. A co-ordinated effort is required
to secure the inward investment into the UK and an organised approach
to the regional agenda.
7. Providing advise and practical help to
companies seeking to establish businesses in emerging markets
on such matters are the various pros and cons of outright ownership,
joint venture or using agency agreements, title, local laws and
regulations and taxes;
8. Government needs to lobby on behalf of
UK manufacturers to advocate open standards of governance and
fewer barriers to competition around the world.
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