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Asia Business Development – Asia Business Consulting » Emerging Threats to MNCs

SpirE-Journal 2008 Q1

Emerging Threats to MNCs

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Emerging Threats to MNCs

IBM’s sale of its PC division to Chinese maker Lenovo in late 2004 was a wake-up call to global brands about the threat from low-cost competitors from emerging markets. In the last decade, many low-cost businesses with global ambitions have emerged from Asia. The current inflationary environment may increase demand for their products. But established Multi-national Corporations are fighting back with their own counter-strategies – extending product lines, forming alliances or adopting low-cost business models themselves.

Rude awakening

When International Business Machines (IBM) sold its USD11 billion personal computer (PC) division to Beijing-based Lenovo Group in December 2004, it hit the headlines. The takeover of a venerable global brand by an Asian company, which had seemed unthinkable, was now a reality. Lenovo has since reportedly claimed the third spot in global PC rankings – behind only Dell and HewlettPackard (HP).

Rising Asian companies have been acquiring established Western trademarks in a range of industries. In addition to IBM’s PC business, other familiar examples include the Esprit fashion line, Jaguar and Land Rover cars, Thomson and RCA television sets and hospitality brand Swissôtel.

Where emerging economies in Asia – home to half the world’s population, with economies growing at 5 to 10 percent each year – used to be a mere marketplace for global brands to take root and blossom, they are now producing low-cost makers that have begun to threaten the very existence of the big players.

Indeed, companies in developing economies are no longer just tapping local markets. The first wave of emerging-nation players like Samsung and Lenovo are flourishing on the global stage, demonstrating how far they have moved beyond tapping home market advantages. The next wave of world-class companies from emerging economies is taking flight against an inflationary environment, in a shift that may herald a new global game.

And the game begins

Generic, low-end and local Asian brands started out targeting the low-income market segments that multinational corporations (MNCs) did not perceive as profitable. Consumers tended to associate the products manufactured by these low-cost producers to be of inferior quality.

Japanese car makers in the past were not recognized as a threat to automobile manufacturers in the US as they started by selling inexpensive and lower-quality vehicles that yielded smaller margins. The Japanese were considered ‘safe’ competitors because they tackled a market that the incumbents did not want. Yet the Japanese quietly gained experience, improved production and crept up-market. Today, American players can barely keep their lead in anything else other than trucks and SUVs.

Similarly in recent times, Western telecom equipment leaders viewed China’s Huawei Technologies as an insignificant competitor that follows rather than leads. But in 2005, Huawei snared billions in new orders, including contracts from British Telecommunications PLC for its USD19 billion program to transform Britain’s telecom network.

Licensed to design

Conventional wisdom has it that the West innovates and Asia manufactures, allowing MNCs to capture the lion’s share of profit in the value chain while Asian companies rely on cheap labor, government patronage and market distortions. Today, the new breed of low-cost Asian companies are catching up on the technology front and revamping their image to attract a wider consumer base, not just in their home markets but globally.

Asian countries (aside from Japan) have increased their share of global patents from 0.5 percent in 1985 to a more respectable 3 percent in 20003 – a six-fold increase in less than two decades. Patent applications from Asia are growing at 17 percent each year, more than four times the Western average4. Asian companies have also been investing aggressively in IT, at a rate 50 percent faster than the global average.

Consumer-driven innovation, coupled with savvy marketing, has led Samsung onto BusinessWeek’s 100 Most Valuable Global Brands list as the first non-Japanese Asian company. The Seoul-based chaebol is a hotbed for innovation and has successfully invaded consumer IT and mobile phone markets, upsetting big names Intel, Sony and Nokia. R&D is widely recognized as a key factor that has enabled Samsung’s rise to prominence in these technology-intensive fields.
India’s Tata Group recently launched a revolutionary hatchback vehicle dubbed the “People’s Car”. It is small, compact and the cheapest of its kind. The car is the culmination of five years’ research and input from across the world, including Italy and Germany. The car was designed and made in India, defying expectations that a company best known for its transport lorries could produce a cutting-edge passenger product.

Licensed to brand

Asian companies that are moving up-market tend to elevate marketing to the boardroom, integrating branding, research and development, design and traditional advertising and promotions so as to become more consumer-centric.

Lenovo Group is successfully pursuing its global ambitions, thanks largely to its low pricing and aggressive marketing. In a global 2007 brand survey, the company was highly ranked as the best brand ambassador for China. Its annual sales rose 10 percent year-on-year to USD14.6 billion in mid 2007 and its computer shipments grew 17 percent in the fourth quarter, 6 percentage points higher than the average market performance.
Similarly, China’s USD12 billion consumer-electronics leader Haier also ranks advertising and promotions high on the agenda. Other than huge billboards in major business districts, the company sponsors events such as the MTV Asia Awards. Its high-definition television serves as the official National Basketball Association TV and its sponsorship of Russian tennis player Anastasia Myskina (globally ranked third in 2004) has heightened its popularity in Russia. “We used all our resources to get into the market at the low end, then we crept into the mid-range,” says Michael Jemal, president of Haier Group’s American operations. “Now we are entering a new strategic phase.” The formula seems to pay off – the company’s total overseas sales in 2006 were reportedly $3.3 billion.

Licensed to hire

Many of these successful companies are also headed by entrepreneurs who were trained in the West and know how to attract top talent.

Haier has given Jemal, a former New York electronics retailer, free rein to pursue markets where Haier wants to be in the top spot.
Wipro of India recruited Vivek Paul from General Electric and he in turn helped build Wipro into a highly profitable, global information technology powerhouse.
The heat is on

Some would like to believe that low-cost providers will go under because no business can sustain itself if it is selling below its cost. However, a business that operates a different model with a lower cost structure can be hugely disruptive to a mature market operating at a much higher cost structure.

Local and regional brands make up 75 percent of top brands in Singapore, 60 percent in India and 40 percent in China. Successful price warriors stay ahead of bigger rivals by using several tactics. They focus on just one or a few consumer segments. They deliver the basic product or provide one benefit better than rivals do. They also back low prices with extra efficient operations to keep costs down.

In 2005, Forbes magazine named AirAsia one of Asia’s “Best Under A Billion” companies. The Malaysian airline pioneered the low cost carrier (LCC) in Asia and is based in the Kuala Lumpur International Airport. AirAsia operates with the world’s lowest unit cost of USD0.023/ASK and a passenger break-even load factor of 52 percent. Cumulative passengers of the Group totalled 33 million by the end of calendar year 2007.
Chinese consumer appliance maker Haier has transformed the market for wine-storage refrigerators from the preserve of a few wine connoisseurs into a mainstream category sold through America’s Sam’s Club at half the then-prevailing price. That earned Haier 60 percent of the market share while niche players were left floundering 11. Haier tapped niche markets and customised products, but instead of looking at premium pricing they chose to go mass market with everyday low prices.

While generic, house or regional brands have been in existence for some time, the inflationary environment will see sales of these cheaper products soar in the marketplace. As consumers become more price-sensitive, MNCs will have to contend with greater competition from low-cost rivals.

House-brand products, for instance, come in no-frills packaging and are mostly stacked below eye-level on retail shelves. Yet they are catching on with cost conscious shoppers in Singapore, whose inflation rate hit a 25-year high of 4.4 per cent in December. The higher costs of raw materials and production have significantly increased prices of everyday items. Sales of house-brand items at supermarket chains – Giant, Cold Storage, FairPrice and Carrefour – witnessed double-digit growths in 2007.

Counter moves

Faced with threats that promote increasingly low prices with innovation, some established MNCs have veered from conventional strategies to launch a new line of products at lower prices or begin low-cost businesses of their own as second brands. These so-called dual strategies succeed only if companies can generate synergies between the existing businesses and the new ventures. Another alternative is to fraternize with the ‘enemy’ for a common good.

Diving in

A popular strategy is for an MNC to enter low price markets with new product lines designed with low costs in mind.

In India, entrenched brands like Nokia, Motorola and ZTE have aggressively launched ultra low-cost handsets to compete with local and regional players. ZTE is expected to sell around 10 million handsets this year in India. According to an ABI research, by 2011 25 percent of handsets shipped globally will be ultra low-cost handsets.
Buick originally positioned itself as a luxury car in China for business tycoons, on par with or more expensive than BMW and Mercedes. They sold well, but then noticed that competitors were pushing lower-end cars for the middle-class. Buick then started selling cheap USD10,000 cars under the same Buick label.

Launching new lines under the same brand takes advantage of the firm’s established brand image. The danger of watering down a brand is that it may confuse customers, especially in markets where the brand is relatively new. Such brands may have a hard time moving forward.

Second chance

To succeed without diluting incumbent brands, some MNCs have taken to launching so-called second brands which have an identity that is linked to but distinct from the core brand.

Singapore Airlines (SIA) showed particular concern about the emergence of low-cost airlines in Asia, when four budget carriers had either already, or intended to, set up a base in Singapore in 2004. Acknowledging that it could no longer ignore competition from budget airline, SIA tapped several high-profile airline financiers to launch its own no-frills service under the name of Tiger Airways.
Dow Corning’s Xiameter unit (a low-cost provider of silicone products) sells only 350 of Dow Corning’s 7,000 offerings, effectively limiting cannibalization of the parent company’s sales. It schedules manufacturing when Dow Corning’s factories are idle, sells only large orders, and offers no technical services. After launching Xiameter, Dow Corning turned a USD28 million loss in 2001 into a USD500 million profit in 2005.
Second brand strategies have also been seen in fields as diverse as automotive parts (Honda’s HAMP and Yamaha Motor’s YTEQ parts brands) and power tools (Makita’s Mactech).

A second brand allows a company to expand while still protecting the integrity of its core brand

Half to a whole

A joint venture with or acquisition of a local company enables a foreign brand to benefit from its partner’s established distribution network, brand loyalty or low cost production competence.

In an effort to break into the China’s local brand-dominated beer market, Anheuser-Busch purchased a stake in Chongqing Brewery Company in 2002, ahead of its nearest rival, SABMiller, Scottish & Newcastle. Overseas brewers paid a total of over USD700 million for stakes in Chinese breweries over the next two years, so as to gain access to domestic distribution channels, local production capacity and brands.

France’s Renault has also teamed up with Indian company Bajaj Autoto assemble a small, low-cost car in an attempt to rival Tata’s Nano, the Tata group’s 1-lakh car.

A new dawn

The best of the established MNCs are resilient, having weathered previous waves of new rivals. Japanese giants such as Sony and Toyota appeared on the scene in the 1960s and 1970s, followed by South Korean powerhouses such as Hyundai and Samsung and then Taiwanese electronics heavyweights like Acer. The best corporations adapted and emerged stronger than before. For example, US firms Hewlett-Packard and Xerox have held their own and thrived against determined Japanese and Korean competition since the 1970s.

Yet this latest group of game-changing companies from Asia’s emerging economies is different on many levels. One twist is that the competitors are neither established, premium brands nor struggling businesses content to sell low quality goods. They are in fact low-cost innovators after the lion’s share of the market. For another, the new players are coming from many developing nations and deploying an array of strategies that deviate from the norm. There is no doubt that these new rivals are here to stay, and will grow by the day as developing nations gear up for globalization.

To a large extent, as the new low-cost providers move up the value chain and MNCs move down, the boundary between global players from the OECD and emerging economies will blur. In time, the chief distinction will be that between good and bad global firms – with cost innovations being a critical success factor for all players.

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