Emerging Markets: Tackling the Challenge of Continued Subdued Consumer Demand

Breaking into or extending their presence in emerging markets has become the central pillar of many businesses' growth strategies as they seek to overcome the challenges presented by an unpredictable economic recovery and the continued sluggish growth of developed economies.

In this context, the prospect of population growth, rising incomes and a fast growing middle class makes China, together with other emerging market economies like Brazil and India, must-win markets. There is a risk, however, that corporates are increasingly viewing emerging markets through rose tinted spectacles, spurred on by board and investor growth expectations.

Recent research conducted by the Corporate Executive Board illustrates the extent to which businesses are relying on emerging markets as a new source of growth. According to the study, while today just 7% of businesses earn more than 50% of their revenue from emerging markets, this is expected to rise to 38% of companies in just 10 years time.

The size and scale of these emerging market's growth ambitions present real risk for these companies.  In response, we see leading Finance Directors doing two things:  a) adjusting performance reviews to allow for a much deeper pressure testing of leading trends and strategies at risk and b) investing significantly more time to develop their own viewpoint on market intelligence.  This latter point of course begs the question, what should they be monitoring?

The rebalancing of the global economy

Much has been made, for example, of the size of the Chinese population, with the perception among businesses that there are 1.3bn consumers with large disposable incomes and vast savings accounts ready and waiting for them.

One thing we can be relatively sure of is that while emerging markets will continue to offer strong potential for growth this will not conform to previously established norms of international economic development.

China's export market has delivered dizzying levels of growth in recent years but it is becoming clear that as western consumers remain cautious, further growth can only be fuelled by as yet unrealised demand from the Chinese consumer.

Indeed, in a recent speech at the "Summer Davos" China's Premier Wen Jiabao described China's path to economic growth as unbalanced, uncoordinated, and unsustainable and he highlighted a lack of coordination between economic and social development, and an uneven urban-rural development.

Miranda Carr, Research Director at First China Invest, the independent investment research provider, makes the point in a different way.  According to Carr, wage growth in China has increased at a slower pace than GDP and when inflation is taken into account the level of disposable income for the average consumer has actually fallen.

When combined with the relative immaturity of the social security net in most emerging markets, it becomes clear why the average consumer is eager to save what remains of their take-home pay in order to provide protection from loss of earnings and the cost of healthcare that the state does not currently offer. This leaves the average consumer relatively constrained, leading them to focus their spending on housing, education and transportation rather than leisure activities and luxury goods.

The development of a mature welfare system and the reforms to the tax system needed to fund it will have a key role to play in kick starting consumer demand and thus will be an important leading indicator to track.

It is unlikely, however, that social reform will fall into place overnight and even then the consumer will take time to loosen their approach to spending. This will create inconsistencies across different sectors and regions, meaning that the imperative to fully understand the pace at which institutional reform is taking place is critical for companies seeking to grow their businesses in these markets.

Preparing for the new industrial revolution

Corporate Executive Board research has found that in recessionary times industry rankings are twice as likely to change as in a more stable economic environment.

This means that individual companies have a much higher likelihood of losing their top spot if they don't position themselves to take advantage of the changing environment.

A dependency on informal institutions, weak regulatory influence and cross-cultural management problems necessitates that businesses tailor their approaches based on the unique characteristics of emerging markets right down to the regional level.

China is again a good illustration of the game-changing regional differences that can exist in what appears to be a single marketplace. Inland regions of China are expected to provide much higher rates of growth than its coastal regions but infrastructure within these regions can be severely under developed, requiring businesses to develop alternative strategies to ones that have already been implemented to break into the more developed east coast.

Such spatial disparities, the fragmented nature of logistics and distribution networks, and the imbalance in development can and should critically affect business decisions.

So what should Finance Directors be considering amidst all of this uncertainty?

• Can Beijing fine-tune China's economy? Invest time in understanding the pace of change in the social security and tax systems, as both of these factors will act as strong accelerators for the growth in consumer demand and therefore the economy.
• Get more out of your business reviews.  Spend more time on "theory of the customer" and ensure you develop your own point of view of how to interpret emerging market intelligence.
• The devil is in the detail, watch out for misleading averages. Get granular in your analysis of market segments by region, and ensure you are targeting the best growth areas for your product set.

Sarah Schwab is Managing Director of the Corporate Executive Board's Finance and Strategy Practice. She and her team support CFOs and their teams in decision making and improvement in corporate performance. Sarah also personally manages the European CFO Thought Leaders Network.