What will the ranks of the world’s leading multinational corporations (MNCs) look like 25-50 years from now? And what will be the effect of the rebalancing of economic activity towards China and India, in particular, if they continue to grow rapidly and regain some of the share of gross domestic product that they ceded in the 19th and most of the 20th centuries?

At one extreme, one might imagine companies from these and other emerging markets crowding out ones from advanced economies: what has been dubbed the decline of the west and the rise of the rest. At the other, one could conceive of the companies from emerging markets continuing to be confined to marginal positions, with a few exceptions of the sort that we are already starting to see. Which of these extremes is likely to prove closer to the mark?

China and India present nearly ideal conditions for getting an early look at outcomes in the competition between developed economy MNCs and emerging market challengers. Both are large, inviting markets and have already produced serious competitors to older multinationals.

At the same time, India and especially China are now open to foreign competition in most key industries, making them highly attractive to MNCs, which appear increasingly aggressive and long-term in their investment time horizons in those markets. China and India account for more than two-thirds of all new research and development centres established by multinationals in recent years. Multinationals’ total incoming capital investment into China and India combined dwarfs the amount flowing into other emerging economies.

Moreover, the markets and operating environments of China and India are radically different from multinationals’ home markets, making possible a wide range of competitive encounters and outcomes. For example, both have several layers of product and customer segments that reward different approaches from competitors, making it possible for both local challengers and patient MNCs to find starting places and, over time, compete more directly as they migrate towards each other.

Finally, outbound foreign direct investment by Chinese and Indian companies, while much discussed, is still very limited relative to both the size of the targeted foreign markets and domestic gross fixed capital formation, and is focused on a few sectors (particularly energy and metals). In addition, recent outflows spiked with the global credit bubble, and are likely to fall sharply in the medium term. It is in the domestic market that most challengers are going head to head with established MNCs.

Industry influences

There is plenty of admiring discussion of specific Indian and Chinese companies, with India’s TCS, Infosys, and other software groups, and Haier, Pearl River Piano and Huawei from China cited repeatedly. But we want to go beyond this handful of examples to look more systematically at the unfolding competitive situation between MNCs and Indian and Chinese challengers.

Current business models of multinationals in China

Global brand leaders (e.g. Procter & Gamble, Kodak)
Come in on the strength of premium brands, then extend to lower price points and second- and third-tier cities. Build full organisations in China as brand businesses require the biggest presence.

Global networkers (e.g. Cummins, LG)
Establish China position in a high-performance part of the market. Source globally from a broad design and production network. China is not the only good place to produce standard products at low cost.

Hybrids (e.g. Li&Fung, Hon Hai)
Use China as production base, mainly keeping higher-value design and marketing at home while transferring the simpler of these tasks gradually to China.

Pure technology leaders (e.g. Tokyo Electron, Intel)
Leading position in China driven by unique technology. Very limited value added in China.

Service network builders (e.g. Otis Elevator, FedEx)
Global leaders establishing a China-wide service network that draws on global expertise and links. Capitalise on Chinese competitors’ inexperience in modern service mentality.

We have the most detailed data on these questions for MNC-Chinese company competition in China, covering 33 modern industries. Chinese companies occupy the top two or three spots in 10 of these industries in China, multinationals in 10 and overseas Chinese in three. In the other 10, leadership depends on the segment, with Chinese typically leading lower performance, lower price point segments and MNCs leading in higher performance, higher price point ones.

The type of industry matters. MNCs tend to dominate industries in which R&D and advertising represent relatively high percentages of sales, and Chinese companies tend to dominate in industries where these measures are low. The first type tends to move at relatively high speed – fast rates of new product introduction, frequent technological advances, escalating customer demands, or frequent refreshing of the brand message. Examples of companies and industries of this type include Applied Materials and Tokyo Electron in semi-conductor-making equipment; Apple and Sony in advanced consumer electronics; Procter & Gamble and L’Oréal in personal care products; and Coca-Cola and Pepsi in beverages. Furthermore, MNCs are generally not losing these positions and, in some cases, are strengthening them.

In contrast, Chinese companies tend to lead in slower-moving businesses where product capability and design change less often, broad distribution is critical, customer needs change less frequently, production cost is a high percentage of price, or factory capital-intensity is high. Examples include Pearl River and Beijing Xinghai in pianos; Sichuan Changhong, Konka and TCL in tube-type television sets; Mengniu and Yili in dairy products; and Haier and Rongsheng Kelon in home appliances. These Chinese leaders are the survivors of fast-growth rivalries with other Chinese producers, where the basis of competition has been price, product reliability, production capacity growth and distribution.

Similar patterns show up in the 10 industries where leading depends on segment characteristics. Advanced product segments such as, for example, clean, high-performance diesel engines, the latest generation of telecom switches, leading-edge food packaging equipment, upscale autos and so on are led by MNCs, while less advanced, older versions of products are led by Chinese producers.

While India was relatively open during colonial times, independence in 1947 brought a shift to self-sufficiency and socialism. It was only in 1991 that it re-opened to foreign competition, and even then in many respects to a lesser extent than China. It is, therefore, less ideal for observing the competitive outcomes of MNCs versus challengers. Nevertheless, data on 79 manufacturing industries in India show that in the years after India started to open up in the early 1990s, MNCs, as in China, performed better in faster-moving businesses and worse in slower-moving or capital-intensive commodity businesses.

Three elements of strategy leverage

There are, of course, exceptions to these tendencies, and in an article published in Harvard Business Review last November, we focused on deviations from the patterns described above. The three kinds of methods MNCs and emerging challengers use to tilt outcomes in their favour are: by aggressively moving into new, fast-growing segments; better managing the convergence in costs across advanced and emerging markets; and reworking the value chain. However, here we want to focus on the patterns described above, not least because they also show up in other emerging markets. More generally, R&D- and advertising-intensity are the most robust markers, across country markets, of MNC presence.

Based on this pattern, which we have termed the AAA triangle, there seems to be a simple way of looking at the evolving rivalry between MNCs and their challengers. Each type of company has radically different strengths and weaknesses of position based on where they come from, how they are managed, and the specific capabilities and business positions they have built.

MNCs typically start with advantages in terms of marketing and technological know-how; and they can circulate this know-how globally and adapt it to local markets. More broadly, MNCs can be characterised as starting with an advantage in aggregating or achieving cross-border economies of scale and scope on the basis of their market positions and broad experience with products, processes, advanced technologies, customers, channels, supplier networks, partners, regulators and so on across the world, as well as the generally greater resources available to them.

Local challengers, in contrast, often base their cross-border strategies on leading positions in large home markets and operations well-adapted to the local context, for example Haier and Huawei in China and Bharat Forge and Ranbaxy in India. These companies prevail at home by adapting to what are often severe domestic operating conditions – a large population of rural poor, weak distribution, unreliable suppliers, uneven infrastructure and so on. Reflecting their less developed home markets, these challengers tend to have fewer, more standardised product and service offerings, in contrast to established MNCs’ differing regional product lines and even brand positions.

The example of the Indian software companies, however, remind us that some challengers are born global rather than local; they start out by trying to project competitive advantages across borders, rather than domestically. The most likely source of cross-border advantage for any Chinese or Indian company at an early stage in its organisational development will be low costs at home, not just for workers, but for materials, construction and even spartan management practices – an arbitrage strategy.

These different starting positions translate into the three basic elements of strategy which we call the “AAA triangle” for companies engaging internationally:
■ Aggregation: overcoming differences across markets to achieve cross-border economies of scale and scope;
■ Adaptation: adjusting to differences in conditions to achieve greater local responsiveness;
■ Arbitrage: exploiting differences (for example, cost or product standards) as a source of value creation.

This way of thinking about sources of advantage in cross-border competition suggests a way of visualising MNC and challenger interactions.

Figure 1 visualises a race towards the middle or beyond, even though neither side is likely to give up entirely on its initial types of advantage. In this race, effective MNCs operating in India or China adapt to these unique environments and work to neutralise any cost disadvantages against local competitors. This takes organisational patience, attitude changes and considerable investment in these local markets. For example, P&G in China and Unilever in India have localised their managements, broadened product lines to address needs and driven deep into rural markets by creating new distribution channels. Ogilvy & Mather, the advertising agency, has partnered with the Communist Youth League of China for market research. And on the supply side, LG in India and Nokia in China have both used huge production scale and sophistication to level the cost playing field against local producers.

But the MNC must maintain aggregation as its primary strength against emerging challengers, whose evolution they have considerable power to influence. This means taking new products, technology, customer knowledge, sales propositions, brand management, upgraded employee skills and so on from one market to another. Innovation by MNCs is a major reason why lower cost does not always prevail. Great multinationals do not give up on earning price premiums in emerging markets.

In contrast, the typical challenger seeking a presence in the MNC’s home market or other markets where the MNC is present needs to build aggregation strength by developing deeper customer knowledge, local partnerships, global branding and so on. Another asset that has to be cultivated is corporate reputation, as illustrated by recent scandals ranging from Chinese dairy foods producer Sanlu’s tainted milk powder to Satyam Computer Service’s alleged $1bn fraud in India. Moreover, studies, such as the recent report by Transparency International, reveal that Chinese and Indian companies are perceived as most prone to pay bribes overseas. The scandals also highlight the need for professional management. Building up all these intangibles takes a great deal of time and money, and while acquisitions can help to substitute the latter for the former, the record to date illustrates that they also carry significant risks for novices.

Challengers must also move up the arbitrage ladder at home by upgrading its workers and value propositions, especially since the arbitrage opportunity at home is no longer reserved for domestic companies. Thus, in software services, western competitors such as IBM and Accenture have responded to the explosive profitability and growth of TCS, Infosys and other India-focused competitors by building up their own operations in India, lowering their costs as well as raising those of their competitors. TCS is responding effectively, increasing revenue per employee from less than $15,000 in 1990 to more than $50,000 today (and profit per employee from $2,000 to more than $10,000). This record reflects growing aggregation: emphasis on large projects, cross-selling “solutions” and integrated delivery to one worldwide service standard from a global network of delivery centres.

Challengers need to be careful in going head-to-head with MNCs. Thus, Ranbaxy, formerly India’s largest pharmaceutical company, got into trouble partly because its litigiousness cost it valuable collaborative opportunities with foreign pharma companies and, ironically, ultimately forced it into the arms of one of them. In other situations, the optimal response may not be to attack or to ally but to avoid established MNCs, at least in the short-to-medium run, by focusing on undeserved segments, such as Haier’s focus on compact refrigerators; or focusing on newer ones, as Huawei has done in broadband telephony; or focusing on emergent segments or industries, as Suzlon of India is doing in wind energy (although it is currently hobbled by product problems).

Some challengers are not looking to internationalise or have an attribute that renders aggregation unnecessary. For example, home-grown websites Baidu and Taobao displaced early multinational leaders Google and Ebay in China by cleverly adapting to local customer needs but are not likely to challenge outside China. And Russian energy group Gazprom does not need to operate outside Russia to retain its advantage.

The past as a prelude to the future

It would be a mistake to interpret rapid growth in China and India as a guarantee that companies from those countries will emerge in large numbers as full-fledged MNCs. Adaptation may be a tall order for MNCs, but aggregation for challengers is equally or more difficult. And in technology- and advertising-intensive industries, few challengers will make it and most of those will grow to look much like today’s multinationals.

There are two significant differences between today’s competitive situation between established and aspiring multinationals and a generation ago, when Japanese companies caught many western MNCs by surprise. First, the Chinese and Indian economies are not only big and growing but essentially open, with some notable exceptions, to MNCs. Even Indian politics has shifted to favour at least partial modernisation.

The other difference is the readiness of MNCs. Twenty-five years ago, they had ageing product lines, no quality programmes, no sense of emerging markets’ importance, and kept their rising management stars home. Today this has changed significantly, so that when Jeffrey Immelt, General Electric chief executive, said he was expecting 60 per cent of his revenue growth to come from emerging markets in the next 10 years, no one batted an eyelid.

Current recession and credit conditions do not change our findings. China and India will still grow while developed markets stand still or shrink, and emerging market currencies will most likely depreciate against developed market ones. But MNCs are now firmly embedded into China and India and enjoying these advantages. And their global balance sheets, cash flows and share prices will hold up better than those of challengers.

So we have our doubts about MNCs from emerging countries crowding out established ones. Instead, we see both types of companies as trying to move towards the centre of the AAA Triangle. We know the multinationals’ game plan. It has unquestionably sharpened and evolved over the years to take account of new markets, offshoring, partnering, 24/7 communications and so on, but it has not invented fundamentally new ways of being a multinational. Emerging market challengers do not appear to have found fundamentally new paths to becoming multinationals.

Cross-border advantage will continue to come in the three forms we have described, and the job of management will continue to be to emphasise a subset of them while doing an adequate job on the remainder through appropriate management of tensions and trade-offs. And while many challengers will not succeed (or will be bought out), the interplay between them and established MNCs is bound to be one of the more interesting competitive stories to unfold over the next few decades.

Pankaj Ghemawat is Anselmo Rubiralta professor of global strategy at Iese Business School and the author of ‘Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter’
pghemawat@iese.edu

Thomas M. Hout is visiting professor at the University of Hong Kong’s School of Business and fellow of the Center for Emerging Market Enterprise at the Fletcher School of Law and Diplomacy
Hout.Tom@bcg.com