This post first appeared in Forbes.
In the coming decades, the majority of the world's economic output and market growth will come from the emerging markets. Already, the seven largest emerging markets collectively contribute more to global output than do the G7 countries combined. That said, once one gets beneath the aggregate statistics, these emerging -- and dynamic -- markets are rife with inequities, bottlenecks and missing institutions.
The societies in each of the emerging markets face many economic challenges -- most of which have to do with the potential for fast growth being undermined by a lack of inclusive growth. This is a tension that global companies cannot ignore as they look to the emerging markets as the primary sources of growth in the coming years.
Under-investment in inclusive growth can pose a challenge to growth itself. The majority of citizens of the newly developing economic powerhouses do not have access to products and basic services we would take for granted in the industrialized world.
Consider some examples: more Indians have access to mobile phones than to toilets; Brazilians live in a country with an abundance of fresh water sources and yet many contend with crippling shortages; and only 20 percent of Indonesians have access to a bank account.
Emerging markets worth $30 trillion by 2025
In the meantime, annual consumption in the emerging markets is projected to be worth $30 trillion by 2025.This means an increased urgency for global companies to strategically invest in business innovations designed to be inclusive of the disadvantaged populations in these countries. Otherwise, much of the trillions of dollars worth of value offered by the emerging market consumer will remain trapped.
There are several reasons for global CEOs to be concerned. For one, there will be limits to the sustainability of growth, because not enough potential consumers will be pulled into the middle class, and supply chain and distribution bottlenecks will limit the capacity to deliver goods and services.
There is also a significant risk of political and social disruption because of the intensification of economic inequality. Recent protests from Brazil to Turkey to Thailand demonstrate the seriousness of these concerns. Gaps in the market will open the door to lower-cost local players that know the territory and could not only pre-empt the low end but also gain experience and move upmarket as well.
To pull off "inclusive innovation" requires a fundamental shift in mindset and operating tactics on the ground. Executives may have to put aside some of the core business principles handed down by courses on strategy designed for an earlier century.
Move beyond typical business class strategy
A typical business class considers strategy to be about making certain choices, namely where to play, how to win and how to organize. Thus far, the managerial mantra has been:
1. Choose where to play by picking the most attractive markets. Do not spread yourself too thin. Segment the market and focus resources on the most profitable segments.
2. Choose how to win by identifying the most attractive segments and use market power as leverage to extract the highest margins when negotiating with other industry participants.
3. Choose how to organize by focusing the company's activities on its core competencies.
Developing a strategy for inclusive innovation demands a significant departure from these principles. Consider some of the adjustments that a manager has to make.
First of all, there must be a willingness to play in less attractive markets. You must develop models to serve unprofitable consumers. Regardless of expectations for the "fortune at the bottom of the pyramid", for much of the manager's tenure these segments will not deliver returns that match those in the more profitable segments of the company's business. For the foreseeable timeframe, they will remain low-margin segments even in the best of possible scenarios.
Second, inclusion will require easing up on optimizing negotiating leverage. Otherwise, you will deter small entrepreneurs, smallholder farmers and other "low leverage" players from joining your value chain, as suppliers or distributors essential for operating in many emerging markets.
In other cases, optimizing negotiating leverage may force small players to accept disastrous terms in order to do business with you. The poor working conditions at Foxconn's electronics assembly plants in China and the Rana Plaza factory collapse in Bangladesh, which led to the deaths of over a thousand workers, are evidence of the risks inherent in driving deals with local suppliers that are asymmetrically advantageous to global players.
Traditional formula can lead to disaster
It is time for managers to recognize that in parts of the world where good governance, the rule of law, labor rights protections and building safety codes have not matured, applying the traditional "how to win" formula can lead to disaster. At best, it presents a serious business risk. If outsourced production happens on terms that are highly disadvantageous for the outsourcing suppliers, it creates conditions for a race to the bottom on environmental and working conditions, as suppliers attempt to recover margins wherever they can.
Third, an inclusive approach to business will require that the manager considers engaging in parts of the value chain that may be outside the organization's core competencies. This is because the company may have to step in to fill voids, both upstream and downstream, to ensure that its business operations can run and grow sustainably.
The company may have to develop creative solutions to fill in the gaps in its supply chain and distribution networks or provide technology transfers and capital to enable local entrepreneurs and NGOs. In some cases, companies have worked with local governments and businesses, as the agri-business giant Olam has done in Gabon to establish infrastructure and a special economic zone. In other cases companies have developed partnerships with other critical agencies to move into unfamiliar portions of the value chain. For example, Coca-Cola worked with the Gates Foundation and Technoserve to enable technology transfer and provide capital to farmers in Uganda and Kenya, to ensure local supplies of mango, passion fruit and other fruits for its juice products.
It is time to take another look at how we are preparing managers to do business in emerging markets. Business strategy needs to be re-thought and re-learned. If you remain trapped by axioms developed for twentieth century industrialized markets, you will suffer trapped value in the emerging opportunities of the twenty-first century.
Bhaskar Chakravorti is the Senior Associate Dean of International Business & Finance at The Fletcher School at Tufts University and the Founding Executive Director of Fletcher's Institute for Business in the Global Context. He is co-author of the study "Growth for Good or Good for Growth" and is grateful to Citi Foundation for supporting his research on inclusive business.