On European Airlines

“A recession is when you have to tighten your belt; depression is when you have no belt to tighten. When you’ve lost your trousers – you’re in the airline business.” – Sir Adam Thomson, Founder British Caledonian Airways

A dash of wit or an instance of profound foresight, make of it as you wish but although the late Sir Thomson uttered those words back in 1984, their relevance remains true today. Historically the airline business is one that has seen more than its fair share of bankruptcies, bailouts and buyouts over the years. The market environment is unpredictable, the competition cut throat and cost structures ridiculously burdensome. However despite all of this, commercial air travel has been around for around 100 years and it seems that in all probability, the airline industry will be here to stay, in one form or another, far into to the foreseeable future. The question is though; in what form will commercial air travel continue to exist? Below follows an extract from a recent dissertation I wrote on the matter:

“I think historically, the airline business has not been run as a real business. That is, a business designed to achieve a return on capital that is then passed on to shareholders. It has historically been run as an extremely elaborate version of a model railroad, that is, one in which you try to make enough money to buy more equipment.” — Michael Levine, Executive VP Northwest Airlines, 1996.

According to a June 2013 press release by IATA, the International Air Transport Association, the return on capital in the airline industry for the 2004 – 2011 period is around 4.1%. Although an improvement over the previous period assessed from 1996 – 2004 of 3.8%, this is a rather poor return when compared to investing assets of similar risk in other industries. 7.5% being the average return on capital that investors would expect. (IATA 2013) Thus from a shareholder’s perspective, Mr Levine is quite correct in his assessment.

However, despite the industry’s poor return on capital, one area where the industry has created enormous value is in lowering the cost of air travel for passengers. Over the past 40 years, IATA reports that the cost of air transportation has more than halved. (IATA 2013) This was obtained as a direct result of better fuel efficiency on the part of aircraft and engine manufacturers as well as more streamlined utilisation of assets and infrastructure on the part of airlines. This is thanks no doubt in recent years to the emergence of LCCs.

Up until the early 1990s, Western Europe was the sole domain of the state-owned full service network carrier. A moderately growing market with an established status quo governing which airlines served which markets was the order of the day. The fall of the Berlin Wall, the end of protectionism and the opening up of the Western European market heralded an era of uncertainty for the originally dominant market players.

The appearance of Ryanair and then easyJet were a shock to the establishment with their cut-price policies, rapid expansion rates and unique value propositions. While their flamboyant CEOs snapped up the public lime-light with at times rather controversial proposals, to the average man in the street, it was now possible to book ridiculously low priced tickets for previously unheard of weekends away to exciting destinations such as Barcelona, Dublin or the Greek island of Pathos. Businesses started to send their managers on low cost airlines too for their meetings all over Europe, horrified by the fact that the Full Service Network Carriers might be over-charging them. Air travel in Western Europe had changed forever.

The Full Service Network Carriers, in response to this maddening competition shed jobs, dropped routes and went to great length to lower costs in general. In this cut throat environment some airlines were bailed out by their government shareholders while others listed on stock exchanges to get access to much needed capital. Many airlines merged or joined alliances while the rest, unable to compete any longer, simply closed down never to fly again.

Essentially two questions need to be asked:

• Low cost airlines, is their approach set to become the dominant business model of the aviation industry?
• Do Full Service Network Carriers need to adapt themselves more along the lines of Low Cost Carriers in order to remain competitive?

Addressing the first question, low cost airlines have a place in the future of aviation in Western Europe. They offer a service that adds value to certain passenger segments and, as long as they are able to keep growing, deliver reasonable value to shareholders too.

The key question for LCCs is growth. The onset of legacy costs and the general saturation of the Western European market at present will mean that the current dominant LCCs will be forced to look beyond their traditional airspace and start considering offering more flights to North Africa, the Middle East and Eastern Europe. The possibility of long haul flights should not be ruled out either. What could also be of use in capturing more passengers from the traditional long haul Full Service Network Carriers is for LCCs to consider providing through-baggage-check-in to enable passengers booked on a regional LCC flight to then plug into a full service carrier long haul flight. This move however, might be opposed by Full Service Network Carriers, unless the LCC forms part of that airline’s group of companies. (As is the case of Germanwings with Lufthansa and Vueling with Iberia and British Airways)

Regarding the second question, Full Service Network Carriers on the other hand have already changed their business models substantially to meet the LCC threat. In flight services in economy class are progressively more threadbare. Seating is tighter in an effort to squeeze in more passengers and the check-in process is starting to resemble that of the LCC online check-in systems.

It is only on long haul flights that the traditional Full Service Network Carriers are able to make money. This represents a defendable niche for their operations as the LCCs, at least in Western Europe, have deliberately avoided taking the Full Service Network Carriers on in this game.

Clearly both business models have changed over the years and unsurprisingly, in some aspects of the product offering, both models appear to be moving towards each other. The diagrams in Annexure 4 provide a nice illustration of this trend. The interesting thing is LCCs are becoming more like Full Service Network Carriers. As stated in a report by Sabre Airline Solutions, “This is mainly because price, although it is still a key competitive factor, it is no longer the only driver of their business strategy. LCCS are now starting to explore other areas such as multi-channel strategies” as a way of increasing revenues. (Sabre Report, 2013)

The logical end of the trend is the emergence of more hybrid-type carriers taking place. This will occur from both ends of the operating model spectrum – the LCCs by increasing their product offerings and the Full Service Network Carriers starting to provide more LCC services on short and medium haul routes.

This is the situation in Western Europe in general. There is one country though that stubbornly seems to be marching to a different beat in the face of the onslaught of the LCCs in recent years. That country is France. No more is the historical “French Exception” more apparent than in the aviation industry. France has the lowest number of LCC departures than any other country in Western Europe. The reason for this is twofold.

Firstly the stranglehold that Air France holds over the French market and secondly, more than ever, because of the prevalence of an extremely effective high speed train network within the country.

Regina Clewlow, an expert on Engineering Systems at the Massachusetts Institute of Technology, said in her paper, The Impact of High-speed Rail and Low-Cost Carriers on European Air Passenger Traffic, “the improvement of rail travel times was found to be a significant factor in reducing short-haul air traffic in Europe. Furthermore, analysis of demand at the airport level revealed that the presence of high-speed rail contributed to lower domestic air passenger traffic.” (Clewlow, 2013)

She then goes on to say, “While the introduction of high-speed rail has played a significant role reducing domestic air travel in Europe, over the same time period low-cost carriers have had a more significant influence increasing air travel, through primarily medium-haul, intra-EU rights. Considering both trends, the result has been a significant net gain in the total passenger-kilometres travelled in Western Europe.” (Clewlow, 2013) As new high speed rail networks continue to be built around Europe, domestic short-haul air travel traffic in the continent will come under more pressure.

Passengers will continue to benefit while the airline companies themselves will continue to suffer. As Warren Buffet in his 2008, annual letter to Berkshire Hathaway shareholders said, “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville down.”

On the German Economic Miracle and the Efficiency of Their Airports

Otto von Bismarck once said that “an appeal to fear never finds an echo in German hearts.” No more is this true than the economic powerhouse that Germany has developed into today. Having courageously risen phoenix-like out of the ashes of destruction from Second World War, the German industrial engine at the heart of Europe now plays a pivotal role in the EU and is a reference point for all those seeking an example of design, manufacturing and administrative excellence.

A few weeks ago I was privileged enough to attend a study tour with the MIB School of Management to the southern heartland of Germany – the mighty province of Bavaria. Never having been to Germany before, I was quite literally, bowled over. Allow me to cite two incredible examples of the trip that help illustrate my opinion:

Munich Airport

Of those passengers who have ever travelled through Munich Airport recently, many an eye-brow has been raised as to how quickly they are able to transfer from one flight to the next, while having a most pleasurable experience, and almost every time, their luggage follows them on to their final destination too! It may sound banal, but Munich Airport has worked this down to a fine and extremely efficient art.

As explained by Mr Wolfgan Martini, Deputy Head of Customer Services at Munich Airport, it is all about managing the airport as more than just a simple airport. It is about the seamless integration of international best practice – by being constantly aware of the latest developments in the industry, innovation, sustainability and attractiveness. Coupled with a determination to constantly strive to be the best airport in Europe, substantial support from all stakeholders and you have a winning formula for success.

The story of Munich Airport has been the constant evolution of the airport from a basic city-airport into a fully-fledged airport-city. In other words, more than just offering aviation related services such as flight handling facilities and passenger transfer terminals, an added emphasis has been placed on transforming the airport into a multi-function office and communication service centre so as to provide real value on multiple levels to a wide variety of potential users. Supporting this are extensive retail, dining, beauty and wellness services and last but not least is the use of the extensive airport facilities as a venue for events such as indoor surfing, polo tournaments, concerts and public viewing. All this creates not only value for the airport traveller but also provides an attraction for people living in Munich and its surrounding areas to visit the airport more often and to view the establishment as an integral part of social fabric of Bavaria.

One should bear in mind though that a fundamental pillar to any organisation which is determined to make a positive impact on society is growth. Without growth, all well wishes to sustainability, efficiency and being the number one airport in Europe is all pie-in-the-sky. Munich Airport plans to maintain its current passenger growth rate at a constant 6% while its cargo facility it will ramp up to 8% year on year till 2025. All of this is possible as a result of two major expansion projects – the construction of a new passenger island-terminal which will provide capacity for another 11 million passengers per annum and the addition of a third runway which will enable the airport to handle 120 aircraft movements per hour. A significant increase by any standard!

Lufthansa Munich

Last but not least is the special relationship that Munich Airport enjoys with Lufthansa, the German National Airline. As mentioned by Christoph Titze, Lufthansa Director of Passenger Services at Munich Airport, key to the success of the Munich Hub was Lufthansa’s decision to permanently base a significant portion of their fleet there and operate this detachment as an independent-like sub airline.

The majority of the Lufthansa fleet based in Munich is standardised around the Airbus model-range. This enables the use of only one type of aircraft-rated pilots and simplifies training and maintenance procedures, all resulting in significant cost savings. Furthermore, the use of code-sharing arrangements with the many Star Alliance partners who have been enticed to fly to Munich too, enable the airlines to more efficiently benefit from each other’s unique route offerings.

As a compliment to the efficient and pleasing Munich Airport environment, Lufthansa has also gone to great lengths to improve their own service offering. This is evident through the Lufthansa Service Excellence program which focuses on the following 5 points:

• We take care of you personally
• We respect your status and culture
• We ensure safety you can feel
• We show professionalism in appearance and performance
• We have an eye for details

This and special services for First and Business Class passengers such as curb-side check in services and limousine services, for regular passengers a self-check in facility and an internet notification system updating all passengers on the status of their flight (if it is delays or on schedule) all help guarantee a high level of customer satisfaction and all while leveraging off the benefits Munich Airport has to offer passengers too.

Conclusion

It is not just about the joining of synergies of two companies at the end of the day that has ensured the operations taking place at Munich Airport are a model for all to follow in the aviation industry. It is also about the Germanic desire for efficiency, order and the unrelenting quest to develop the German economy, in all respects.

Munich Airport and Lufthansa have helped to a significant extent in reinforcing the idea of a Germany at the heart of Europe. Or is it though a Germany that is in intent on controlling Europe by being the central pivot of the European continent? The latter is perhaps a topic of another essay but from whichever perspective you look at it, the German economic miracle, and the lessons one can learn from it, in today’s globalised world simply cannot be ignored.

(Picture source: http://www.airportsinternational.com)

Recombinant Innovation – about finding a solution from where you would least expect it

Can lessons learned in one industry can assist another industry? It seems so. Keeping with the theme of Open Innovation started in my previous post, I will now explore an example of perhaps one of the most fascinating examples of recombinant innovation. That is the application of Formula One pit stop disciplines to the hand over procedures of intensive care hospital patients during critical and complex surgery. Hard to believe? Well then read on to find out more!

It all started when surgeons at a childrens hospital in London became aware of the similarities between the handover disciplines from the operation theater after a complex heart surgery to the intensive care ward and what they noticed in the pit-stop of a Formula One team during race day. [1]

During the surgical hand over procedure, a bewildering array of technology and support equipment (ventilation, 2-4 monitoring lines, multiple inotropes and vasodilators) is transferred twice, all above the young patient’s head. First from the theater systems to portable equipment, and then from the portable equipment to the intensive care systems and it must all be accomplished within 15 minutes. In addition to this a further difficulty arises from the fact that the theater team during the course of the operation have acquired intimate knowledge of the patient while the intensive care team knows nothing about the patient at the time of transfer. All this information needs to be passed over seamlessly to ensure proper care can be provided to the vulnerable patient. It is this combination of complex, time critical tasks that make this process extremely susceptible to error at a time when the patient is at their most vulnerable. [2]

A Formula 1 pit-stop has been viewed by many experts as an ideal example of how a multi-professional team cooperates as a single unit to effectively and efficiently perform a complex task under extreme time pressure. During the approximately 7 second pit-stop, the crew have to change four tyres, refuel the car and if required, make a number of small adjustments to the set-up of the vehicle.

The similarities between the stresses and objectives of the two scenarios are evident. Not only are there requirements for teamwork and safety but also for split second coordination under decisive leadership and direction for all team members should something go wrong.

By working together with the pit crew of the Ferrari Formula One team and their Race Technical Director Nigel Stepney and applying the established procedures from Formula One, the hospital surgeons were able to significantly improve the hand-over procedure and dramatically reduce the number of information omissions and technical errors.

Below is a diagrammatic comparison between a Formula One pit stop and Open Heart Surgery team member positions. As can be appreciated, the implementation of the Formula One Approach was a resounding success resulting in many young lives being saved.

Who knows in how many other industries there are examples to learned from and applied in many completely different situations? One thing is for certain though, we are just beginning to scratch the surface of the potential that Recombinant Innovation has to offer.

References:

1 – http://www.doorsofperception.com/social-innovation/recombinant-innovation/

2 – Patient handover from surgery to intensive care: using Formula 1 pit-stop and aviation models to improve safety and quality – KEN R. CATCHPOLE PhD, MARC R. DE LEVAL MD, ANGUS MCEWAN FRCA, NICK PIGOTT FRCPCH§, MARTIN J. ELLIOTT MD, FRCS–, ANNETTE MCQUILLAN BSC, CAROL MACDONALD BSC AND ALLAN J . GOLDMAN – Paediatric Anaesthesia 2007 17: 470–478

Open Innovation – a case of overcoming the Not-Sold-Here Syndrome

It can be argued that the Not-Sold-Here Syndrome is perhaps one of the biggest obstacles facing new product development in companies today. Stifling innovation, clipping brilliant new ideas in the bud and restraining progress are just some of the implications of such a mindset. If these prejudices had not been overcome, a number of great products would not have made it off the drawing board. As a case in point is the Smart Car.

Love it or hate, it almost every motorist today has seen an example of the Smart Car on the road. An iconic and extremely fuel efficient two seat micro-car that has come to embody one of the most drastic steps ever taken in automotive history – that of a watch manufacturer setting out to revolutionise the world of motoring.

It all started in the 1980s when Nicolas Hayek, the engineer and industrialist who founded the Swiss watch company, had the brilliant idea to develop a new car using the same type of manufacturing strategies and personalization features he had used for the then incredibly fashionable Swatch watches. However he did not have in mind just any type of car; he felt that the car industry had largely ignored a very popular sector – that of a small and stylish city car that would have the fuel economy of around 3 litres per 100 kilometres with practicality and safety to match. 

Although Swatch Group initially began to develop the car themselves, Nicolas believed that established motor manufacturers would feel threatened by his Swatchmobile, as it was now called, and as a result began to look around for a potential partner. In 1991 an agreement was reached with Volkswagen to share the development of the new project. Not only would this help relieve the cost burden on Swatch but it would also enable the new product to leverage off the automotive manufacturing know-how of Volkswagen as well as eventually benefiting from an established selling and distribution network when the Swatchmobile was eventually brought to market. [1]

Unfortunately this arrangement did not last long. In 1993 a new CEO at Volkswagen brought down the axe on the joint venture in order to develop Volkswagen’s own subcompact car, the Lupo. This was because it was believed by the powers that be to be a better business proposition, featuring four seats and more cargo room. [1]

Thus left in the lurch, Swatch was forced to look around again for another partner. Rejected by BMW, Fiat, General Motors and Renault, it was eventually Mercedes Benz, (then Daimler-Chrysler) with whom Swatch teamed up. Not only did it prove to be the saving grace of the Swatch project and the partnership that eventually brought the car to market, this partnership was a very drastic move on the part of Mercedes, as the company was traditionally known for its C, E and S class luxury saloons and coupes. As one of the most premium brands on the market, venturing into the sub-city car class could be a rather risky move. One can only think how such an idea was opposed in the company’s boardroom by more traditional directors possibly claiming that the car was “not one to be sold here.”

Never the less, the two companies prevailed and the Smart car took the market by storm in late 1998. Still in production today, albeit in only slightly modified form, its popularity has skyrocketed in the face of rising fuel prices and city traffic jams. Involvement in the project even helped channel Mercedes thinking along the lines of developing the successful A-class – which to a degree is a big brother of the tiny Smart. In the end, it proved to be a very smart move by both Swatch and Mercedes.

References:

1 – http://en.wikipedia.org/wiki/Smart_%28automobile%29

 http://www.treehugger.com/cars/smart-car-how-smart-is-it.html

Choice

Today at the MIB School of Management during a course on Cross Cultural Communication in Marketing (by Prof Irena Vida), we were presented with the following video:

It was a TED Talk by Sheen Iyengar, a Columbia University professor on the subject of choice. She asks a number of fascinating questions and provides some interesting answers. Some of the questions are given as examples below:

• Is the desire for choice innate or created by culture?
• Why do we sometimes choose against our best interests?
• How much control do we really have over what we choose?

Fascinating and thought-provoking questions that I am sure not many of us have dared ask ourselves. Let me take it one step further which our Professor presented. In 1725 a chart, the so-called Volkertafel of European stereotypes was published in Germany. The aim of this publication, be it humorous or otherwise, was to be a reference point for the characteristics of the various principal European nationalities.

Allow me to provide some translations. For French man, it says that their science is war, their love is war, their past-time is to stab each-other in the back and their lives end in war.

Looking at another example but with all the nationalities together, they love the following:
Spain: Rum
France: War
Walloon: Gold
Germans: Drink
English: Lust/Sex
Swedes: Delicious Food
Pole: the Nobility/Royalty
Hungarian: Plotting/Sedition
Turks/Greeks: Themselves

In hindsight we know that these are absolutely ridiculous assumptions, but at the time they were probably widespread at the time. The joke of the matter is, things are little better today. The Greeks are lazy, the Spanish don’t work, the Italians are more interested in chasing women and the Germans are forced to foot the bill to bail out Europe. However the question is, in the light of this and coupled with what Professor Iyengar said, do we expect other people to make decisions too based on our assumptions of their characteristics?

In all probability, yes. And this is perhaps where a lot of misunderstanding comes in between different cultures. We just have to think back to the drama that is still been played out in Europe today in the aftermath of the Financial Crises. With the discredited austerity measures been imposed without mercy on many European economies, the “bail-out” and now “bail-in” programs with their  ruthless conditions cutting into any hopes of a decent economic recovery coming anytime soon, one can not help thinking how the various assumptions about choice that we instinctively make effected the outcome of the “rescue” process imposed on the South of Europe.

Taking it one step further, able to move more money at the click of a mouse than some governments of the world have at their disposal, what if a rogue trader or a financial institution accidentally decided to rely on false perceptions and mistaken choice and as a result make a catastrophic decision that caused a country to default on its sovereign debt, with all the consequences for the fate of millions of people’s savings tied in as a result? Or maybe North Korea launching a missile by mistake or the Americans giving the go-ahead for a preemptive cruise missile strike to avoid just that too? Not the kind of outcome any sane person would want to live out.

It boggles the mind just how much rests on choice and the assumptions that come with it. That simple selection that goes on in our mind is the fulcrum on which history and our lives pivot. Let us hope that those who have the power to make such choices are able to exercise due discretion and that we are able to exercise suitable responsibility ourselves in our own lives too.

How emerging markets “emerge” to become developed markets.

A lot has been said about emerging markets in the financial press as of late. With the recent BRICS Conference in Durban recently concluded, the eyes (and dare we say expectations) of the world are now on emerging market economies to start to flex their financial muscle and perhaps one day become the future economic engines of the world. No more might it be that “when America sneezes, the rest of the world catches a cold.” Indeed we might see very soon that when the Russian Bear shivers or the Chinese Consumer marches does the rest of the world tremble and await the outcome. In the light of this one may then ask, how is it that emerging markets “emerge” to become developed markets? This essay hopes to answer that question.

Let us start with a definition of what an emerging market is. It is generally accepted that emerging markets are nations which are in the process of rapid growth and industrialisation. However looking at things from another angle the economist Dr. Vladimir Kvint of the Russian Academy of Sciences published this definition: ” An emerging market country is a society transitioning from a dictatorship to a free-market-oriented-economy, with increasing economic freedom, gradual integration with the Global Marketplace and with other members of the Global Emerging Market, an expanding middle class, improving standards of living, social stability and tolerance, as well as an increase in cooperation with multilateral institutions” [1] As to which nations fit this list is open to question and whether or not that country need to have been ruled by a dictator is a matter of debate but suffice it to say that the above two definitions are enough to give the reader a fair idea as to what an emerging market is.

Now let us define what is a developed market. Although there is no fixed definition either for a developed market, it generally refers to a country which has a relatively high level of economic growth and development along with a high level of industrialisation and developed infrastructure, a high living standard and GPD per capita, and free and well developed financial markets. Examples of this would be Australia, France, Germany, Italy, Japan, USA, UK and Switzerland. So how emerging markets “emerge” then? Emerging Markets are starting to catch up with developed markets, mostly as a result of their higher growth rate. (See picture) Thanks no doubt to their higher than average population growth, sustained economic development and a growing middle class – resulting in increased economic opportunities for all concerned in these markets.

Ernst & Young published an article in 2011 which confirms this potential, “Most of the world’s new middle class will live in the emerging world, and almost all will live in cities, often in smaller cities not yet built. This surge of urbanization will stimulate business but put huge strains on infrastructure. Physical infrastructure, such as water supply, sanitation and electricity systems, will need to be built or upgraded to cope with the growing urban middle class. Addressing such concerns in Asia alone will require an estimated US$7.5 trillion in investments by 2020.” [3]

Clearly the numbers involved are staggering by any standard. As Simon Johnson of the IMF reported, “Over the past five years, these (emerging economy) countries have accounted for between one-quarter and one-half of global growth (depending on how it is measured). They have also weathered the recent global financial disturbance well and, through growing financial and trade linkages, have helped keep advanced economies from slowing down. And, now, the way emerging markets handle the latest round of inflation challenges will have profound effects on growth and inflation around the world.” [2] Emerging markets are clearly beginning to play an increasing role in the world economy and the interesting thing is this view was expressed just as the financial crisis of 2008/2009 was unravelling. So how did the emerging economies rise to prominence? According to the IMF it seems to be the result of three factors: [2]

1. Although emerging markets are highly connected to the world in terms of goods flows, they are not (yet) fully connected in terms of financial flows – this had a protective effect during the recent financial crises as the emerging market banks tended to be more cautious after burning their fingers in years gone by. As a result they were not significantly exposed to US subprime mortgages and other financial derivatives that proved problematic during this period thus ring fencing their balance sheets from any significant write-downs.
2. Emerging markets have continued to maintain sound economic policies – the authorities in these countries seem to be learning from their lessons and unlike during some previous booms, they did not throw fiscal caution to the wind. Furthermore attempts have been made to reign in corruption which has had a positive effect.
3. Global trade remains strong and so-called south-south trade (not involving advanced economies) has proved resilient. – Countries understood that throwing up trade barriers can hurt them more in the long run and this enabled the free flow of goods to continue unabated.

So in conclusion, clearly emerging markets are on the rise, but this is not necessarily likely for all countries that fit this category. For example China and India, despite having seen spectacular GDP growth in recent years, are faced with great social imbalances that could spoil their continued rise – uneven distribution of wealth, unsustainable population levels and finite resources will all have their role to play in the near future. Just as the Asian Financial Crises illustrated in the early 1990s, growth does not last forever and sooner or later a level of equilibrium will have to reset market conditions. As, when and where that will happen though, is still to be seen.

References:

1. The Global Emerging Market: Strategic Management and Economics – Kvint, Vladimir (2009) – January 2009 – ISBN-13: 9780415988407; ISBN: 0415988403
2. Straight Talk: Emerging Markets Emerge – Simon Johnson – Finance and Development Magazine – September 2008, Volume 45, Number 3
3. Tracking Global Trends – How 6 key developments are shaping our business world – Ernst & Young – 2011 – EYG No. DK0061

Picture Source:

The Economist: www.economist.com /blogs/dailychart/2011/08/emerging-vs-developed-economies Date: 9 March 2013 Time: 16:30 UTC +2

Is the Prisoner’s Dilema holding markets hostage?

Let us take a look at the following simple game:

There are four players. Each player has two cards he can play – green and yellow.

• If all four players play green, they all get three points.
• If three play green and one yellow, one point goes to the each of the green card players and five points goes to the person who played yellow.
• If two play green and two play yellow, no points for anyone.
• If one plays green and three play yellow, zero points to the green player and one point for each of the yellow players.
• If they all play yellow, two points each.

Clearly the most obvious thing to do is for all the players to co-operate and play green. In that way they are all better off and no-one loses out. The thing is though, this is only possible if all the parties are able to communicate with each other.

If we assume that the players are unable to communicate with each other, it is not necessarily clear what is the safest option to go for. All players would like to be better off, but what if there is the suspicion that one player might decide to play a yellow when everyone else is thinking green? One might then be tempted to play a yellow card instead so as to hedge the risk of losing out and thus nullify the effect of the yellow card move.

The question is though, is the attempt to minimise risk on an individual basis resulting in  a lower amount of benefits been available to the whole group? Is seems so. Take a look at attached picture for a multiple round game. It appears as if a large set of the potential benefit for the group as a whole is been lost thanks to the hedging strategy.

Food for thought. So would it be unreasonable to conclude that the lack of communication between market players and attempts to act in one’s own best interest might not be so good for the group in the long run? It seems not.

 

The Invisible Hand – 60 Second Adventures in Economics (1/6)

A most entertaining and concise video explaining Adam Smith’s famous Invisible Hand. Compiled by the Open University.

On examining the challenges of developing products and services for emerging markets

Challenges in developing products and services for emerging markets

Many first world companies have been lured to emerging markets by the promise of easy profits from selling low-end products and services to the so called “bottom of the pyramid” of society. One of the reasons is the belief that they will be able to sell their low-end products and services in high volume. The other reason for companies to follow this approach is that most high-end products and services are supposedly already widely available in these markets for the few who can already afford such luxuries.

Despite this supposedly grand opportunity to exploit untapped demand, a fair number of western companies are experiencing stiff challenges in entering emerging markets. The reason, according to Eyring, Johnson and Nair in their article New Business in Emerging Markets is as follows: Companies have “struggled not because they can’t create viable offerings but because they get their business model wrong.” Simply adapting techniques and products that are successful in developed countries is not enough to ensure success. In other words the same product, just downgraded does not equal profits and success in emerging markets. [7]

The emerging market consumer is looking for something that is tailor made to his very specific and unique requirements which exist under conditions that do not exist in the developed world. For example the sms cell-phone based money transfer facility that is widely used in Africa now days was developed out of the basic need for people to send money home safely and make payments on microloans without having to travel to the nearest bank branch which in some parts of the country could be hundreds of kilometres away.

This is all in the context of very different cultural, political, legal and financial circumstances, not to mention logistical, with respect to the first world.

Steps companies need to take to achieve this

When a company from the developed world takes the decision to enter into an emerging market economy, the best strategy to adopt is one that a typical start-up company would take: instead of looking for more outlets to offer the same product or service that are currently been offered in the emerging market, they should rather focus on identifying and addressing the “unmet needs” of that market. In other words, the company that can address the unmet needs of the emerging market profitably is in the best position to ensure success. Such unmet needs may not only be in the product or service range, but also pricing, distribution and marketing.

This is what the authors of the article cited above call “starting in the middle.” It involves focusing on two areas of the customer value proposition: [7]

1)      Affordability – offer something that is cheap and gives the best value for money. (For example the Tata Nano car)

2)      Access – the product must be easily accessible by people in remote areas (The reason why the cell phone payments system described above works and creates value)

Looking at the argument from another angle, a recent report by Accenture Consulting on Emerging-markets Product Development and Innovation highlights four essential challenges that a firm must meet in order to develop competitive products for emerging markets: [8]

1. Defendable Niche – companies must have a clear and distinct emerging market strategy and operating model. This must be linked to their long term corporate strategy and specifically drawn up to take on the unique characteristics of emerging markets.
2. Talent Pool – the talent already present in emerging markets should be employed to develop products and services that are unique to the emerging market environment. People in emerging countries already know their environment. As a result they are best positioned to come up with ideas to solve their specific needs. [9]
3. Cost Advantage – Emerging markets generally have a cost advantage over the developed world. The advantage of operating in a low cost environment is obvious but cognisance should be taken of the fact that quality must still be adhered too.
4. Differentiated products – innovation must be built on the specific and relevant values of the market; adapted specifically for local needs, cultures, social and economic preferences and conditions [9]

Concluding remarks

The authors of the Accenture article above go on to say that given the generally unique and un-homogenous nature of emerging markets and although there is a temptation to focus on the so called bottom of the pyramid, it would be prudent for firms to also keep a look out for opportunities in other segments as well. Although the bottom of the pyramid is always looking for a no-frills basic functional product to meet their needs, there is also a growing and upwardly mobile class in emerging markets which is a tempting attraction to the exclusive luxury goods and fashion houses. This sector too presents a fantastic opportunity for growth but products should be adapted to meet local requirements such as cultural norms, heritage and lifestyle. [8]

What is also imperative for companies working in emerging markets to bear in mind is the need to pay careful attention to how the market reacts to the product and to be flexible in adjusting the product or service to market demands. Thus considerations and approaching business with an open mind are fundamental when working in emerging markets.

Sources:

7 – Matthew J. Eyring, Mark W. Johnson, and Hari Nair (January 2011) New Business Models in Emerging Markets, Harvard Business Review, Page 3 & 5, R1101E

8 – Ana Mundim, Mitali Sharma, Praveen Arora and Ryan McManus (2012) Emerging-markets Product Development and Innovation – A new competitive reality, Accenture Consulting, Page 10 & 11, 11-2282 / 11-4602

9 – http://experientia.com/perspectives/designing-for-emerging-markets/   Date of access: 26 December 2012 Time of access: 08:31 (GMT + 2)