Industrial Revolution 2.0

For a few minutes, I held the future in my hand. The third-generation cell phone in my palm made a BlackBerry look like a Model T Ford. Looking down at the color video screen, I could see the person on the other end of the line. The gadget, which fit easily into my pocket, could check local traffic, broadcast breaking television news, and play interactive computer games across continents. Internet and e-mail access were a foregone conclusion. So were downloading music and watching video clips.

None of this would be all that surprising were it not for where I was standing. I wasn’t visiting Apple Computers in Cupertino, California, or Nokia headquarters outside Helsinki. It was January 2005, and I was in Taiwan, standing in the research lab of High Tech Computer Corporation (HTC). The innovative Taiwanese company employs 1,100 research engineers, invented the iPAQ pocket organizer (which it sold to Hewlett-Packard), and developed a series of advanced handheld phones for companies such as Palm, Verizon, and Vodafone. All around me were young, smart, ambitious engineers. They represented the cream of the crop of Taiwanese universities with, in some cases, years of experience in international firms. They were hard at work testing everything from sound quality in a sophisticated acoustics studio to the scratch resistance of newly developed synthetic materials.

I was being shown not just the prototype of a new smart phone but the prototype of a new kind of company — savvy, global, and, most important, well ahead of its nearest competitors in the United States and Europe. My experience in Taiwan is not that unusual. From Asia to Latin America, companies that many still regard as "Third World" makers of cheap electronics or producers of raw materials are emerging as competitive firms capable of attaining world-class status. Only a decade ago, the attention of the international business community was focused on a new economy backed by hot tech firms in California and Tokyo. But the reality of the current global dynamic is that, more likely than not, the next Microsoft or General Electric will come from the "new economies" of Asia, Latin America, and Eastern Europe, not the United States, Europe, or Japan.

Today, emerging-market countries account for 85 percent of the world’s population but generate just 20 percent of global gross national product. By 2035, however, the combined economies of emerging markets will be larger than (and by the middle of this century, nearly double) the economies of the United States, Western Europe, or Japan. The reality of globalization — which is only slowly and reluctantly sinking in — is that outsourcing means more than having "cheap labor" toil away in mines, factories, and call centers on behalf of Western corporations. Yet in the West, business leaders and government officials cling to the notion that their companies lead the world in technology, design, and marketing prowess.

Increasingly, that just isn’t so. South Korea’s Samsung is now a better recognized brand than is Japan’s Sony. Its research and development budget is larger than that of America’s Intel. And its 2005 profits exceeded those of Dell, Motorola, Nokia, and Philips. Mexico’s CEMEX is now the largest cement company in the United States, the second largest in the United Kingdom, and the third largest in the world. The gas reserves of Russian giant Gazprom are larger than those of all the major oil companies combined, and its market capitalization — or total stock value — is larger than that of Microsoft. South Korean engineers are helping U.S. steel companies modernize their outdated plants. New proprietary drugs are being developed in Indian and Slovenian labs, where researchers are no longer content to turn out high volumes of low-cost generics for sale in the United States and Europe. New inventions in consumer electronics and wireless technology are moving from Asia to the United States and Europe, not just the other way around.

The growth in emerging-market companies has been nothing short of astounding. In 1988, there were just 20 companies in emerging markets with sales topping $1 billion. Last year, there were 270, including at least 38 with sales exceeding $10 billion. In 1981, the total value of all stocks listed on stock exchanges in emerging markets was $80 billion. That was less than the market capitalization of the largest emerging-market firm, Samsung, in 2005. Over the past quarter century, the total market capitalization of emerging markets as a group has risen to more than $5 trillion. Twenty-five years ago, portfolio investors had invested less than a few hundred-million dollars in emerging-market firms. Today, annual portfolio investment flows of more than $60 billion constitute the leading edge of a trend. Fifty-eight of the Fortune 500 top global corporations are from emerging markets, and many of them are more profitable than their peers in the West. The era of emerging-market companies being nothing more than unsophisticated makers of low-cost, low-tech products has ended.

LIFTING THE VEIL

Most people are blissfully unaware that companies from emerging markets already play a major part in their lives by making much of what they eat, drink, and wear. One reason that these new multinationals have flown below the radar of so many executives, as well as the general public, is that companies such as Taiwan-based Yue Yuen and Hon Hai remain deliberately hidden in the shadows. Even though Yue Yuen produces the actual shoes for Nike and Hon Hai makes much of what can be found inside Dell computers, Apple iPods, and Sony PlayStations, the bigger brands continue to control the distribution and marketing. When will they remove their veil? These firms’ prevailing invisibility — a conscious stealth strategy in some cases — does not mean that they are powerless, less profitable, or that they will be content to have a low profile forever. It won’t be long before the biggest companies you have never heard of become household names.

Companies like Samsung, LG, and Hyundai, all based in South Korea, began by making products efficiently and cheaply. Now, they have recognized brand names, a high-quality image, world-class technology, and appealing designs. China’s Haier, the country’s leading producer of household appliances, is following in their footsteps. In fact, it is already better known than GE, Sony, or Toyota by hundreds of millions of consumers in China, India, and other emerging markets. Firms such as Haier have not relied on big brand names to reach consumers in the United States and Europe. Instead, they used niche products such as small refrigerators and wine coolers to get their lines into big-box stores such as Wal-mart. And as time goes on, more emerging-market firms will overtake the long-established Western companies that they now supply.

That has already happened in a number of industries ranging from semiconductors to beer. Samsung now holds the No. 1 global market position not only in semiconductors used in hard disks and flash memory cards but also in flat-screen monitors used for computers and televisions. In 2004, China’s Lenovo purchased IBM’s ThinkPad brand. In a wholly different industry, Brazilian investment bankers merged domestic beer companies in 1999 and then swapped shares with Europe’s largest beer giant, Interbrew, to form a new entity that is now managed by a Brazilian CEO. Meanwhile, Corona beer, produced by Mexico’s Modelo, is now the leading imported beer brand in the United States. Elsewhere, the global supply chain is turning upside-down, with Western companies selling components and services to multinationals from emerging markets. GE, for instance, sells jet engines to Brazilian plane manufacturer Embraer. Other smart firms will soon follow suit. Just as the rise of the United States after the Industrial Revolution turned American companies from imitators into innovators, emerging-market multinationals will increasingly do the same.

For many of these firms, the road to success included weathering global financial crises. These economic shocks squeezed out many emerging-market companies. The ensuing Darwinian struggle for survival left only battle-hardened firms still standing. As newcomers, emerging multinationals had to fight for shelf space against preconceived notions of inferior product quality (a bias that wasn’t always without justification). When the financial crises were over, a few world-class companies had carved out leading roles. Today, more than 25 emerging-market multinationals have attained a leading global market share in their respective industries. Fifteen command the No. 1 market share — and they are no longer limited to a narrow slice of low-tech industries. The truth is, emerging multinationals now maintain dominant market positions in some of the world’s fastest-growing industries. Consider Samsung, which is the global market leader in flash memory cards used in iPods, cameras, and mobile phones. The memory card market was worth $370 million in 2000. This year, it is valued at $13 billion. In fact, more than half of all emerging-market companies of world-class status operate in capital-intensive or technology-oriented industries, where high rates of spending on research and development are required to remain competitive.

NOTHING TO LOSE

But the road to success has not been easy. Emerging-market multinationals did not succeed simply by following textbook practices and solutions. Contrary to popular belief, it is unconventional thinking, adaptability, a global mind-set, and disciplined ambition — not natural resources or the advantage of low-cost labor — that have been the crucial ingredients for their success. As newcomers, emerging-market firms could only wrestle away market share from deeply entrenched incumbents through audacious solutions. Their success hinged upon novel thinking that was widely ridiculed by competitors from the rich world. In many cases, emerging multinationals became successful only by following the opposite of tried and true textbook policies. Two of the best examples are Taiwan’s HTC and Argentina’s Tenaris.

By the 1990s, Taiwanese companies had carved out a leading position in notebook computers and various PC accessories. But they were way behind on smaller, more cutting-edge personal digital assistants (PDAs) and smart phones. Until 1997, that is, when a group of Taiwanese engineers got together and decided that the future was elsewhere. Instead of making knockoff organizers or cheap cell phones, the engineers at HTC designed the stylish iPAQ, the first PDA to challenge Palm’s unrivaled position. The iPAQ had elements that Palm and other manufacturers had studiously avoided — a Microsoft operating system, an Intel chip, and a Sony screen, all technologies that mobile companies had hitherto considered inferior. But HTC recognized that wireless technology would soon turn PDAs into pocket PCs, combining cell phones with e-mail and Internet access. That insight helped them land a contract to become the primary manufacturer of the Treo PDA and inspired them to embark on a leapfrogging effort by designing a whole series of versatile handhelds and smart phones that eventually became the chief Windows-based competitors of BlackBerry.

A similarly innovative approach was taken in Argentina by oil-pipe manufacturer Siderca. Realizing that government protection had led to technological mediocrity and a poor global image, Siderca CEO Paolo Rocca decided that global oil giants wanted more than top-quality pipes. They wanted suppliers that could react quickly to their needs anywhere in the world, able to deliver a pipe to a remote oil well in the middle of Nigeria on short notice. Siderca already had loose alliances with companies in Brazil, Italy, Japan, Mexico, and Romania. Rocca transformed this ad hoc group of companies into a well-oiled machine that was able to integrate researchers from far-flung subsidiaries to invent sophisticated pipes that were increasingly in demand for deep-ocean and arctic drilling operations. He also introduced high-tech systems that enabled the company to deliver its pipes "just in time" to the major oil companies, a feat that took leading, rich-world players such as Mannesmann several years to match. When Rocca was finished, the small "club" of traditional Western oil-pipe makers had lost its stranglehold on the market.

Other examples abound. Take Aracruz, in Brazil. The company used eucalyptus trees to make market pulp, even though it had generally been looked down upon before as "filler pulp" while the "real" pulp was made from slow-growing pine trees. In Mexico, CEMEX began a global acquisition spree by taking over two Spanish cement producers after it was locked out of the U.S. market by anti-dumping laws. The company’s CEO, Lorenzo Zambrano, says, "For Spaniards, the idea of a Mexican company coming to Spain and changing top management was unthinkable."

Superior execution and an obsession with quality are now hallmarks of virtually all of the world-class companies based in emerging markets. That has helped feed a mind-set in which emerging multinationals are no longer content with being viewed as leading Chinese, Korean, Mexican, or Taiwanese companies. They aspire to be global, and this aspiration is rapidly becoming a reality.

BACK TO THE FUTURE?

Those who recall the Cold War may be forgiven for entertaining a sense of déjà vu. The launch of Sputnik in 1957 prompted anxieties that the West was falling behind. Two decades later, the overwhelming success of Japanese firms Toyota and Sony resulted in alarmed cries that "the Japanese are winning." Similar calls, proclaiming that the Chinese and the Indians are winning, can be heard today. But those who speak of winners and losers are regarding the global economy as a zero-sum game. There is ample reason to believe that is not the case — not based on naïve internationalism, but on the well-justified belief that, in the current global economic order, both sides can come out ahead.

Many emerging multinationals are already owned by shareholders from all over the world. Foreign shareholders own 52 percent of Samsung, 71 percent of CEMEX, 57 percent of Hon Hai, and 54 percent of India-based Infosys. As a group, emerging multinationals can claim about 50 percent of their ownership as being foreign. Emerging multinationals are also becoming significant employers in the United States and Europe, as well as attractive prospective employers for business school graduates and scientists. More than 30,000 people in the United States and Europe work for CEMEX, many more than the company employs in Mexico. Its management meetings are conducted in English, because more than half of the firm’s employees do not speak Spanish. Hyundai just opened a plant in Alabama, creating 2,000 American jobs; its regional suppliers employ an additional 5,500 workers. Haier makes most of its refrigerators for the U.S. market at a plant in North Carolina.

Of course, the road ahead for these emerging-market winners will not be without setbacks. Motorola’s Razr cell phone has already helped the firm recover much of the ground it lost to Samsung. CEMEX’s aggressive acquisition strategy may have worked, but the takeover bids of other emerging multinationals have failed, including Haier’s bid to buy Maytag. Others have fallen flat, such as the Taiwanese company BenQ’s failure to turn around Germany’s Siemens Mobile. The very fact that the Latin and Asian financial crises are receding in memory and that new public offerings by Chinese and Russian companies are often oversubscribed could tempt these emerging competitors to rest on their laurels. An unexpected crisis or decline in China’s growth could deliver a blow to the economy that many consider the anchor of the developing world. And a growing list of innovative companies — such as Amazon, Apple, Google, Qualcomm, and Toyota, with its new hybrid car in Japan — reveals that the rich world’s creativity is far from dead.

Still, the larger trends are clear. In recent years, it has become apparent that the dominance of the United States as a superpower is resulting in its deepening dependence on foreign money, foreign resources, foreign professionals, and, increasingly, foreign technology. Only 25 years ago, most sophisticated investors scoffed at the notion of investing even a tiny portion of respectable retirement funds or endowments in developing-world companies. Just as the conventional wisdom then wrongly depicted emerging markets as "Third World," today it is all too common to underestimate the leading companies from these markets. Emerging markets now control the bulk of the world’s foreign exchange reserves and energy resources. They are growing faster than the United States and many European countries (and have been for decades). Most have budget and trade surpluses, and a few are even recognized as major economic powers.

Standing inside a research lab in China, South Korea, or Taiwan, it is painfully clear just how stymieing Western protectionism has been for Western companies. Such measures led to a false sense of security, a reluctance to streamline, and a lack of innovative thinking in industries ranging from steel and automobiles, to electronics and cement. As Western firms spent the 1980s and 90s protecting themselves from foreign exports, emerging multinationals built campuses of bright, young software engineers in India and incredibly efficient mining operations in Brazil and Chile. Instead of denying the new reality, the West must formulate a creative response to this global shift of power. That task is now the central economic challenge of our time.