This article was first published in the May 2016 UK edition of Accounting and Business magazine.

The prolonged downturn in emerging market equities has not deterred companies in those markets from pursuing their relentless drive for growth and global market share. So powerful is this drive that McKinsey, the consultancy, confidently predicts that emerging market companies pose an existential threat to their developed market counterparts.

The success of emerging market companies will provide a powerful headwind to the revenues, market share and profits of developed market companies according to McKinsey’s analysis of 30,000 companies in its report Playing to win: the new global competition for corporate profits. In the US, the ratio of corporate profits to national income is now at its highest level since 1929 at 11.6%, double the level of 1990. McKinsey believes this is an all-time peak, with the rise of emerging market corporates – combined with technology advances and climbing labour costs – denting corporate profits.

The report argues that, as a result of their ownership structures, emerging market companies do not have profit maximisation as their top priority – they are often family-owned or partially state-owned. This allows them to reinvest their profits for growth and increase their global market share. Between 1999 and 2008, they returned only 39% of their earnings to shareholders via dividends, compared with 80% in the developed world. Their ownership structure also means they don’t have quarterly targets and can keep prices and margins low, further increasing sales and market share.

Faced with such powerful forces, are developed market companies doomed to a slow demise? Do they have any defence mechanisms at their disposal and, if so, how can they deploy them?

Natural advantages

Mark Mobius, fund manager at Franklin Templeton Investments, is not optimistic about their chances. He says that companies in developing regions also have natural advantages that those in developed markets cannot replicate.

‘Emerging market companies have experienced and overcome difficulties such as bureaucracy and corruption in their own countries, so they are able to adjust fairly easily to doing business in the West,’ he says. European and US companies, by contrast, have it relatively easy in their home markets, so find it hard to adjust to emerging markets: they experience language and cultural barriers, they may come up against corrupt practice, and they do not always find it easy to hire the right local talent.

In other words, emerging market companies can both grow their businesses abroad and comfortably defend their domestic position. As a result, turnover growth has been four to five times greater in emerging markets than in the West over the past decade. This is partly a result of the overseas success of emerging market companies – over the past decade, the 50 largest companies in the emerging markets have more than doubled the proportion of revenues they derive from overseas activities from 19% to 40%.

Not all this growth is organic. Emerging market companies have spent freely to buy rivals and complementary businesses in developed markets. David Wijeratne, head of PwC’s Growth Markets Centre, says M&A activity by emerging market companies is aimed not only at increasing revenues today, but also at creating structures that can continue increasing revenues deep into the future. ‘More than anything, they are buying capabilities to make their businesses as strong as their developed market counterparts,’ he says. ‘They are often not buying to directly increase market share but to learn how the businesses operate, and to leverage that.’

Developed market companies are also at a disadvantage from a technology standpoint. ‘Emerging market companies are good users of technology,’ says Mobius. ‘They have an advantage in that they can take technology that is already tried and tested in developed countries and leapfrog incumbent companies that have older and obsolete technology frameworks. Emerging market companies have a blank canvas.’

Try as they might, few developed market companies are able to fully re-engineer their technology enterprise-wide. The technological equivalent of ripping up the floorboards and pulling down the ceilings is just not healthy for ongoing business operations. 

Having the know-how

But all is not lost for developed market companies. They can build on their own natural advantages, says Wijeratne. ‘What a developed market company can bring is its business model – its know-how of running a business, of manufacturing techniques and of developing products.’

In trying to wrest back momentum from emerging market companies, they shouldn’t panic and seek to completely overhaul their models. ‘They are world leaders for a reason.’

Developed market companies must fight emerging market competitors on their own turf, he says. If the battle for global growth and market share is to be won and lost in emerging markets, then that’s where companies have to be.

To compete, they must establish clear goals. Many companies enter growth markets without a clear sense of what success will look like, says PwC. Management must decide if success is about attaining market share, achieving higher brand awareness among a certain demographic or, more prosaically, about growing revenue and profits.

CFOs take the lead

Once the goals are established, the CFO will usually take the lead in establishing the incremental investment that the company is willing to make to support the required innovation for the new market. Investment will be needed to develop and maintain market-specific brands and to find, vet and maintain relationships with local suppliers. Companies may also have to invest to disrupt the manufacturing and logistics processes that were originally designed for mature markets.

The finance team is important in a broader sense too, Wijeratne believes. For companies to adapt their operations for emerging markets, they need financial and governance support to make sure that they adhere to and benefit from local and domestic regulations and working practices. The benefits of new processes and products are frequently negated by a lack of fiscal structuring in a new growth market.

Creating an efficient fiscal and operating model in developing markets is complex and cannot be taken for granted. A straight ‘lift and shift’ of a developed market model is unlikely to prove successful, Wijeratne notes. However, over time, as emerging markets mature, trade liberalises and the operational imperatives to centralise emerge, the developed markets’ fiscal model can be adapted to fit the emerging market profile.

And so the fight back begins. The McKinsey report says incumbent industry leaders have to respond positively to the dangers – they cannot simply focus on ring fencing their existing markets. The report concludes: ‘Firms with vision, optimism and agility can realise enormous opportunities if they are willing to disrupt their own operations before some new challenger does it for them.’

Phil Davis, journalist