Innovating for new purchasing power

Population in middle-class income bracket set to triple by 2030

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By Ernst & Young

Companies will need to change their strategic direction to capitalize on new demands from a fast-growing global middle class, particularly in emerging markets. And this will involve creating entirely new products and services if they are to truly innovate and grow.

These are the main recommendations from a new Ernst & Young report, ``Innovating for the next three billion: The rise of the global middle class,’’ based on a survey of 547 executives worldwide and in-depth interviews with some of world-leading entrepreneurs.

The survey highlights that the majority of companies from developed economies currently direct most of their energies and activities towards the premium end of the market in their main high-growth segments. Even among high-performing companies in these markets, that proportion remains as high as 40 percent.

This focus on luxury goods, however, will have to change.

With the new middle-income customers expected to grow by three billion by 2030, representing a growth in demand from $21 trillion to $56 trillion, the report identifies the capabilities necessary to innovate: customer insight, people culture, research and development (R&D) and operations and business model ― combining local relevance with global scale.

Ernst & Young Global Vice Chair for Strategic Growth Markets Maria Pinelli explains that there is a huge potential for middle-class consumerism in rapid-growth economies and the latest Ernst & Young report demonstrates the scale of opportunity for companies that develop innovative products.

``Companies need to think about fundamentally changing the way they work in order to take advantage of these changing demographics,’’ she says. ``By 2030, 40 percent of spending by the global middle class will take place in Asia, which compares to 10 percent currently.’’

Frugal innovation

Ernst & Young’s survey demonstrates that companies are at least beginning to innovate in these markets. More than three-quarters of the respondents think that adopting ``frugal innovation’’ ― economical use of resource to provide products affordable by those in a lower income ― is a major opportunity.

Companies with higher-than-average earnings before interest, taxes, depreciation, and amortization (EBITDA) growth seem more likely to recognize the scale of the opportunity, with 81 percent of the high performers thinking frugal innovation is a major opportunity, compared with 68 percent of those with lower EBITDA growth.

Pinelli emphasizes that companies ― regardless of market ― are currently missing a significant and increasingly important opportunity in developing economies and must bring products in line with the income distribution in rapid-growth markets. This requires a fundamental re-thinking of innovation and go-to-market strategies.

It’s no coincidence, she goes on to say, that those companies leading the way with innovation in rapid-growth markets are headquartered in those regions, where they have an advantage in generating ``frugal innovations,’’ or products and services that can be sold to the emergent middle class.

``Companies in rapid-growth markets have long operated under an environment where there is a shortage of resources and poor infrastructure and these constraints have forced them to be highly creative and entrepreneurial,’’ she said.

In conclusion, the report recommends four capabilities needed for companies to ``frugally’’ innovate for the next three billion consumers:

1. Customer insight: Successful innovation requires companies to get close to their customers and understand the problem that needs to be solved.

2. People and culture: Companies need to adopt a culture and mindset that are willing to tailor products to customers’ needs.

3. Research and development: A global network of R&D centers enables companies to leverage global resources and re-apply innovation across multiple markets.

4. Operations and business model, combining local relevance with global scale: Rapid product innovations are important, but equally as important is the need for companies to think about the business model and ensure that it is appropriate for a lower-income customer base.

Pinelli concludes: ``Each of the key capabilities identified comprises various components that are either local or global in nature. The key to success will be for companies to combine these local and global components to ensure that their products and services will be relevant to local customers, while still enabling the company to leverage global resources.’’

This article was contributed by Ernst & Young Korea.