'Boats in a Rising River': The Challenges of a Hypergrowth Economy
It is no secret that the economies of India, China and other developing nations have been growing by leaps and bounds in recent years. Entrepreneurs have started small companies, small companies have gotten larger, more people have gotten better jobs, and many firms now find themselves playing key roles in the global economy. It sounds like a win-win for all involved.
While it is true that a growing economy is desirable, companies in economies experiencing hypergrowth face any number of tough challenges, which, if left unmet, could reduce the ability of firms wishing to take advantage of these markets, according to experts at Wharton. The challenges run the gamut from hiring practices and shifting corporate cultures to issues related to product quality and the environment.
Z. John Zhang, professor of marketing, calls hypergrowth a "mixed blessing" for companies -- a phrase that aptly sums up the views of all the Wharton faculty members interviewed by Knowledge@Wharton for this article. "Hypergrowth can be good or bad," says Zhang. "It can cause a lot of problems, but it offers a lot of promises, too."
Companies in a country undergoing tremendous economic growth are like "boats in a rising river," Zhang adds. "Without doing anything, all boats rise. Because you have a boat on the river, you don't really have to do anything elaborate -- in terms of strategy, employee training, all those things -- for your company to grow. When you are a company in a hypergrowth environment, you may also find that many opportunities will just present themselves -- opportunities not just in the business you’re already in, but also in businesses you can get into. That's what some companies in China are doing." For example, some Chinese manufacturers have branched out into hotels and tourism.
Daniel A. Levinthal, professor and chairperson of Wharton's management department, agrees. Broadly speaking, he says, companies in fast-growing economies feel "an impetus to seize opportunities and establish a position in a growing market. But at the same time, you have to be concerned with maintaining quality and the associated reputation of your company. Different organizations will have different challenges."
Other countries, of course, have experienced rapid growth in the past. Industrialization picked up steam in the late 19th century in the United States, and in a matter of a few decades, America was the world's most formidable economic power. But Levinthal says today's emerging economies probably have little to learn from the U.S. experience.
"With the development of railroads and so forth, you're talking about the formation of new industries at the beginning of the Industrial Age, whereas in the context of emergent economies, you're talking about rapid development of existing corporate forms and industries," Levinthal notes. "It's true that call centers in India are a somewhat new form of business, but it's not as if call centers hadn't existed already."
That makes the task of companies in emerging economies easier in some ways, according to Levinthal. Since businesses are already well defined -- whether the business is a call center or steel plant in India or an automobile or footwear facility in China -- firms have the advantage of not having to start completely from scratch. But Levinthal says this advantage may, at the same time, place more pressure on a company's hunger for rapid growth and heighten the chance of missteps simply because firms are moving too quickly without adequate planning. Such risks can emerge, for example, "if a domestic company is trying to achieve scale and efficiency before big foreign multinational entities arrive" to set up shop in the firm's home market.
There are other challenges. Zhang cites several, and notes that although they apply to China, they can also apply to other emerging economies. "Countries can face a rise in the cost of oil, commodities and other resources, especially in China and India. Labor costs also increase. In some parts of China the labor market is pretty tight, so you have to pay more to induce people to come to work for you."
Hypergrowth can also place stress on the economy in the form of inflation and income disparity. Inflation in China is running above 6%, says Zhang. Left unchecked, rising prices can cause "social instability." A third risk is environmental degradation. Land moved from agricultural production to industrial production has created major environmental problems in China. Another risk in go-go economies is an increased likelihood of corruption. "A lot of money is going to be put on the table -- or under the table," Zhang suggests.
When growth is running high, some firms and government officials may hunger for an even faster pace. Over time, people's expectations can run high and they risk being disappointed and angered. "It's like riding a bike," Zhang says. "You have to keep up a certain speed to be stable. But speed can be too fast, which can cause problems, too."
'Conflicts and Incompatible Decisions'
Peter Cappelli, management professor and director of Wharton's Center for Human Resources, says issues related to hiring and corporate culture are among the most difficult faced by companies in fast-growing economies. Cappelli, along with Wharton management professors Jitendra Singh and Michael Useem, is conducting a study of the 100 largest companies in India. The study has yet to be completed, but Cappelli notes that interviews with the CEOs of these companies have found that employment issues top their agenda. Their biggest concern: managing the cultures of their companies.
In addition to the usual hiring, retention and employee development issues -- which themselves are not easily dealt with in an atmosphere of fast growth -- Indian companies confront the associated problem of communicating to employees the firms' corporate cultures, according to Cappelli.
"You have people constantly churning and changing the culture of these firms," he explains. "The companies are growing so quickly that employees coming in at different times have entirely different experiences of what the companies are like." For example, Infosys, a giant information technology services concern in Bangalore, "was a different company when it employed 500 people versus the thousands it employs today. It has a huge training center to teach employees about the company."
Cappelli says the CEOs of the Indian firms he is studying take this issue seriously and meet regularly with employees to discuss and reinforce their cultures. The executives realize that getting employees to buy into the culture is a vital way to prepare them to make everyday decisions that are aligned with the company's values and goals. "Communicating and culture are important because the culture can [reinforce] company rules. If you don't manage culture, you have employees with a different sense of what the company's goals are. That means, informally, when nobody's watching them, you have employees doing things differently, which can result in conflicts and incompatible decisions. If you don't get people aligned, you need to have lots of and supervision, and that can get expensive."
Other human resources issues have arisen in India. "There seems to be a scarcity of middle-manager talent, people who are conversant in contemporary business methods and who are multilingual," according to Levinthal. "That supply is growing, but the increase in demand is exceeding the increase in supply. The challenge, if you are a call center, for instance, is whether you set up shop outside Hyderabad to tap new labor pools or find ways to make it easier for managers to relocate to your corporate center in Hyderabad. These firms tend to be located in areas where competitors are nearby, making it easier for your people to walk out the door for slightly better deals. Firms should offer people career paths as opposed to asking them to work on a contractual basis."
An 'Employability Gap'
Wharton management professor Saikat Chaudhuri says India is suffering from an "employability gap," especially in sectors like information technology and retailing. India produces plenty of university graduates, but many are not trained well enough to actually obtain and keep jobs.
"India is missing a lot of middle-management talent," says Chaudhuri. "You can find people at the high end, but not in the middle-management ranks. Technical people get promoted to project management in IT firms but don’t have the necessary skills to be able to interact with clients." So-called "finishing schools" have emerged in India to fill this gap, but Chaudhuri is not certain what the long-term solution might be. "I don't know if the answer is trade schools or programs in universities; probably a bit of both," he says.
Indian firms also have to work to find talented managers who can surmount problems associated with distributing their products and managing their supply chains. "Logistics is a bit of a stumbling block," Chaudhuri says. "Infrastructure beyond the cities is not that strong yet. This limits market possibilities. If you don’t have managerial expertise, those challenges are hard to handle. A lot of companies want people with broad experience, but that's going to be hard to achieve. It's easy to find people who have worked internationally and in local markets, but it's hard to find people who have done both who can bring both perspectives to the table. That’s the tricky part."
The Talent Hunt in China
Wharton management professors Witold Henisz and Marshall Meyer note that management shortages are also being felt in China.
Henisz, who attended the recent World Economic Forum meeting in Dalian, China, and spent time at a program for Wharton Executive MBA students in Shanghai, had an opportunity to hear Chinese managers discuss growth-related issues. "It was striking to me, hearing about the scarcity of highly trained, capable management in China," he recalls. "The executives were bemoaning finding people who could think creatively, who could fill top management positions."
Henisz says he heard such complaints from both multinational corporations operating in China and indigenous Chinese companies. Laments about a dearth of management talent are hardly new in China, but Henisz says he believes things are "getting worse. I started hearing noise about this a year or two ago, that human resource management was increasingly a determinant of success."
Meyer, who has visited China many times to conduct research, predicts that China will at some point move in the direction of a service-based economy, and in doing so will be even more in need of talented managers than it is today. One factor limiting the availability of managers is that fast growth in China's interior has made managers more reluctant to relocate to coastal China, which has for a long time been the engine of China's growth.
"Finding managerial talent is a bear," Meyer notes. "If you talk to any headhunters, they'll tell you they're constantly on the lookout for managerial talent -- even though there's a surfeit of university graduates in China. That's a big failure."
China's extraordinary growth has put some highly unusual pressure on companies because of the conflicting ways growth is viewed by the central government in Beijing and the provincial governments throughout the country. "It's a paradox," says Meyer. "The central government is trying to reign in growth and the provincial governments are trying to do the opposite."
Provincial governments are doing all they can to stimulate growth because local officials are rewarded for "growth at any cost," Meyer adds. The central government, by contrast, wants to slow the rate of growth because Beijing understands that China's growth has been extremely unbalanced, not just between urban and rural areas, where the GDP gap has grown substantially, or between coastal and inland regions, but also by sector. About 50% of China's GDP is in fixed-asset investment -- roads, bridges, real estate and factories -- while another 30% to 40% goes to exports. That means a surprisingly small proportion of China’s GDP, perhaps as little as 10%, goes to households as wages.
"China is an economy that's been driven by these fixed assets and exports, as distinct from household consumption," Meyer says. This poses a long-run sustainability problem: How many roads, tunnels and factories can China build? How much can they invest in real estate? Is there an upper limit to how much China can export before its trading partners get angry and take retaliatory steps in trade policy? So is China's hypergrowth sustainable? "My feeling," Meyer notes, "is many people in China believe it probably is not, especially at the central government level where they are trying to shift toward an economy driven more by household consumption."
Meyer predicts that, before long, new opportunities for growth in China will lie in the service sector. The reason: Households will begin to do more to drive growth and they will use their income to fund education, medical care and retirement -- which means business opportunities for doctors, dentists, private-university employees, financial-service providers and others. "Today, households are saving as much as they can for education, medical and pension expenses because China has no real pension system," Meyer says. "But if the central government, and government at all levels, can build a social safety net in terms of making medical care more affordable and creating a social security system, then household consumption should increase."
Boom and Bust in Latin America
Some emerging economies in Latin America have experienced fast growth, but their experience differs from that of India and China. For one thing, growth rates are not as high as those of India and China. Moreover, Latin American executives, given the region's history of economic volatility, know that busts can quickly follow booms.
Wharton management professor Gerald A. McDermott, who keeps a close eye on Argentina's economy, says that the country has enjoyed GDP growth of 7% to 8% annually the past four years. But, unlike their Chinese or Indian counterparts, a key challenge Argentina's executives face in coping with growth is determining whether it will be short-lived.
"The first thing you have to think about in Latin America -- at the country and industry level -- is what would make you believe that growth is sustainable at this rate, or is this going to be another boom-bust cycle," McDermott notes. "That’s the first thing that everybody in emerging markets looks for. Even in Argentina, investment rates are still low, relatively speaking, because to a certain degree, a lot of investors don’t have confidence, given the history of the country, that this is sustainable. Eight percent a year isn't a sustainable growth rate, but maybe 5% is."
In addition, says McDermott, there is the question of where a country stands along the growth cycle. "If you're coming from a pretty low rate of growth, there's a certain part of your growth cycle that can sustain a high rate of growth. Is the growth simply coming from a one-time shift in exchange rates or relative prices that will soon be used up, so to speak? The fear in Latin America -- especially in agricultural and commodities markets right now in Argentina, and to a certain degree in Brazil -- is that we're seeing a boom. The big question is at what point do businesses stop buying land and hiring workers? What's the size at which firms will be comfortable?"
Part of the answer is just simple business forecasting. But McDermott cautions that accurate forecasting can be made more difficult by any of several factors -- the business one is in, government policies, labor agreements and general economic stability. Often, economic uncertainty leads businesses to be complacent; they know that cash will roll in during the growth period and they will be satisfied with that. They are aware that investing in new plants, equipment or employee training is a dicey proposition given the possibility of an economic downturn. At the same time, they take the easy road by relying on cost cutting and cheap labor to provide growth.
One reason why companies in Argentina do not invest more in themselves is they fear their efforts will be undercut by the anti-business policies of the central government, says McDermott. "The current administration plays with the rules on a regular basis -- messing with tax rules and prices and accusing companies of doing dirty things -- in a way that creates a lot of uncertainty. The energy industry doesn't know if it should invest. They don’t want to because the administration is fighting them tooth and nail on every little thing. Part of that is general politics. So when you get into these growth cycles, you have to ask: 'Where does the administration stand? Are public policy leaders doing anything about investment and value creation?' If they aren't, companies will compete based on cost cutting and cheap labor. And when there's a bust, they will get rid of the employees."
McDermott says regional governments in places like Argentina need to work closely with companies to help them create more sophisticated, valued-added products that can be sold domestically and abroad for greater profits -- an idea that can be applied in many places, not just in Latin America. Such cooperation has occurred between the Argentine province of Mendoza and its wine industry. Mendoza and business associations jointly created an export promotion agency for wineries (and for other firms, too), says McDermott. Journalists and others with an interest in wine production were invited to Mendoza to visit vineyards where they learned about wine and overseas markets.
"The firm has to say to itself, 'I'm enjoying high growth right now because I’m making money off an existing strategy. How do I alter that strategy so that I can push myself up the value chain?' If you stay in low-value-added activities, you won't win."
Chaudhuri says Indian firms also need to meet that challenge. "In India, services have achieved high growth. Manufacturing is slowly catching on. But manufacturing won't realize its full potential on the low-end side. The agriculture sector has not grown recently. The only way to grow agriculture at 10% instead of 3% or 4% is to add value to your products: Instead of selling potatoes, you sell potato chips."
A number of states are promoting that approach by assisting small- and medium-sized enterprises in developing common production facilities to achieve economies of scale. Chaudhuri points out, for example, that the state of West Bengal has worked to beef up its traditional leather manufacturing industry in this way. In addition, the central government has set up a technology center to develop new applications for jute, a product long used to make bags but whose tensile strength also allows it to be used in road construction.
Moving to the Next Level
Perhaps the major challenge for firms that have basked in the glow of fast-developing economies is preparing to compete successfully in the global economy. Henisz says they must realize that making that transition will not be as simple as exploiting the economic growth of their home country. "Firms need to work to make that transition rather than taking it easy. They won't al survive the shakeout. They will have to be more sophisticated in things like financial control systems and building up their brands. Very few of these firms invest in brand building because the demand has just been there. But now, if you want to sell outside [your home country], you need brand and reputation."