International Strategy: Reverse Innovation - Literature review Example

International Strategy: Reverse Innovation Introduction With the rise of globalisation and liberalisation of economic policies across most countriesin emerging markets, western companies started targeting emerging markets in order to drive business growth and use low cost labour of these markets in order to reduce cost of operation (Govindarajan and Trimble, 2012). In such context, Govindarajan and Ramanurti (2011) proposed an alternate concept named as ‘Reverse Innovation’ that can help companies to drive financial and non-financial growth in a more sustainable manner. Due to theoretical and empirical depth of the topic ‘Reverse Innovation’, the objective of this essay will be to critically assess the impact of ‘reverse innovation’ on sustainable economic growth for both Emerging Nations Multinational Enterprises (EMNEs) and Developed Nations Multinational Enterprises (DMNEs). In order to put structure in the discussion, the essay will focus on answering three questions. Discussion With the rise of zero-cost or low cost reverse innovation, a question arises on whether EMNCs present some challenges for DMNCs or not. To answer the question, one has to consider resource based view (RBV) theory proposed by Barney (1991) and also needs to understand the concept of ‘dynamic capability’ proposed by Eisenhardt and Martin (2000) and O’Reilly and Tushman (2008). Eisenhardt and Martin (2000) defined dynamic capabilities as set of identifiable and specific processes such as establishing partnership, strategic decision making, product development etc. The term product development of dynamic capability is directly linked with reverse innovation or traditional innovation. To achieve innovation or reverse innovation, firms need to integrate knowledge capital which is a VRIN (valuable, rare, inimitable and non-substitutable) resource for companies Kogut and Zander, 1992). In such context, Porter and Siggelkow (2008) argued that firms need to achieve sustainable competitive advantage in order to protect its market leadership position. In such context, Govindarajan and Trimble (2012) pointed out that DMNEs need to use knowledge as strategic resources and low cost infrastructure, low cost human capital, low cost supply sources etc in order to achieve reverse innovation. Govindarajan and Trimble (2012) and Govindarajan and Ramanurti (2011) gave five reasons for understanding how EMNCs present challenges for DMNCs when it comes to achieve competitive advantage through innovation. Reason 1 (Performance) - due to low income, emerging market customers are ready to make sacrifices in terms of product performance. For example, through reverse innovation, EMNEs are offering 50% of solution at 85% less cost such Nokia cell phones for India priced between US$25 to US$35. With traditional innovation in high priced developed countries, DMNCs are unable cope with price sensitivity of customers in emerging market and loose opportunity to penetrate (Govindarajan and Ramanurti, 2011). Reason 2 (Infrastructure) - people in poor countries prefer solutions not depending on reliable infrastructure while EMNEs can adopt cutting edge innovation through copying. As a result, EMNCs become able to adopt reverse innovation low cost manner while DMNCs are struggling to decrease value chain cost due to high price infrastructure requirements. For example, portable battery-powered electrocardiogram machines are being innovated in South Asian emerging countries plagued with electric power supply shortage (Govindarajan and Trimble, 2012). Reason 3 (Sustainability)- due to over population and shrinking of natural resources, sustainability challenges for poor & emerging countries are much deeper than developed countries. Therefore, it becomes difficult for DMNCs to meet the meet the critical environmental solutions requirement of people in emerging countries. On the other hand, EMNCs are aware with the local condition and they use local low cost resources to develop sustainable products that can even be used in developed countries. For example, Electric cars in China are example of reverse innovation and the car is being used even in developed nation. Reason 4 (Regulatory) - in case of emerging market, regulatory system and legal procedure is under developed and as result it waiting time for EMNCs to launch new innovation gets decreased in comparison to DMNCs. As part of reverse innovation, EMNCs use the regulatory loopholes in home country to launch new products which might not get approved in western market due to stringent regulatory control. For example, Pharmaceutical companies from Brazil, Indonesia and China etc are innovating new drugs more frequently than Pharmaceutical companies in countries like Germany, USA and UK etc due to less regulatory hurdles (Govindarajan and Trimble, 2012). Reason 5 (Preferences) - each of the emerging countries are blended with different cultures, preferences and traditional values. Therefore, without having in depth knowledge of local cultures, it becomes difficult for DMNCs to innovate new products that can satisfy local cultural requirements. Through reverse innovation, EMNCs customize the innovation as par local requirements. For example, low cost paper-based diagnostic tests (chemicals embedded paper is being used the paper changes colour when in contact with urine, sweat or saliva) being innovated in emerging market but now the product is being adopted in USA in the name of ‘Diagnostics For All’. Another example is that PepsiCo which has started developing soft drinks based on lentils for particular countries in emerging market but the product is being appreciated in developed nations (Govindarajan and Trimble, 2012). These five reasons are explaining how reverse innovation has empowered EMNCs to throw challenges to DMNCs. In such context, Govindarajan and Ramanurti (2011) pointed out that market leadership position DMNCs can be threatened by EMNCs through reverse innovation. However, DMNCs can respond to the challenges and retain competitive position in two way manner such as through ‘‘marginalized market’ or through ‘‘mainstream market’’. Response 1 (Marginalized Market)- DMNCs should establish partnership with low cost innovators in emerging market or outsource the research & development division to countries like India, China, Indonesia, Philippines etc. As a result of such partnership, reverse innovation can be achieved DMNCs and start selling the product to marginalized market (market consisting of customers having limited access to financial resources and being underserved by DMNCs) of developed nation. Response 2- (Mainstream Markets) - DMNCs should investigate value chain activities of reverse innovator and use low cost country bases in Eastern Europe and countries like Hungary, Bulgaria etc to execute the value chain activities of reverse innovator. Product developed in such manner can be customer or differentiated in comparison to existing product manufacturer in developed countries. As a result, DMNCs will be able to fill the gap in the mainstream market in developed countries through products being developed through copied reverse innovation (Govindarajan and Trimble, 2012). According to Govindarajan and Ramamurti (2011, p. 191), reverse innovation should be defined as “an innovation adopted first in a poor country before being adopted in rich countries.” According to Govindarajan and Ramanurti (2011), in case of innovation, multinational companies develop the product in developed countries or rich countries and sell the items in poor countries but in case of reverse innovation, western companies are developing the product in poor countries and selling the item in rich countries. Figure 1: Reverse Innovation and Traditional Innovation (Source: Govindarajan and Ramanurti, 2011, p. 192) It is evident from the above diagram that reverse innovation is being referred as ‘trickle-up’ innovation while traditional innovation (multinational companies develop the product in developed countries or rich countries and sell the items in poor countries) is being refereed as ‘trickle-down’ innovation. While considering the research works of Tallman and Fladmor-Lindquist (2002), one may get confused regarding the relationship between reverse innovation and frugal innovation. Lee and McNamee (2013) defined frugal innovation as resource constraint innovation where companies minimize the use of financial and material resources without deviating from predetermined quality standards. Discussion on frugal innovation will be done in later part of the essay. While competing in international market, it becomes important for EMNCs and DMNCs to compete on the basis of innovation capabilities due to existence of asymmetry in terms of resource capabilities. Consideration of seminal research work of Porter and Ketels (2003) and Porter (1996) reveals the fact that success of particular strategy depends on its ability to explore opportunities present in macro and micro environment. Verbeke and Brugman (2009) pointed out that both DMNCs and EMNCs can achieve range of benefits while going for internationalization such as, 1- adopting new knowledge from foreign operation and agglomerating the knowledge into strategy transformation, 2- arbitraging cheaper resources that can decrease value chain costs, 3- exploring firm specific assets in foreign countries, 4- accumulating global expansion power, 5- leveraging international scale of operation and 6- decreasing business performance volatility through geographical diversification. To be specific, internationalization provides opportunity to DMNCs to expand business revenue, access low cost resources and achieving capabilities for decreasing cost of innovation. On the other hand, while entering in international market, EMNCs get the opportunity to increase business revenue by selling the product to large set of customers. Govindarajan and Trimble (2012) pointed out that competition between DMNEs and EMNEs in international markets can be presented over three stages of reverse innovation. 1- Winning in key emerging market- main problem for DMNEs is to decrease cost of innovation during independent operation. On the other hand, partnering with emerging-market subsidiary might give undue advantage to low cost subsidiary for using global technological resource of DMNEs and such strategic initiative might create problem for DMNE to control activities of low cost subsidiary in future context (Yamin and Andersson, 2011; Sarkar, 2011). From strategic advantage perspective, DMNEs have much more resource capabilities as against EMNEs in order to bring innovation. On the other hand, EMNEs can easily compete with DMNEs in emerging markets like BRICS (Brazil, Russia, India, China and South Africa) due to their access to low cost resources (cheap labours, cheap raw materials, low supply chain cost due to nearness of resources) and understanding of local culture. For example, using reverse innovation, Tata Motors of India launched Nano at just over $2,000 (cheapest car in the world) by optimizing resource usage in frugal car engineering (Govindarajan and Trimble, 2012). On the other hand, foreign automakers found it difficult to compete with Nano in terms of price benefits offering to customers. 2- Winning in other emerging market- DMNEs can enter into different emerging markets through low risk distribution channels (franchising, licensing) or using the brand name. However, DMNEs are bound to face challenge like achieving low cost innovation or customizing product suited to local requirements (Petrick, 2011; Schotter and Beamish, 2011). On the contrary, due to access of low cost resources and understanding of culture in emerging market, EMNEs can easily customize product pricing at par with other emerging market requirements. For example, local mobile manufacturers of China are copying technology of global Smartphone makers and producing low cost Smartphone having features similar to Smartphone of Samsung, Nokia, and Apple through reverse innovation (Govindarajan and Trimble, 2012). Chinese manufactures are offering the product to other emerging markets at different price point and subsequently creating challenges for mobile manufacturing DMNEs in some emerging markets. 3- Winning in developed market- for DMNEs, offering reverse innovation product might create risk of brand cannibalization and positioning of the brand might get perturbed due to positioning conflict between reverse innovation and existing offering. However, Govindarajan and Ramanurti (2011) pointed out that dominance of DMNEs over EMNEs is being decided through factors like strong presence in developed countries, wide distribution channel penetration and customer intimacy. On the other hand, EMNEs can benefit while offering reverse innovation products in developed nations leaving no possibility of brand cannibalization and no internal resource constraints in international expansion. For example, Shenzhen (China) based Automobile Company named as BYD announced the launch of environmentally sustainable plug-in electric cars (using lithium-ion ferrous-phosphate battery) in Europe (Govindarajan and Trimble, 2012). Launching the car will help the company to challenge Automobile DMNEs to come up with environmentally sustainable cars that can meet requirements of customers of developed countries (Govindarajan and Trimble, 2012). According to Govindarajan and Trimble (2012), EMNEs and DMNEs can both contribute to global economic growth but they need to merge frugal and reverse innovation all together. Dimensions of reverse innovation has already been discussed, therefore, the essay will discuss characteristics of frugal innovation. Frugal innovation is being done in order to produce products that can serve needs of bottom of the pyramid (BOP). For example, Lee and McNamee (2013) pointed out that in many parts of India ChotuKool (a battery-powered refrigerator) is being invented by a local company that can deal with power supply fluctuation in the country. In order to bring down cost, manufacturer of ChotuKool simplified the design by eradicating redundant product parts. From strategic perspective, frugal innovation and reverse innovation bear orthogonal relationship and difference exist in the applications of these two types of innovation. In case of frugal innovation, innovative product or service are being developed only for emerging markets while in case of reverse innovation, innovative product or service being developed for both developed and emerging market. However, from economic perspective, both frugal innovation and reverse innovation or ‘trickle-up’ innovation have their own importance and can be used in situation specific manner to drive economic growth. Consideration of research works of Helfat and Winter (2011) and Zhou and Chen (2011) reveals the fact that innovation is driven by knowledge integration while economic growth is driven by innovation and new market creation. While discussing about economic development, Romer (1993) identified two types of gaps; object gap such as lacking physical facilities like factories, roads and idea gap such as lacking the knowledge capital to continue innovation. In case of emerging market, countries have object gap but EMNEs are driving economic growth through reverse innovation. In relative terms, some of the developed nations are suffering from idea gap in such context; DMNEs can decrease the margin of idea gap by encouraging product development through reverse innovation. Citing real world examples can clarify the validity of arguments. Micro-financing- due to laggard effect of economic recession and rising unemployment rate, disposable income level of people in developed countries is decreasing (Govindarajan and Trimble, 2012). In such context, high profile banks of developed nations are not ready to disburse loans to these people due to existence of possibilities that these people may default on repayment of loan. On the other sand, Muhammad Yunus (Nobel Peace Prize winner in 2006) established Grameen Bank or a micro financing institute that provides tiny loan amount to poor people with minimal interest (Govindarajan and Trimble, 2012). In some cities of USA, Grameen Bank is operating and providing financial assistance to inner city poor. Therefore, opening the door for reverse innovation in USA has economically empowered powered certain segments of the society. While adopting reverse innovation or ‘trickle-up’ innovation, DMNEs can learn from success of EMNEs such as, 1- how to integrate knowledge into innovation in order to come up with low cost products, 2- how to achieve dynamic capabilities and using the capabilities to create sustainable competitive advantage and 3- how to adjust value chain activities in order to drive innovation and business growth. Transnational knowledge sharing and reverse innovation or ‘trickle-up’ innovation product transfer can strengthen emerging economies through increase in exporting activities. Similarly, reverse innovation will help developed economies to achieve economic growth via low cost product innovation, new market creating and economically empowering social members. Kogut and Zander (1992) stated that in order to sustain competitive advantage earned through product innovation, companies and countries need to mix knowledge-based view (KBV) and resource based view (RBV) simultaneously. For example, A DMNE can achieve competitive advantage by selling high priced innovative product in home market but similar strategy would not work in price sensitive emerging market. Similarly, from economic perspective, transnational knowledge and reverse innovation sharing might help both DMNE and EMNE to fulfil market gap and resource gap in their own home countries. Such transnational product transfer as economic activity is bound to create monetary surplus. Porter and Siggelkow (2008) and Porter (1990) argued that nations can achieve competitive advantage by performing activities like product differentiations, research & development, cutting down cost through mass production, focusing on particular segment innovation, partnership etc. Reverse innovation provides opportunity to emerging nations to achieve competitive advantage by strengthening their domestic economic sector. On the other hand, developed countries can revive their struggling economies (due to economic recession, sovereign debt crisis and rising unemployment rate) by creating market for low cost reverse innovation products that can offer price benefits to social members. Therefore, DMNE and EMNE should invest more resources to backup reverse innovation that can drive global economic growth and prosperity. Similarly, there are examples that DMNEs have influenced economic growth by bringing ‘trickle-down’ innovation. For example, DMNEs like GE and Texas Instruments introduced technological innovation in countries like health devices; portable electronic devices for small scale industries in countries like Bangladesh, India etc. ‘Trickle-down’ innovations like health devices, portable electronic devices gave MSMEs in these countries to expand business, generate employment opportunities and achieve sustainable economic growths. Therefore, these examples are showing how DMNEs used ‘trickle-down’ innovation in order to bring economic growth (Govindarajan and Trimble, 2012). Conclusion It is evident from the above discussion that over use of the global localization strategy has decreased its functionality and western companies are finding it increasingly difficult to drive business growth by following traditional strategies in emerging market. It has also been found by the researcher that as part of reverse innovation, companies like GE and other global giants are slowly shifting research & development bases to emerging countries like India and China. On the basis of above discussion, it can be said that multinational enterprises (MNEs) are yet to achieve full potential of ‘Reverse Innovation’ but there are MNEs like Nokia, GE that are consciously using reverse innovation as growth alternatives. 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