Collection of Thought Pieces on Learnings from Three Box Solution: Number 12; The Case for 'Reverse Innovation'

No doubt, populism and nationalism have re-emerged. Yet, a sophisticated emerging-market strategy is not optional for companies that want to survive and thrive in the 21st century

Is it possible that the most important innovations of the future will be adopted first in the developing world? In a 2009 Harvard Business Review article, I argued that this phenomenon, "reverse innovation," is a profitable strategy for growth.

To understand why, let us analyze how American companies became global and why a new approach is needed going forward.

There have been three distinct phases in the history of globalization so far.

Phase One: Globalizing Market Presence [1950s and 1960s]

American corporations didn't "think global" for a long time because their biggest strength happens to be their biggest liability: the huge and robust domestic market. An American company could produce in Milwaukee, sell in Chicago, and still continue to grow very aggressively. Therefore, American companies never really felt the need or the pressure to cross the borders to achieve growth. However, in the 1950s, a new opportunity presented itself. As a result of the two World Wars, the rest of the world was destroyed and had to be built back up economically. American corporations took advantage of this opportunity to go global by selling products and services originally created for the American consumer to markets all around the world. For instance, Xerox Corp. developed big, bulky, expensive copiers for U.S. consumers; it then sold them in Europe through its subsidiary Rank Xerox and sold them in Asia through its subsidiary Fuji Xerox.

Phase Two: Globalizing the Resource Base [1970s and 1980s]

To maximize efficiency, American corporations moved many operations overseas, including manufacturing and back office processing, seeking the lowest cost locations worldwide. American companies also established R&D centers around the world. Still, innovation endeavors were chartered overwhelmingly for the needs of the rich world. Globalizing resources was driven by two forces; ideological revolution and technological revolution. By ideological revolution we mean almost every country embraced free-market ideology and opened up its borders to global competition, reducing political risks in terms of locating mission-critical activities such as R&D in parts of the world other than developed countries. Technological revolution, meanwhile, reduced coordination costs, allowing companies to connect dispersed resources. For instance, Microsoft has development centers in the U.S., India, and China.

Phase Three: Glocalization [1990-2005]

In this phase, U.S. companies recognized that while the first two phases had minimized costs, they were not as competitive in local markets as they needed to be. Therefore, companies focused on winning market share by adapting global offerings to meet local needs. Innovation still originated at home, but products and services were later modified to win in each market. For instance, McDonalds changed its menu in India to include a lamb burger while still maintaining its core global product platform.

In a world where markets were broadly similar, glocalization made sense. Historically, American companies were taking their products into Europe and Japan. Those consumers weren't hugely different than consumers in the U.S. This made selling them global products, with suitable local adaptations, both viable and attractive. But the world is changing. In the future this approach will not be sufficient.

That's where — and why — reverse innovation comes in.

Phase Four: Reverse Innovation [2005-?]

In the first half of the reverse-innovation process, companies focus on developing products "in country, for country." Companies take a market-back perspective. That is, they start by assessing customers' needs in emerging markets rather than assuming that they only need to make alterations to existing products. As teams develop products for the local markets, they remain connected to, and benefit from, global resources and technology.

Phase Five: Bringing Innovation Home [2005-?]

Companies complete the reverse-innovation process by taking the innovations originally chartered for poor countries, adapting them, and scaling them up for worldwide use. This phase introduces the idea of "in country, for the world."

Emerging markets such as India, Brazil, and Russia and the continent of Africa are the new mass markets of the world. Yet, the customers in these new mass markets are fundamentally different from those in developed markets. Contrast the average per capita income in the U.S. [$44,000] vs. India [$2,500]. Emerging markets are a paradox: They are mega-markets with micro-customers.

Glocalization means that multinationals target only the top of the pyramid in these markets, the wealthiest 10%. But the real potential lies in unlocking the other 90%. Adapting global products created for the U.S. customers in India simply will not work to capture the full opportunities in India. Reverse innovation holds the key.

The Oxygen for Future Growth

Already, Western multinationals — with all their resources, technical superiority, and established global presence — are being beaten to the punch. In the developing world, local competitors are often at the forefront of economic expansion. Think of companies such as Tata, Mahindra & Mahindra, Lenovo, and Cemex. They are very different organizations in very different places in very different industries. Yet all are leaving established multinationals in their wakes — not just in emerging markets but also in developed markets.

The biggest opportunity for multinationals in the next 25 years is to focus on the vast segment of unserved and underserved in poor countries. Reverse innovation is not only required to capture growth in emerging markets; it is the very oxygen that will fuel future growth of multinationals in their home markets.

Note: This article was originally published in BusinessWeek.Com, May 7, 2009.