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The middle market has become the battle ground between foreign and local firms in emerging economies . Many foreign investors have in recent years been earning healthy margins in the premium segment, yet realize that they miss out on faster growing lower-price markets. At the same time, some local competitors are steadily moving up from the lower tier to the middle market, and have started to challenge leaders in the premium segment. Whether and how to engage in the middle market – also known as the ‘good enough’ or ‘frugal’ market – is thus a major concern for European and American businesses in emerging economies such as China .
But before you leap into the good enough market, let’s do a quick “5-Forces” analysis. First: competition is often intense with local start-ups competing for market share – along with multinationals like Haier who are spreading across emerging economies. Local firms tend to dominate the market, especially for products of low market heterogeneity and low manufacturing complexity, as highlighted in research by my colleagues Sea-Jin Chang and Sam Park. Hence, many ‘good enough’ markets are fiercely competitive ‘red oceans’
Second: barriers to entry are much lower than in premium segments, suggesting that new entrants may quickly intensify competition. Third: with vague industry boundaries, substitutes may also be readily available, including labor – in many places washing machines and dishwashers compete with domestic helpers. Fourth: customers likely have bargaining power because products are more homogenous and distributors are plentiful. In fact, some multinationals sourcing in China actively help local firms develop their capabilities in an effort to reduce the bargaining power of their existing European or American suppliers. Fifth: control over key supplies might – just might – be the only factor that gives a multinational player some bargaining power. This quick analysis suggests that good enough businesses can rarely earn margins seen in the premium segment, or the profits expected by distant headquarters in Europe or North America .
In addition, the good enough segment also presents numerous risks. Operating in an unfamiliar environment, with vaguely defined rules of the game, foreign investors may encounter more surprises than they can handle. Businesses introducing middle market products with respectable quality and a good brand also risk cannibalizing their premium segment sales: some customers may migrate across segments, not just within China but also in export markets, even in Europe. There is also the possibility that companies may put their reputation at risk because once their name is associated with low quality in one segment, it gets harder to convince customers elsewhere that their brand stands for ‘always reliable’ and trustworthy products. Another potential downside is that a global player offering good enough products may not only tell customers that quality at a lesser price is feasible, but encourage local players to try their luck in the segment. Finally, when competing on price, companies may be drawn into practices that are common in lower tier segments but not acceptable to European HQs, practices such as low health, safety and environmental standards, or bribing purchasing managers.
With so many risks, and such low profit potential, why do foreign companies even bother entering the good enough market at all ? Often it’s a defense strategy with two objectives. First, they want to be present in the middle market to learn about new cost-efficient operational processes, emerging market trends, and ideas for new business model ideas. New ideas first emerging in fiercely competitive market segments sometimes have the potential to disrupt entire industries. Second, they want to engage early with potential future competitors. Local players typically develop their capabilities in the middle market and achieve vast scale economies, which form the basis for challenging upwards into the premium segment. Engaging them early may prevent unpleasant surprises later on.
When global players consider entry in the good enough segment, they thus need to be very selective in choosing just the right product . Preferably, they would offer an affordable product at a level of quality that local competitors cannot (yet) reach. For example, for their initial good enough venture Schenck Shanghai Machinery (a subsidiary of the German Dürr Group) selected a product category (balancing machines for armatures) where they had virtually no sales in China while Japanese competitors dominated the market. They developed a machine for China that was less automated and somewhat slower than its German counterpart, but lived up to the highest standards in reliability and precision. After a successful market introduction, they added other products such as industrial cleaning machines to their good enough portfolio. While gaining traction in the segment, however, they did not lose focus on where they earn money: the premium segment remains their main revenue earner, both worldwide and in China.
Once a company decides to engage in the good enough segment, the next question is how to get in . I will discuss this in my next blog.
Thanks to Jenny Zhu for helpful research assistance.
