The Brave New World of Emerging Markets

When Gen. Cornwallis surrendered to Gen. Washington after the Battle of Yorktown, the British band supposedly struck up the tune “The World Turned Upside Down.” After all, such an outcome would have been unthinkable at the start of the American Revolution.

That is in the nature of things, however. No one stays on top forever. Only recently, the mighty U.S. consumer — long the dominant force in world trade — has lost its top seed. There is a brave new world emerging, and it has a brave new consumer. This time, it’s Americans that might want to strike up that old ballad.

Consumers in emerging markets are now the dominant consumer group in the world, surpassing the U.S. We’ve crossed an important threshold.

As The Economist notes, “The emerging world is enjoying the most spectacular growth in history.” Some of the growth rates are just blistering. Thailand grew 15% on an annualized basis in the fourth quarter. Taiwan grew 18%. “Multinationals expect about 70% of the world’s growth over the next few years to come from emerging markets,” The Economist adds, “with 40% coming from just two countries, China and India.”

It’s a great time to be an investor as we witness this history-making shift in global markets that will surely create great opportunities for us. Just look around and you can see the impact already.

For instance, Coca-Cola reported a 20% increase in first-quarter profits despite the fact that North American sales declined. Sales in emerging markets, such as India (up 29%) and Turkey (up 18%), made it possible. About 75% of Coca-Cola’s sales are now overseas. This is just one example. There is a whole slew of iconic companies that now generate more sales overseas than in the U.S. It’s still early.

The next big consumer market to open up might be Indonesia. It’s the world’s fourth largest population, behind China, India and the U.S., with 240 million people. Ford just opened its first dealership here. Honda says it can’t make motorcycles fast enough. And H.J. Heinz reports that Indonesia is a big part of why its Asia sales rose 41% last year.

So the long-awaited emergence of the emerging markets consumer is at hand. More than that, the emerging markets are also becoming a source of innovative ideas. Fortune 500 companies are happy to set up brainy shops in emerging markets. They already have 98 R&D facilities in China and 63 in India. GE has a vast R&D facility in Bangalore, its biggest in the world. Cisco is spending a $1 billion on a second HQ, also in Bangalore. Accenture has a quarter of its work force in India. Microsoft’s biggest R&D center, outside of Redmond, is in Beijing.

And they are enjoying tremendous success. For example, GE’s Bangalore laboratory invented a new hand-held electrocardiogram that sells for $800, instead of the usual $2,000. The cost per test is only $1 per patient.

As The Economist put it, emerging markets have become a “fizzing cocktail of creativity.” Moreover, it’s not just Western companies doing the creative work. (Huawei, a Chinese telecom giant, is now the world’s fourth largest patent applicant.) Companies in China, India and other places outside the U.S. are inventing game-changing technologies. A few of the stories The Economist highlights in its report are simply amazing.

In Chennai, a Tata company created a water purifier that uses rice husks — a common waste product. A family can enjoy bacteria-free water for the grand price of $24. New filters every few months will cost $4. It’s cheap and portable and will make a big impact on the poor the world over, most of whom lack access to clean water.

Another Indian manufacturer concocted a $70 fridge that runs on batteries! A Chinese company, Mindray, makes a lithium battery for $12, compared with $40 previously. Bharti Airtel, an Indian company, has the lowest cell phone fees in the world — 2 cents a minute and nationwide coverage. It’s worth $30 billion.

One of the most startling tales was that of Devi Shetty. He is applying Henry Ford’s assembly-line techniques to hospitals. Shetty’s flagship hospital in Bangalore has 1,000 beds. (The average American hospital has only 160.) His team of 40-some cardiologists cranks out 600 operations a week. Open-heart surgery costs about $2,000 — compared with $20,000–100,000 in an American hospital. Shetty and his team have performed tens of thousands of such operations with results as good as the best of American hospitals. Incredibly, these hospitals even make money! According to The Economist, “Dr Shetty’s family-owned hospital group reports a 7.7% profit after taxes, compared with 6.9% in American private hospitals.”

So where are the opportunities? I believe that the biggest opportunities and the biggest rewards will go to the homegrown companies in these markets. The biggest winners won’t be the multinationals, their present success notwithstanding. (And it hasn’t all been sugar and spice. Ask Google or Yahoo or Black & Decker or a host of others who met defeat in foreign markets.) As in baseball or football, the odds favor the home team, which has more knowledge of local markets, customs and the like.

For example, China’s auto market grew 45% last year to become the biggest in the world. GM, for the first time ever, now sells more cars in China than in the U.S. But Chinese automakers have made the largest market share gains. As of 2004, Chinese automakers were 21% of the market; today, they are 32% and rising. Of the 89 new models unveiled at the global auto show in Beijing recently, 75 were Chinese brands.

We are now at a point, too, at which we can list a host of companies that are world-class in what they do and call an emerging market home. Mittal as recently as 1990 was an unknown steel maker in Indonesia. Today, it’s the world’s largest steel company. China’s Lenovo didn’t even exist in 1990 and today is the world’s fourth largest PC maker. There are many more examples from Brazil’s Embraer to China’s battery maker BYD.

Warren Buffett bought a piece of the latter company in September 2008. BYD went from about $7 to $80 in about 18 months. (The question to ask yourself is if you bought BYD for $7, would you have held on to $80?)

The above is just a snippet of the mind-bending changes taking place right now. As Marco Polo once said, “I have not told the half of what I saw.” Stay tuned for more on this front soon…

Chris Mayer
Whiskey & Gunpowder

May 19, 2010

The Daily Reckoning