The U.S.-based firm Mary Kay Cosmetics (MKC) is a direct marketing company, going to market via a force of independent “beauty consultants” who buy and resell cosmetics and toiletries to contacts either individually or at social gatherings (the “party plan” distribution channel). When considering market entries in Asia, the company arrived at a final decision between Japan and the People's Republic of China (PRC). By the standards of most country-level data, Japan was by far the most attractive: it boasted the highest per capita spend of any country in the world on cosmetics and toiletries, it had high disposable income levels, it already hosted a thriving direct marketing industry, and it had a high proportion of women who did not participate in the workforce. As MKC learned after participating in both markets, however, the market opportunity was far greater in PRC, principally because Chinese women were far more motivated to boost their income by becoming beauty consultants than were their Japanese counterparts. The entrepreneurial opportunity represented by what MKC describes as “the career” (i.e., becoming a beauty consultant) was a far better predictor of how many sales could be made than high-level data on incomes and expenditures. In fact, MKC has come to employ a business-specific indicator of market potential within its market assessment framework: the average wage for a female secretary in a country, which can then help the firm estimate the size of the opportunity provided to the average working woman by a career as a beauty consultant. It is, of course, valuable for inter-country comparisons to be made in terms of GDP, population, regulatory requirements, tariffs, industry size and concentration, and all the other high-level data available. International marketing executives need to ask the right questions when assessing alternative markets.
This framework is based upon analysis at the level of the product-market rather than the country market, assuming that the dynamics of different industries are at least as different as the characteristics of different countries. In other words, a country that is attractive to one company might be unattractive to another firm because each requires different conditions in order for its business model to thrive. While country analysis might still be useful as a first screen in a hierarchical assessment process (to be followed by more detailed product-market level analysis), it is only at this more local product-specific level that accurate assessment can be realistically attempted. This is a fundamentally different method of market assessment from the prevailing country-level analysis, which is usually based upon macroeconomic or national demographic data. It is based upon two product market-level concepts:
Different product-markets require different levers for the business to grow, a fact that is self-evidently true to anybody involved in marketing at the operational level. Some markets are brand-sensitive, while others will not grow without intensive distribution or a cadre of technically qualified salespeople. It is a significant insight for Mary Kay to identify that the entrepreneurial opportunity of becoming a beauty consultant is the real driver of its business rather than the overall level of expenditure on toiletries and cosmetics.
The second core concept is that of enabling conditions—the structural characteristics of the market that are necessary for the marketing model to operate effectively. Only if the enabling conditions are in place will a firm be able to realize its potential. For example, consider a market that is driven by a large number of impulse purchases (such as toys, soft drinks, or ice cream). For marketing to be effective in such product categories, the product has to be available at the moment of impulse, and so an intensive and well-developed distribution system is a prerequisite or an enabling condition. In fact, the lack of such a distribution system is usually identified as the major barrier to market growth in many of the large emerging markets such as China or Russia.
Cost of Entry vs. Cost of Waiting
Finally, the cost side of the business equation should be analyzed and weighed against the demand s already calculated. This has two aspects. First, a company should have a clear idea of the economic costs of participating in the market. This will include questions such as whether local production and/or assembly are required, how many local employees will be required, tariff requirements, and so on. This is another area in which there will be significant differences between product markets, depending, among other things, upon the bulk-to-value ratio of the products being sold a lightweight and/or small product, such as a branded pen or an electronic component, incurs far lower transportation costs to import than a high bulk-to-value product such as a disposal bin, which makes the projected income statement for the first few years in the market look more attractive.
Forecasting Market Potential
Forecasting market sales levels remains an exercise in the art of estimation rather than the science of marketing, and even after years of international marketing experience, the difficulty of this challenge explains many of the managerial errors in market entry strategy that have been observed.
However, it is significant that in almost all cases, the error is in one direction—namely, an overestimation of market potential. This may be because other pressures, such as competitor entries or shareholder pressures for aggressive investment are driving market expansion strategies, and without robust market data, a firm errs on the side of optimism in its forecasts. The key approach to really reading a market is to start at the demand level rather than the aggregate level of country macroeconomic or demographic data, a distinction previously described as bottom-up as contrasted with top-down. These approaches will now be illustrated using data from the case study on the entry of Mary Kay Cosmetics into China.
The typical method of market assessment can be described as “top-down” because it is based upon country-level variables, and the data are then reduced to arrive at an estimate of sales. The progression is therefore from country data to product-level data. The two most commonly employed categories of indicator are macroeconomic and population data because both are readily available for almost any country. If a country's GNP is known, for example, market size can be estimated by calculating the proportion of the population likely to have the necessary disposable income to buy the relevant product. Similarly, if the population is known, estimates can be made of the size of the relevant demographic segment (e.g., men aged 18–40). In some cases, one of these indicators can be used alone to produce a simple market forecast. For example, a company might know, from experience in other international markets, that there is a correlation between GNP and market size and that a GNP of x therefore supports a market forecast of y. More frequently, however, the national data is processed via a series of assumptions about the proportion of the economy or the population that will constitute the market. An example of this will follow. The final assumption, of course, will be to estimate the share of the market that the company will be able to achieve.
In principle, this is a perfectly good method of market assessment or forecasting because the variables are certainly relevant to market size. In practice, however, this method tends to produce inaccurate forecasts, and in particular it is responsible for overestimates of market size because macroeconomic and population data provide a good indication of market potential, but no indication of the likelihood of potential customers (or “prospects” as salespeople call them) being converted into actual customers. The existence or availability of a certain number of prospects is certainly relevant to market plans, but a more fine-grained view of marketplace dynamics is necessary to arrive at realistic estimates of market revenues. Interestingly, many Internet businesses foundered after it was realized that “eyeballs,” or website traffic, was in fact only market potential. A typical “Dutch auction” process entails that we start with an unrealistically high that is repeatedly reduced to arrive eventually at the forecast. Starting with the total population, a series of assumptions are made to adjust a limited set of known facts: 50 percent of the population is accessible nationally, but all in Shanghai province; 50 percent is female; 33 percent of females are in the right age group; a certain proportion (higher in Shanghai province) have the necessary disposable income; a certain proportion of the income will be spent on cosmetics and toiletries; and MKC can achieve a certain market share. None of the assumptions is irrational, and it should be noted that this top-down forecast is working with some product-level data and not just national macroeconomic and demographic s. Nevertheless, the resultant forecast is far higher than proved to be realistic and far higher than the bottom-up forecast discussed in the next section. This is because the forecast is produced using assumptions taken from static and established structures within markets and economies, and it completely fails to address the challenge of the change required before Chinese women purchase cosmetics and toiletries at these rates.
Top Down Market Forecasting
Estimates are for country and for Shanghai province.
1. It is known that 80 percent of the Chinese population lives in the east and 30 percent in urban areas, which makes those portions of the population more accessible. It is assumed that all Shanghai provinces are accessible.
2. It is known that 41 million households have disposable income above $18,000 per annum, and it is estimated that significant expenditure on cosmetics and toiletries begins at $10,000.
3. Research indicates that the typical consumer in Shanghai has $120 disposable income per month, of which 75 percent is spent on essential items (e.g. housing and food), of which 30 percent is spent on cosmetics and toiletries, resulting in potential spending of $27 per month and equaling $320 per year.
It is known that the equivalent for Japan is $400 and that Japan's GDP is some 20 times larger than China's. It is assumed that Chinese women spent twice as much of their disposable income on cosmetics than Japanese women do.
The restriction to the most prosperous province of the country in itself constitutes a more realistic starting point. More fundamentally, this forecast adopts an entirely different approach, starting from MKC's customized indicator and building up to an answer to the question, What level of business would be required to offer secretaries the opportunity to increase their wage by 50 percent by becoming a Mary Kay beauty consultant? This quantifies the opportunity at an individual level, and it is assumed that the number of women for whom this opportunity is valid can then be estimated. Some of the assumptions here are more robust because they are within the control of the company (e.g., the assumption that beauty consultants would have a revenue of $4.50 per unit, representing a 50 percent margin, is based upon company costs and pricing decisions). This forecast also makes a number of other assumptions already seen in the top-down forecast (for example, that women in the target age and income group spend on average $324 annually on cosmetics and toiletries and that MKC can achieve a 5 percent market share), but it employs them quite differently. In this case, the conservative assumption is made that all the expenditure is on items at the MKC price level of $9, even though this is at the higher-priced end of the market. This forecast produces an estimated market potential of $324 million, compared with $640 million in the previous top-down forecast. This reflects the quite different approach taken—put simplistically, it is based on answering a “What is required to achieve x?” question rather than a “How large might the market be?” question. The task to be achieved, a 50 percent increase in income for the average secretary who becomes a beauty consultant, is specific to the company and based on experience in other markets. It is quite typical that a realistic bottom-up forecast would produce an estimate of market potential much lower (in this case, 50 percent lower) than a “top-down forecast.” Such an approach, using benchmarks or hurdle rates, is commonplace in investment projects, but it is rarely used in international market assessments. In this case, the bottom-up forecast proved to be more accurate. In fact, sales were below the projected level in the first year, but they exceeded all fore-casts after a few years in the market. Because the company had planned conservatively, based upon a realistic and market-driven forecast, it has been able to build a successful business in China without falling prey to initial overestimation of sales potential and the challenge of building the business.
Bottom-Up Market Forecasting: Mary Kay in Shanghai
1. Assume that the Mary Kay opportunity is attractive if it can increase the average female wage in Shanghai by 50 percent to $2,250. Note that this is high, as the average wage in Taiwan is $3,000, and Taiwan has much higher levels of GDP and disposable income.
2. To earn $2,250, a consultant must sell 500 units (@ $4.50 gross margin per unit). However, at the average consumer price of $9, this would consume all the cosmetics budget of the average earner for only three units per month or 36 units per year. This is regarded as unrealistic.
3. Alternatively, assume that a consumer purchases three Mary Kay units per month, and that this represents 50 percent of cosmetics spending. It scales up to annual cosmetics spending of $648 per year and (using the income structure from Table 2-2) an annual disposable income of some $3,000 (about twice the average female wage).
4. We know that there are about 2 million households in Shanghai province with disposable income of $10,000, so assume this equates to individual women at $3,000. Assuming 5 percent market capture again, we can expect 100,000 customers, or a market size of $16.2 million, which would support 7,200 consultants at the higher earnings level.
Besides the estimation of market potential, the other major decision in market entry strategy is that of the timing of entry. This, too, has assumed great prominence in the international boom of the 1990s because so many entries, especially in emerging markets, were justified on the grounds of an urgent need to participate in the market early. Whereas the early internationalization of many firms was opportunistic and incremental, this wave of global expansion of the 1990s was characterized by a certain urgency, as if there existed limited windows of opportunity that would reward only those players bold enough to move early. Indeed, companies frequently acknowledged that any reasonable sales forecast would not estimate profitability for years to come, but they nonetheless entered the market because of a belief in the concept of first-mover advantage (sometimes referred to as pioneer advantage), one of the most widely established theories of business in the minds of executives and investors alike.
According to this theory, the first entrant in a new market enjoys a unique advantage that later competitors cannot overcome (i.e., the advantage is somehow structural, and therefore sustainable). For some companies, this reasoning is validated by history. Procter & Gamble, for example, has always trailed rivals such as Unilever in certain large markets including India and some Latin American countries, and the most obvious explanation is that its European rivals were participating in these countries long before it, simply for reasons of European colonial history. Given that history, it is reasonable for Procter & Gamble to err on the side of urgency in reaction to the opening of large markets such as Russia or China.
For many companies, however, the concept of pioneer advantage was little more than an article of faith, and it was applied to country-market entry, to product-market entry, and, in particular, to the “new economy” opportunities created by the Internet. Although the “get big quick” philosophy of the dot-com boom has been rather discredited by the subsequent dot-com bust, the “get in early” philosophy of pioneer advantage remains largely accepted. To some extent, this is correct: the advantages gained by European companies from being early in “colonial” markets provide some evidence of pioneer advantage. Moreover, as will be argued later, there are a number of sources of pioneer advantage that are more likely to be present in emerging economies. Nevertheless, it should be emphasized that first-mover advantage is overrated as a managerial rule of thumb. Indeed, in many situations, there may be disadvantages to being first. These can be of two types. First, at a more general level, the absence of any pioneer advantage results in poor business performance, caused by a lack of return on the investment required for market entry. This is what has happened to many western MNCs who rushed into Russia and China in the early 1990s and a few years later were attempting to stem their losses. Second, and more specifically, there is the danger that a pioneer will not be able to recoup the investment made in marketing required to kick-start a new market. In such cases, it may well transpire that a “fast follower” can benefit from the market development investments of the first mover and, without those pioneering costs, leapfrog into earlier profitability.
An example of this is provided by Sony's attempts to develop and dominate the market for car navigation systems.17 As a result of considerable investment in both product technology and marketing, Sony was the market leader in this category in 1993, at which time some 80 percent of worldwide unit sales were in Japan. However, the drivers of demand in Japan (a widespread love of technology, a complex and relatively poorly signposted road system, and extensive use of cars for leisure driving well away from the home) were not present to the same extent in North America and Western Europe. In those markets, large investments in marketing would be required to persuade customers that they needed an expensive technological addition to their car to replace a cheap paper roadmap. Moreover, product adaptations were required: Europeans needed Multilanguage capabilities, and Americans, more concerned with traffic congestion than with directions, required links to live traffic information services. As a committed pioneer, these up-front costs would have to be carried by Sony, but there was nothing to stop later entrants from free-riding on this market development investment and picking up customers. In fact, later entrants completely outflanked Sony in Europe and America by going to market via the OEM channel instead of addressing consumers directly via the auto aftermarket, as had been the case in Japan.18 It seems likely that later entrants benefited from Sony's market development investment, but they found an even better way of getting consumers to consider navigation systems: by allowing them to try them out in test drives or rental cars. As early as 1995, Sony's market share was in decline even in Japan, and it remains well behind the leaders.
This ability of later entrants to free-ride on the pioneer's market development investment is the most common source of first-mover disadvantage, and it offers insight into the two conditions necessary for first-mover advantage to accrue. Understanding these two conditions is essential for a critical understanding of the market entry situation, and it should inform all such decisions. For first-mover advantage to exist, the following two conditions must apply:
• First, there must be a scarce resource in the market that the entrant company can acquire.
• Second, the entrant company must be able to tie in that scarce resource so that it is not available to competitors.
If there is no scarce marketing resource, then it is clear that later entrants have full and equal access to the market and that, conversely, the pioneer has no advantage. For example, consider the widely held opinion that the first brand in the market can have the advantage of establishing the standard in its category and become the generic example of the product (like “Band Aid” or “Hoover”). In such cases, the scarce resource is at the front of the consumer's mind—or an established position in the limited attention or memory the consumer is prepared to devote to this category. In the case of car navigation systems, this appears not to have happened, and consumers did not regard the pioneer products as the gold standard. Alternatively, consider the role of government in markets in which it is necessary for foreign firms to obtain a permit or license to sell their products. In such cases, the license, and perhaps government approval more generally, may be a scarce resource that will not be granted to all comers.
The second condition is also necessary for first-mover advantage to develop—and for the same reason. The most common supposed source of first-mover advantage, brand preference from being the first brand known, is based on the idea that brand attitudes are unlikely to change once established. In fact, a long stream of research has failed to establish conclusively the existence of this phenomenon, and it is clear that in many cases, consumers consider the alternatives available at the time of their first purchase. In other cases, such as contracts with distributors or other partners, it is clear that the advantage can be expected to last years rather than months, so it might provide a sustained competitive advantage.
Sources of First-Mover Advantage in Emerging Markets
Having emphasized the need for caution and rigor in thinking about first-mover advantage, it should be noted that there are a number of potential sources of advantage, relating to structural aspects of the market or country, that are more likely to accrue in international markets than in the domestic situation. In particular, these structural factors are more likely to be present in emerging markets because in such less-developed markets, more resources are likely to be scarce.
National and local governments and other regulatory bodies are far more influential in emerging markets (EMs) than in developed-country market systems. This reflects both the recent history of many emerging-market countries as command economies or closed markets and the desire of many host governments to build local business as the economy grows and FDI inflows increase, rather than allowing foreign firms to capture all the growth. On a more operational level, it also reflects the importance of government-led infrastructure projects in the early stages of development. The early establishment of relationships with government can result in tangible benefits such as the granting of one of a limited number of licenses or permits; China, for example, has decided to restrict the number of western MNCs to which it gives joint venture permits in many industries. In addition, many EM governments are still in the process of establishing a new pro-business regulatory framework for their countries, and MNCs already investing in an EM will clearly be favorably positioned to influence the regulation of the market in areas such as price control or the opening of communications media suitable for their promotional activities. On a more general level, early market entry may also demonstrate a commitment to an emerging market that wins longer-term government favor. Executives familiar with EMs invariably stress the greater importance of personal relationships with key local players (in both the public and private sectors), and MNCs that have participated longer in EMs can be expected to enjoy stronger and more favorable relationships than later entrants. First entrants also get access to the best government-nominated local joint-venture partners.
A substantial reservoir of pent-up demand for previously unavailable but known western brands may exist in EMs, offering a platform level of sales not available in the new product-market spaces assumed by most models of first-mover advantage. In former command economies, surplus (i.e., unsatisfied) demand had prevailed for many years in a “seller's market” in which choice was so restricted that cash was not spent. In addition, customers may already have been aware of the product, even though it was previously unavailable in their country, via international travel, international media, or informal channels. In many cases, therefore, conditions may be different from those encountered in the introductory stages of product life cycles in developed markets, where slow diffusion of product awareness and familiarity often result in slow sales take-off after launch. The distinctive conditions of EMs provide first entrants with a nonrecurring beachhead of sales, which can be expected to provide medium-term advantages through repeat purchase.
The low cost base of EMs has long been recognized in production location decisions, but it is also relevant to the timing of market entry. In this case, the relevant comparison is not only with global costs, but also with future costs. Low advertising rates per capita in EMs enable brands to be launched and brand awareness to be built very economically. Advertising rates increase rapidly with economic development; for example, they increased ten-fold in real terms in Poland within five years of the fall of communism. Lower levels of competitive spending in EMs can also mean that marketing investments produce higher levels of awareness, share of voice (the proportion of total promotion in the market accounted for by one firm or brand), or shelf space.
While an undeveloped marketing infrastructure is frequently used to justify delaying entry, it can also be seen as a plus. Resources such as distribution channels or media access are often more scarce in EMs. Although the number of managers with both emerging market and international experience is growing, it remains a constraint and thus a potential source of advantage to MNCs that have entered multiple EMs and have therefore developed an internal pool of managers with EM experience. This is a difference of degree rather than of kind; the preemptive advantage accruing from such factors is recognized in first-mover advantage research, but the effect is qualitatively more significant in EMs.
Assessment of foreign markets and estimation of international market potential constitute significant challenges that many internationalizing firms have failed to meet. It is critical that senior executives base their assessment on close analysis of a product-market rather than more general economic and demographic country data. Key points covered in this chapter include the following:
• The importance of forecasting demand as possible sales in a 3–5-year timeframe (as appropriate for the firm's planning cycle) rather than total long-run potential sales. This is one area of management in which a solely long-term focus can destroy value.
• The importance of gathering data at the product-market level rather than purely at the country level. The same country-market looks very different through the lens of different industries.
• The concepts of market drivers (the most influential elements of the marketing program) and enabling conditions (the critical success factors for that model). Again, these will differ significantly by industry.
• The importance of customized indicators for each firm; for example, the relevance of the average female secretarial wage for Mary Kay Cosmetics. Such indicators should be part of a multifactor database used for assessing market attractiveness.
• The value of market-based “bottom-up” sales forecast rather than a country-level “top-down” forecast. The former is usually more conservative and more accurate.
• A rigorous definition of first-mover advantage: it requires sustainable appropriation of a scarce marketing resource rather than simply an early entry. The scarcity of some marketing resources in emerging markets in particular make first-mover advantage a real possibility.
Porter Model: evaluation of Industry Forces
The Porter Competitive Model serves to better illustrate the factors that influence the cosmetics industry. It focuses on the five forces that affect any given company: Supply, demand, alternatives, risks, and the direct competition of the firm.
New domestic manufactures
Joint venture companies