Innovative Asia: The next six billion ::CLSA

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The next six billion
Innovation is helping companies - local and MNCs - to reach out to six
billion consumers in the developing world. This is not about technological
breakthroughs yet, but incremental changes to and/or development of
products and processes that address specific issues, like affordability and
accessibility. But there are challenges. Emerging-market firms have limited
appetite for R&D and MNCs have legacy issues. We highlight 12 focus stocks
that we believe will remain in leadership positions on the back of innovation.
Emerging hotbeds of innovation
 Emerging markets (EM) are coming out of the shadows of the developed world to
rival the rich nations in business innovation.
 Business innovation occurs in three areas - product, process and business model.
 Chindia will see a coming wave of innovation, as companies such as GE, P&G,
Haier, Huawei and Tata engage in frugal engineering or reverse innovation.
 These low-cost products also open up new markets in the developed world.
Drivers of innovation
 Indigenous innovation was borne out of Asian governments’ initial desire to pursue
import substitution strategies.
 A transfer of knowledge is happening, with MNCs setting up R&D centres in Asia,
which is seeing rising educational standards and increasing patent applications.
 Other drivers are rising consumption in EMs, lower R&D costs, faster growth in
developing markets, availability of trained manpower and improved infrastructure.
Challenges
 Although improving, Asia still ranks low on Intellectual Property Rights.
 Despite increasing number of educational establishments, industry-academia
linkages remain a challenge and so is Asia’s rote learning.
 Early stage funding remains a constraint, while MNCs face internal resistance to
moving R&D to the EMs; EM companies have low appetite for long gestation R&D.
Investment implications
 We highlight 121 innovative Asian companies that we regard as innovative;
technology firms makes up just over 20%.
 By market, Japanese companies have the highest representation (23%), followed
by China (17%) and Korea (16%).
 Our focus list of 12 companies have ROE averaging 27% and valuations are
undemanding with an average PE of 10.4x one-year forward earnings.
Innovation, the daughter of necessity
Innovation is the specific instrument of entrepreneurship. The act that
endows resources with a new capacity to create wealth.
Professor Peter F Drucker, 1909-2005
The emerging world is coming out of the shadows of the developed world to
rival the rich nations in business innovation. Business innovation is not about
technological breakthroughs, but about incremental changes to products, new
product development, business process changes that address specific
requirements of developing markets, particularly related to affordability and
accessibility and also at times, development of new business models that
cause paradigm shifts in certain industry or specific segments of an industry.
Global MNCs have traditionally approached the developing world with a
glocalisation approach, one based on the tweaking of products developed for
home markets to suit the needs of emerging markets. However, even though
the developing world has 5.7x as many people as the developed world, with
just a quarter of their income, affordability remains an issue.
A new wave of reverse innovation is afoot with the likes of GE’s low-cost portable
ECG machines and Tata’s Nano. As emerging market companies engage in frugal
innovations that may find their way back to developed markets; MNCs that
choose to overlook reverse engineering do so at their own peril.
Emerging markets, once seen as a source of cheap labour in the 80s and 90s,
are no longer just a place for production anymore. With 5.8bn potential
consumers, they are accounting for an increasing share of revenue for many
MNCs and at the margin; they will be the drivers of any incremental growth.


Governments in Asia already recognise that innovation is the key to raising
productivity and moving up towards more value-added production. They are
spending high levels on R&D, mimicking the trend of Western government
spending in the 80s which saw a subsequent productivity boom in the 90s.
The transfer of knowledge has already begun, with cheaper costs enticing
MNCs to set-up R&D centres in the region. This, coupled with a focus on
raising educational standards, sets the stage for future indigenous innovation.
Scalability of home markets overcomes the initial inertia of private sector R&D
expenditure and indigenous business innovation is already happening in
companies such as Haier, Huawei and Tata. These companies are introducing
product and service offerings at new price points with customised features
that are dominating their local market while opening up new ones in the
developed world.


Of course there are numerous challenges ahead: Legacy MNCs face internal
resistance against shifting operations to emerging markets while even Asian
companies face talent shortages and IPR issues and a lack of early stage funding.
We have interviewed corporates, consultants and academic institutions in
China, India and the USA to better understand the process of business
innovation that is taking place in emerging markets and highlight 121 publiclisted
companies that can be described as innovative. Here, we include
innovative companies that have adapted technologies or business approaches
to make their product more attractive and/or broadened their market.
While the list of companies that are innovators is a long one, the stocks that
investors should focus on for returns on the back of Asian innovation is a
shorter list. We focus on a list of companies that have ROE higher than their
cost of equity, where we believe they should remain in a leadership position
on the back of innovation and valuations are undemanding with PE multiples
at 15x or lower on forward earnings.