UNC Kenan-Flagler Insights

Lessons for multinationals targeting emerging economies

January 5, 2011 By Heather Harreld

indianstreetvendorBig-box retailers might have a lot of pull in western economies. But small merchants are nonetheless the dominant form of retailing globally, and businesses of all sizes can stand to learn quite a bit from them about making inventory decisions in emerging economies based on heuristics and not sophisticated analytical techniques.

Sridhar Balasubramanian, associate dean of the UNC Kenan-Flagler MBA program and associate professor of marketing, recently co-authored research that explores the practices and performance of small retail stores in Brazil and other emerging economies.

The study was conducted over several years with co-author Tomasz Lenartowicz, associate professor of international business at Barry Kaye College of Business at Florida Atlantic University.

One of the reasons Balasubramanian and Lenartowicz decided to focus on small retailers is that the bulk of the research that’s been conducted on retailers has largely been centered in developed economies where electronic transactional data is far more prevalent.

Yet changes in the global economy have driven a need to examine how business is conducted in emerging economies more closely, says Balasubramanian. Developing economies now produce 41 percent of the world’s output, and 5 of the 12 largest economies are now in the developing world.

“We thought that was a very under-studied market,” says Balasubramanian. “We were fascinated by the way small retailers in emerging economies make decisions. A deep dive on how they make those decisions has been lacking, and this study fills the gap in the global research arena,” he adds.

For instance, most large retailers operate with a sizeable cash buffer to buy goods or receive goods on credit while small retailers in developing economies have very little capital and cash. The differences in those dynamics “changes the strategy behind how you conduct ordering and obtain payments,” says Balasubramanian.

Overall, the study notes that small retailers operate very efficiently and perform well financially despite having very little infrastructure in terms of IT, transactional databases or sophisticated algorithms for decision making. The key is that most small retailers rely predominantly on heuristics in determining what to order, how much to order and when.

“Typically, what happens is that in developed economies, the salesperson or store owner looks at the stock and uses simple heuristics to determine what to order,” says Balasubramanian. “’I sold 15 bars of soap, let me stock 20 for a buffer of 5’,” he adds.

The Role of Heuristics

Although small retailers typically don’t rely on sophisticated algorithms or analytics to determine who their buyers are or to segment products sold against certain types of consumers, their simple use of heuristics, or experience-based methods of determining inventory levels, tends to work very efficiently for them, says Balasubramanian.

That’s because most small retailers in congested urban locations such as Sao Paolo cater to shoppers who live in the same neighborhood and tend to frequent their stores on a regular basis. As a result, the store owners tend to develop strong, close-knit relationships with many of their customers, many of whom they’ll often deliver goods to. Through these interactions, small store owners learn through repetition what their customers are buying and the frequency in which certain items are being sold.

A heuristics-led approach results in very efficient inventory turnover ratios since smaller retailers are able to maintain low levels of inventory and restock them often. As a result, small retailers aren’t locking up their limited cash reserves in large quantities of inventory, says Balasubramanian. “This comes very close to a Just-in-Time inventory environment,” he says. “The supply is very closely tailored to demand, and the inventory turnover ratios are extremely economical.”

Small retailers have created big headaches for multinationals as they enter developing economies. Giant retailers are accustomed to dealing with large scales of economy and relying upon logistics and extensive supply-chains. But those approaches don’t lend themselves to operating in congested urban areas, says Balasubramanian.

For starters, big retailers looking to open mega-markets that are aimed at drawing consumers through a large variety of goods offered at low prices have difficulty attracting many low-income consumers who lack access to transportation for reaching outlets located several miles outside of a city, says Balasubramanian. “In some cities, driving 15 miles can take an hour and a half,” he says.

Meanwhile, multinationals are hard-pressed to open outlets in congested urban areas since it’s not only difficult to find space there but the means for delivering goods through crowded streets is often done by bicycle, he adds.

“Last mile issues are more of a challenge for large retailers,” says Balasubramanian. By comparison, smaller retailers with relatively tiny footprints are able to rely on goods being delivered by bicycle or on foot.

Opportunities for Multinationals

In order to compete and succeed in emerging economies such as Brazil, India and China, Big-Box retailers need to focus on upper income classes, says Balasubramanian. “They need to create enough space where people can easily park, which is a huge issue in congested, developing economies,” he says. “Large retailers also need to create a shopping experience where consumers are able to buy all they need from a single location with good variety, a clean shopping environment and the ability to travel fairly easily,” he adds.

Although there are vast cultural differences between geographies such as Brazil and India, there are also quite a few similarities between how small retailers operate across different regions. For instance, whether in Mumbai or Rio de Janeiro, urban regions are typically dense with a high concentration of retailers. “They’re often unorganized and unsophisticated, but what they provide to the customer is easy access, a fairly wide range of goods in a small space and reasonable prices,” says Balasubramanian.

Balasubramanian and Lenartowicz also found that as the store standard increases, the use of heuristics becomes less important. For instance, gas stations, bakeries and supermarkets located in good areas are considered high standard stores. “These are the most sophisticated stores with good locations,” says Balasubramanian. “As stores become more sophisticated, the role of heuristics drops.”