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The emerging middle class

Consumers in the west have never had it so bad but the middle class is expanding at an exponential rate across many developing economies, finds Phil Thornton

TO MISQUTE the late prime minister, Harold Macmillan, middle-class consumers in the west have never had it so bad. Rising unemployment, stagnant wage growth and soaring inflation means the average UK household will be less well off in 2015 than it was in 2003.

However, while the middle class is squeezed in the UK, it is expanding at an exponential rate across many emerging and developing economies.

The World Bank estimates the global middle class will treble from 400 million people in 2005 to 1.2 billion in 2030, driven by above-average population growth and rapid economic development in Asia and Latin America. Since it defines the middle class as having at least as much income as the average Brazilian, this translates into a massive rise in spending power.

Jon Copestake, chief consumer goods analyst at the Economic Intelligence Unit, says the critical change is when consumers’ income reaches a “tipping point”.

“This is when your disposable income reaches a point at which you can buy more goods than the basics for life such as food, water and clothing,” he says.

As the World Bank sees it, these families can now “buy cars, engage in international tourism, demand world-class products, and require international standards for higher education”.

Spending boom

Over time this aspirational attitude translates into high spending. McKinsey & Co, the consultancy, estimates the global middle class spent $6.9tn (£4.5tn) in 2010. It forecasts this figure will rise to $20tn during the current decade – about twice the current expenditure level in the US.

This is a vast and important market for western companies, particularly at a time when domestic demand is so weak. The $6.9tn question is how best to exploit it.

So far, luxury goods companies seem to be leading the way. Walpole, a not-for-profit organisation, forecasts UK luxury goods companies will expand by 57% to reach £9.4bn by 2015 after posting growth of 11% last year.

“Retailers in London particularly are doing extremely well in the luxury sector because of demand by the Chinese for brands such as Burberry, Mulberry and Jimmy Choo shoes,” says Mark Henderson, a director at Walpole.

Rahul Sharma, managing director of retail consultancy Neev Capital, says emerging markets make up more than half of the profits for luxury goods manufacturers.

“The attraction is that because they sell to a small upper-middle class population, luxury goods tend to be priced at a premium of almost 25%,” he says. “This is very different from the mass-market story.”

Nevertheless, the longer-term focus will be on household goods such as cars, personal care products and consumer electronics; goods that western families take for granted.

“As incomes rise, consumption habits become increasingly sophisticated,” says Jonathan Jackson, head of equities at stockbroker Killik & Co. “Once consumers enter the middle class income bracket, their spending shifts towards lifestyle-oriented discretionary goods and services, with increasing amounts of money being spent on personal care, entertainment and fashion.”

Jackson says China, which is forecast to see 100 million households join the middle class over the next decade, will be one of the most important markets. He believes companies such as Richemont, the luxury goods giant, carmaker VW Group, L’Oreal and Intercontinental Hotels Group are well placed to capture the long-term growth in Chinese consumer spending.

Chinese tourism is likely to be a strong contributor to global demand. Deloitte predicts that by 2015 the Chinese and Indian tourism industry will be greater than that of the UK, France or Japan.

“The greatest future potential in these markets will lie in developing mid-market and economy-branded products aimed at the domestic traveller,” says Alex Kyriakidis, global managing director of tourism, hospitality and leisure.

Latin American growth

But China is not the only fast-growing economy and Jackson says the analysis can be applied to the rise in the middle class in other countries.

An interesting example is Brazil where there has always been a small traditional, wealthy middle class and a large poor working class making up half the population.

However, according to Brazil’s Center for Social Policies (CSP), the “new” middle class ballooned from 37% of the population in 2003 to just over 50% by 2009. As a result, they now have a greater purchasing power then their richer counterparts.

“From the standpoint of economics, this is the dominant class,” says CSP director Marcelo Neri.

This underpinned a quick uptake in the sales of consumer electricals. The number of homes with a washing machine rose from 33% in 2003 to 44% in 2009. The share with a fridge rose from 86% to 94%.

So far there is little evidence UK companies have responded to this opportunity. While imports by the eight fastest-growing economies – the BRICs plus Indonesia, South Korea, Mexico and Turkey – surged by 15% a year over the last decade, UK exports grew just 3.5%.

Peter Simons, a technical specialist at the Chartered Institute of Management Accountants (CIMA), says it is the role of the finance function to identify long-term opportunities as well as coping with short-term challenges.

“It would be great if they could point to an office in China or Brazil and say ‘this is going really well’, but the chances are they don’t have one,” he says. “But we can look at our competitors and what’s working for them or at analysis from other sectors to see what is working for other businesses that we might transfer.

“That’s when you think that maybe we are missing an opportunity that others are exploiting.”

Key strategies

However, when it comes to harnessing growth opportunities in developing countries, companies need different strategies to match goods with local income levels and domestic tastes.

In India, Unilever sells single sachets of shampoo and mini-soaps for a few rupees while in Brazil it has designed a detergent especially for use in river water rather than by washing machine.

Neev Capital’s Sharma says shampoo sachets worked well in India by attracting people in rural areas that were not used to putting anything in their hair.

“It could be priced really low so it was affordable and because of that it meant that people were not worried about trying it once and seeing if they liked it,” he says.

India has been a test bed for affordable products such as Tata’s Nano car, the cheapest in the world, and a $30 mobile phone handset. “This combination of volume and affordable pricing is driving innovation,” Sharma says.

In rural China, Coca-Cola introduced slightly smaller and cheaper bottles that people had to drink on the spot, so they could return the bottle immediately.

Meanwhile the widening access to media in countries such as India means that companies can lodge their brands in consumers’ minds even before they can afford them.

Sharma adds: “A construction worker in Mumbai might be wearing a fake Nike T-shirt. He is aware of what the brand is and when his income allows, he will trade up to the real thing.”

However, several pitfalls await Western firms. Sharma highlights the move by Kingfisher into China with the launch of DIY stores aimed at home owners.

The hitch was that low labour costs meant the Chinese middle-class paid people to do the work rather than do DIY. “It was a case of not understanding the consumers,” says Sharma.

The EIU’s Copestake says while markets are diverse, one common lesson for multinationals is find a local partner to work with.

“This has been tried and tested with food and drink. It is because partners can give advice on market pitfalls and how to adapt products to the market,” he says.

This can mean reconfiguring the business model – much to the dismay of the CFO – to tap into what seems to be a relatively small market.

“You can’t just go in with a product as you would in London or the US as a means of obtaining success,” Copestake says. “It’s not a quick fix. These firms are spending millions on R&D to get the potential of the market. That’s why it is so important to engage a local partner.”

CIMA’s Simons warns this can be a “double-edged sword”.

“There’s always the danger that people don’t have the same understanding of intellectual property,” he says.

Service opportunities

While multinationals have been focused on growing the markets for goods – both luxury and day-to-day – services may offer the next phase of opportunities.

As well as a growing market for goods, the emerging middle class is also on the lookout for western services, technology and know-how.

The CSP report shows the number of Brazilian households with a computer and internet access has doubled since 2003. Direct rubbish collection and the provision of sewerage systems have shown a noticeable increase. More significantly, as households become richer they will start to prioritise education and better healthcare, which will open up whole markets for western companies.

The CBI highlights financial services, construction, high-tech goods and telecoms as sectors that between them could be worth a 1.5% lift – or £20bn – to UK GDP by 2020.

“As living standards rise, this demand will be increasingly channelled towards goods and services more traditionally associated with consumers in more mature economies,” the CBI said in a recent report.

The long-term goal for companies is to ensure they develop a good position in the market ahead of long-term rises in coming years.

“The most important thing is brand and brand sentiment,” Copestake says. ?


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