• Small wonder that mature markets offer limited prospects for Hong Kong exports, amid an aging population, excessive supply of goods, market polarisation, retail concentration and rising protectionism.
  
  
• In tandem with their significant economic growth, emerging markets, typified by a rising middle-income class, urbanisation and retail modernisation, offer welcome new outlets.
  
  
• However, there are a number of challenges and risks, including market volatility, red tape, inadequate infrastructure and affordability problems in the emerging world.

The developed economies remain as the engine of global growth, but the demand from developed markets has been flattened because of an aging population, excessive supply of goods, market polarisation and retail concentration. Along with rising protectionism, these factors have limited the growth prospects and profitability for Hong Kong exporters selling their products there. Therefore, they are compelled to explore the emerging markets for diversification.

Indeed, the share of Hong Kong exports to developed markets has become smaller since the mid-1980s, declining from 67% in 1986 to 43% in 2006. On the other hand, the share of Hong Kong exports to emerging markets, including the mainland, increased from 33% to 57% during the same period.

With globalisation on course and Asia emerging as another engine for growth, China and India are the top two emerging markets. Countries which are rich in oil and energy resources, such as Saudi Arabia, the UAE and Russia, certain Central/East European countries, spurred by their integration into the EU, as well as some Latin America nations, helped by rising commodity prices, are other notable emerging markets.

In general, the rising middle-income class, along with urbanisation and modernisation of retail sectors, all unfold new dimensions for Hong Kong companies. Hong Kong businessmen should take hold of this opportunity to tap into emerging markets by direct contact with potential buyers and building their own brands, while increasing value-added in their supply chain and leveraging their sourcing capability on the mainland.

Notwithstanding abundant emerging opportunities, obvious pitfalls await the unwary. Hong Kong exporters should be prepared for, among others, market volatility, red tape, inadequate infrastructure, retail fragmentation and affordability problems in the emerging world.

1. Why Emerging Markets?

Despite their falling importance, the developed economies are still the engine of global growth. The demand from developed markets, however, has been affected by an aging population, excess supply of light consumer goods, a polarisation of income among consumers and concentration of retailers. The flattened mature markets, aggravated by the prevailing protectionist sentiment, have offered limited growth prospects for Hong Kong exporters, who are compelled to search for emerging markets for diversification.

Flattened Mature Markets

Aging Population

An aging population is a common phenomenon in the developed economies. For instance, 23% of Germany's population was aged above 60 in 2000, and the share of this age group is expected to increase to 33% by 2025. Likewise in Japan, 23% of the population was aged above 60 in 2005, which is forecast to expand to 34% by 2025. An aging population will eventually lead to slower economic growth and in turn softer demand for imports in general, and those targeting at the youth consumers in particular, although the expansion of the silver market may stimulate an appetite for products such as health care equipment, specialised furniture and communication aids.

Excessive Supply of Light Consumer Goods

While the world demand for light consumer goods will only increase moderately in the future, the rapid expansion in supply capacity because of the participation in globalisation by large developing countries, particularly China and India, will continue to enlarge the excessive supply. Apparently, intensifying competition in the global market has forced suppliers to lower their product prices and squeezed their profit margins. Hong Kong's traditional OEM manufacturers are especially vulnerable, as they mainly compete on prices rather than value-added.

Polarisation of Income among Western Consumers

The polarisation in income distribution of developed markets suggests that the middle-income class in our traditional markets either declines in its relative size or in its relative income. According to OECD, the Gini Coefficient for income among the working-age population in developed countries has increased significantly since the mid-1980s. With the shrinking of middle-income class in these traditional markets, it is necessary for Hong Kong companies to explore emerging markets, in addition to moving upmarket.

Concentration of Retailers

Aside from undesirable trends in the consumer market, developments in the retail industry of the developed world are by no means favourable. In general, the trend of concentration has been commonplace in the retail industry of developed markets for some time. Through restructuring and consolidation, these retailers have become larger in size, thus capturing economies of scale and wielding increased bargaining power with their suppliers. Though slowing somewhat in recent years, the concentration of retailers will continue in developed markets. The resulting stronger bargaining power will further eat into the margins of Hong Kong exporters.

Limited Growth Prospects in Developed Markets

Dwindling Profitability

The flattened mature markets, characterised by aging populations, excess supply, market polarisation and retail concentration, have evidently constrained the growth prospect in developed markets, with the profitability of selling there becoming less rewarding. Furthermore, trade imbalance and trade frictions with the Chinese mainland, and hence the prevailing protectionism sentiment in developed countries, have cast a long shadow on Hong Kong exports to mature markets, especially the US and the EU.

Trade Imbalance

To varying degrees, while the US and EU economies have been expanding at a healthy pace, sluggish performance of manufacturing jobs continues to be a serious concern. To complicate matters, the US and the EU have recorded growing trade deficits with China, particularly in the past few years. Such adverse developments have continued to fuel the protectionist sentiment in the US and the EU. As the mainland is by far the most important production hinterland for Hong Kong, any restrictive measures against the mainland will also affect Hong Kong exports.

Trade Frictions and Protectionism

China's trade frictions with major trading partners, especially the US and the EU, have never failed to catch the headlines of world trade news. Apart from textile safeguard quotas, anti-dumping actions against the mainland are a notable case in point. While for the world as a whole, the number of new anti-dumping initiations decreased from 312 cases in 2002 to 190 cases in 2006, the number of cases against China increased from 51 to 68 during the same period, making the mainland the top target for anti-dumping investigations, accounting for one-third of the initiations.

New Anti-Dumping Initiations

Source: WTO

The Case for Market Diversification

Growing Importance of Emerging Markets

Evidently, the emerging economies have shown a higher growth rate over the past two decades. Between 1980 and 2006, the average real GDP growth was 2.7% for developed countries, while developing countries recorded a growth of 4.6%. There is indeed growing importance of emerging economies to the global GDP. In 2005, it was the first time that emerging economies surpassed developed economies with respect to their shares of global GDP. It is further estimated that the emerging economies will take up 64% of the world's GDP by 2025.

Hong Kong's Experience

The share of Hong Kong exports to developed markets has become smaller since the mid-1980s, declining from 67% in 1986 to 43% in 2006. On the other hand, the share of Hong Kong exports to emerging markets, including the mainland, increased from 33% to 57% during the same period. Given the globalisation and liberalisation of many emerging economies, Hong Kong exporters are making inroads into the untapped markets around the globe. Due to its economic well-being, geographic proximity and cultural affinity, however, the Chinese mainland is often considered the most important market for diversification.

2. How are Emerging Markets Performing?

Thanks to globalisation, emerging markets have remarkable performance on economic growth. Evidence shows that globalisers in developing countries have recorded a faster growth than the non-globalisers. In terms of real GDP growth, China and India are the two top emerging markets in the world. The performance of oil- and energy-rich countries such as Saudi Arabia, the UAE and Russia is also noteworthy.

Globalisation and Development

The world has become a much smaller place over the past two decades. International trade has grown almost twice as fast as worldwide income during this period. The average growth rate of the world's GDP between 1981 and 2006 was 3.6%, while world trade grew by 6.1%. International trade, and globalisation in a bigger context, is a boon to the world. Increased trade generally goes hand-in-hand with more rapid economic growth and helps alleviate poverty, particularly benefiting liberalised emerging economies. Not surprisingly, the more liberalised emerging economies, known as globalisers, have faster growth than non-globalisers.

Uneven Performance: Globalisers versus Non-Globalisers

According to a World Bank study, globalisers refer to the top one-third of developing economies in which trade increased as a share of their GDP during 1980-1999. They, including China, India and many Asian nations, have experienced an increase in their real GDP per capita average growth rate from 2.9% a year in the 1970s to 5.0% in the 1990s. However, the non-globalisers had a decline in their real GDP per capita average growth rate from 3.3% during the 1970s to 1.4% in the 1990s.

Volatile but Robust Growth

While emerging economies have higher growth potential than the industrial countries, emerging markets are more volatile. For example, the frequent bouts of political instability in Africa and financial volatility in Latin America are the main challenges and risks. Hong Kong companies should continuously monitor the changing business environment of the emerging markets before doing business there. Although many emerging markets seem lucrative, Hong Kong companies need to assess their tolerance of risks before doing business there.

Top Two Emerging Markets: China and India

With globalisation on course and Asia emerging as another engine for growth, China and India, having a combined population of 2.4 billion, are fascinating the world with their vigorous economic growth. In 2006, while the GDP growth rate of emerging economies was 7.9%, China and India recorded the highest growth of 10.7% and 9.2% respectively. According to IMF, GDP growth of these two countries will remain strong in 2007, maintaining at 10.0% for China and 8.4% for India. Meanwhile, the growth rate of the world's GDP will slow down from 5.4% in 2006 to 4.9% in 2007. This makes the attractiveness of China and India's markets even more remarkable.

Other Emerging Markets

Apart from the vibrant Asian regions, emerging markets which are rich in oil and energy resources, such as Saudi Arabia, the UAE and Russia, have also recorded prominent economic growth. Surging oil prices since 2002 have evidently boosted oil export earnings, and in turn import demand for consumer products, as these countries have limited domestic production. At the same time, certain Central/East European countries, spurred by their integration into the EU, as well as some Latin American countries, helped by rising commodity prices, are other notable emerging markets.

3. New Opportunities in Emerging Markets

Spurred by fast economic growth, new opportunities abound in emerging markets. A rising middle-income class, urbanisation and modernisation of retail sectors all unfold new dimensions for Hong Kong companies. Now Hong Kong businessmen should find an exciting prospect for tapping into the emerging markets by direct contact with potential buyers and building their own brands, while increasing value-added in the supply chain and leveraging their sourcing capability on the mainland.

Rising Middle-Income Class

Although the definition of the middle-income class varies from one country to another, the overall picture is that it is expanding in emerging markets. According to McKinsey, the middle-income class in China accounted for 22% of the urban population in 2005, with monthly incomes exceeding US$640. It is forecasted that by 2025, 79% of its urban population will belong to the middle-income class. In India, 56 million Indians belonged to the middle-income class in 2005, with monthly incomes between US$360 - US$1,800. By 2025, it is estimated that the middle-income class in India will amount to over 580 million. Little wonder that the rising middle-income class in emerging markets will present greater opportunities for Hong Kong products.

Urbanisation

Urbanisation is a process characterised by a growing portion of a population living in cities, which are ideal places for promoting consumer products and the targets for Hong Kong companies. Not unexpectedly, urbanisation has been closely connected with economic development. In most cases, as an emerging economy develops and industrialises, the urbanisation rate will increase. In China, for instance, the urbanisation rate expanded from 18% in 1978 to 43% in 2005. Yet, there is still much scope for further urbanisation as compared with other developed economies. Interestingly, the second- and third-tier cities in China have been urbanising much faster than the first-tier cities in recent years. Therefore, Hong Kong suppliers should also keep an eye on these cities, in addition to the first-tier cities.

Modernisation of Retail Sector

In emerging markets, an increase in incomes among consumers is also bringing about the advent of retailing. Traditionally, the retail market of emerging markets has been disorganised, marked by a large number of individuals and small retailers. With the growing attractiveness of emerging markets, however, many international retailers, including chain stores, department stores and hypermarkets/supermarkets, are making a direct presence there. Local new players are also springing up, while old ones are undergoing dramatic changes. Many of them have refurbished their retail outlets and upgraded their shops to have a modern look. Many budding retailers in emerging markets are looking for quality products at competitive prices, at which Hong Kong companies excel.

Direct Contact with Retailers/Distributors

Along with modernisation of the retail sector, import channels have also evolved in emerging markets. In general, retailers and distributors are growing in size, and they are able to place orders for consumer goods directly with foreign suppliers, including Hong Kong exporters. In the meantime, some smaller retailers may form buying cooperatives for collective sourcing from overseas suppliers. All these will certainly furnish Hong Kong exporters with added channels for penetrating emerging markets.

Opportunities to Build a New Brand

In general, emerging markets are more receptive to new brands. But even with the rise of the middle-income class, only the high-income group can afford high-end international brand products, and value-for-money products are thus chosen in most cases. It follows that it's opportune for Hong Kong companies to develop their brands with value-for-money attributes, characterised by good product quality at affordable prices. To be sure, as the retail market is now more organised, brand promotion has become increasingly feasible in emerging markets.

Increase Value-Added in Supply Chain

Given the low value-added of production, Hong Kong companies need to increase value-added in the supply chain to strengthen their competitiveness. In particular, because of the low value-added in OEM, Hong Kong companies are advised to engage in design and brand development. Indeed, many importers in emerging markets are looking for ODM rather than OEM products, and some are willing to purchase manufacturers' own branded items, as they do not want to invest too much in product development, thus creating opportunities for Hong Kong companies to promote their ODM and OBM products to the emerging markets.

Leverage Hong Kong's Sourcing Capability on the Mainland

As a matter of fact, many buyers in emerging markets have increased sourcing from the mainland, as the cost of mainland-origin products is competitive. But while most of these buyers believe in China's strong production capability, not many of them have a clear understanding of how to locate and deal with suppliers on the mainland. In this regard, Hong Kong has an edge in acting as a sourcing platform for buyers in emerging markets because Hong Kong, with its cluster of traders and manufacturers, is well known for its professional management skills, quality control and provision of customised sourcing services.

4. Challenges and Risks in Doing Business in Emerging Markets

While emerging markets have impressed the world with their remarkable economic growth and business opportunities, there are a number of challenges and risks of which Hong Kong companies should be aware.

Political, Economic and Financial Volatility

Political instability is one of the key concerns of doing business in emerging markets. For example, Thailand's coup d'état, which took place in 2006, has made business conditions there more complicated. Moreover, although the economic growth of some emerging markets is remarkable, it may fluctuate rigorously from time to time. The recent economic and financial crises in Argentina and Turkey are cases in point. The vagaries of the emerging economies, in tandem with their exchange rate volatility, are set to increase the challenges and risks in doing business in the emerging world.

Red Tape, Corruption and Protectionism

The immature government structure in emerging economies has usually created layers of bureaucracy which lead to red tape and corruption. In India, for instance, the layers of bureaucracy (over 18 million public employees) affect 28 States, seven Union Territories and 602 Districts. Along with considerable corruption risks, red tape is a major hindrance to doing business there. In customs clearance, delays caused by "procedural formality" are not uncommon. Indian customs officers are also given wide discretionary power in determining the suitable value of imports. Sometimes, emerging markets, in order to protect their own industries, may further impose restrictions against imports, thereby curtailing market access of Hong Kong products.

Inadequate Infrastructure

Most emerging markets have poor infrastructure to cope with expanding trade volume. For example, St. Petersburg's ports in Russia have nearly reached their full capacity. Local trucks may have to wait for two days to get containers loaded on their trailers. The under-development and insufficiency of port infrastructure have been a constraint to the growth of cargo handling, and may lead to costly transportation, long transit time and possible delays in shipment. Taking commercial buildings in Vietnam as another example, it is reported that among the very few buildings that are over four to six floors and fit for commercial use, 5% should be demolished and 62% are in need of upgrade. The lack of transportation infrastructure and, to a lesser extent, access to commercial properties, are other challenges for Hong Kong traders.

Fragmented Retail Sector

Despite the advent of modern retailing, the retail sector in many emerging markets is still dominated by individuals and small retailers mainly selling lower-end items. It is difficult for Hong Kong companies to sell their products to emerging markets because these large number of individuals and small retailers have very limited foreign trade experience, and are financially weak and only able to place small orders at low prices. A notable example is India, where organised retail accounts for less than 5% of nationwide retail sales. To make matter worse, product counterfeiting is common among emerging markets.

Difficulties in Differentiating Hong Kong Products from Mainland Products

For selling non-branded goods produced on the mainland to emerging markets, Hong Kong companies need to be aware that the "made in China" label is still associated with a negative image. This is because a large amount of poor-quality Chinese products were exported in the past. In addition, it is almost impossible to differentiate products made by Hong Kong companies from their mainland counterparts as both are produced in the Chinese mainland. Using the "made by Hong Kong" label to distinguish Hong Kong products from their mainland counterparts may be somewhat helpful. In fact, many traders and importers from emerging markets are yet to fully appreciate Hong Kong suppliers' contributions and value-added.

Affordability

Due to the rise of the middle-income class, stylish and quality products selling in mature markets are increasingly sought after in emerging markets. Paradoxically, the purchasing power in the emerging markets is still low when compared with the mature markets, and value-for-money remains the tenet. In this regard, Hong Kong exporters can choose to offer their customers in emerging markets quality products similar to those offered to mature markets, but with appropriately reduced features and product content in order to adapt to the market situation. In addition, warranties and after-sales services should be made available as quality assurance, especially for technically complicated products like electronics and electrical appliances.

5. Conclusion

There is little doubt that mature markets, while remaining an important stimulus to world economic expansion, will present limited growth prospects for Hong Kong exports. For exporters stymied by protectionism, narrow profit margins, intensifying competition and an unassuming demand in mature markets, emerging economies offer welcome new outlets, which are typified by a rising middle-income class, urbanisation and retail modernisation. Despite abundant emerging opportunities, however, obvious pitfalls await the unwary. Hong Kong exporters should be prepared for, among others, market volatility, red tape, inadequate infrastructure, retail fragmentation and affordability problems in the emerging world.

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