Insights for innovating in emerging markets: Integrate, or outsource?

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Dec 6, 2018

In this five-part series, Five insights for innovating in emerging markets, I explore several insights, one by one, that my research has uncovered for innovators interested in emerging markets. This is part four of the series, based on an earlier blog.

I grew up in Nigeria, the most populated country in Africa. Home to approximately 200 million people, Nigeria is classified as a lower-middle income country by The World Bank. And as is the case with many poor countries, there is a dearth of basic infrastructure such as electricity.

I remember inhaling the fumes and hearing the sound of loud generators in our neighborhood whenever the national electricity company would cut the power supply. The electricity company did not have the capability to generate or distribute enough power to meet the needs of the country. And so, unable to get a predictable source of power from the grid, people had to generate their own by developing independent solutions for electricity. They had to integrate power into their homes by purchasing a generator and fuel (typically diesel or gasoline). The electricity from the grid was simply not good enough.

When I moved to the United States for college, the situation was different. The power from the grid never went out, except in times of severe weather. And in the rare occasions when there was a power outage, customers were informed of when to expect their power back.

The electricity that Americans got from the grid was reliable and predictable—Americans could simply plug into it, and had essentially “outsourced” it. The electricity from the grid in Nigeria was unreliable and unpredictable. As such, people had to come up with their own solutions.

This simple illustration can help us understand when firms should integrate their operations or outsource to outside suppliers.

The “should I integrate” test: Is my product specifiable, verifiable, and predictable?

Organizations perform a myriad of connected activities such as design, sourcing of raw materials, manufacturing, testing, distribution, marketing, sales, after-sales service and support, and so on. Each step adds some value to the finished product.

Before an organization chooses to outsource any of these activities to outside suppliers, it should start by asking itself whether the activity meets the following standards:

  1. Specifiability. The standards must specify all the critical design elements for producing desired outcomes.
  2. Verifiability. There must be a way to verify that the standards are met.
  3. Predictability. A system that is verified to meet the standards must produce the desired outcomes with a high degree of predictable success.

If the interface isn’t specifiable, verifiable, or predictable, then the organization must integrate that particular operation by handling it in-house. For example, if the organization cannot rely on distribution companies to get its product to retail stores for sales in a specifiable, verifiable, and predictable manner, then the organization is better off developing its own distribution channel. Alternately, if the organization cannot depend on external retail outlets to sell its products in a specifiable, verifiable, and predictable manner, then the organization is best served by developing its sales channel.

Note that this is the same question many Nigerians intuitively ask themselves before purchasing generators. Can I depend on the electricity provided by the national power service to be specifiable, verifiable, and predictable? Since there are many unpredictable power outages, and power is necessary for them to lead productive lives, many choose to purchase generators.

The performance-limiting activity check test

The second test organizations should perform before they choose to outsource any activity in their product’s value chain is the performance-limiting activity test. In many products, especially at the onset of their introduction to the market, there’s usually an activity that limits the performance of the product—and thus has the most room for improvement. Organizations should be careful not to outsource this activity. Consider the case of IBM and personal computers (PC).

When IBM got into the PC business, it effectively put into business Microsoft and Intel. By outsourcing two critical “performance-limiting” activities—microprocessor design and manufacture and operating system and productivity software—to the two organizations, IBM inadvertently passed on most of the profits that came from selling a PC to both organizations. Because microprocessors, at the time, were slow and had much room for improvement, Intel was able to charge more money as it improved its processor speed. The same goes for Microsoft Windows and Microsoft Office suite of software. Those products were the “performance-limiting” components in a PC. In other words, a PC was only as good as its processor speed and its operating system and software productivity tools. It didn’t matter how beautiful it looked, how fast it was delivered, or how light or heavy it was. The limiting factors were the speed and what it enabled users to do. Organizations should be careful not to outsource such activities.

Innovating in emerging markets comes with a unique set of challenges, such as lack of adequate infrastructure, a small group of reliable suppliers, and a dearth of technical expertise. But with an understanding of when to outsource, and when to integrate, organizations are more likely to see their products succeed, sometimes even creating new business opportunities in the process.

For more, see:

Insights for innovating in emerging markets: There are 2 types of economies

Insights for innovating in emerging markets: Pull, dont push

Insights for innovating in emerging markets: IdentifyingJobsopens up innovation opportunities

Efosa Ojomo is a research fellow at the Clayton Christensen Institute for Disruptive Innovation. Efosa’s work focuses on using disruptive innovation theory to fundamentally change the discourse in the global development community, thus enabling nations to engender their own path to long-term growth and prosperity.