The most important feature of any market is the ease with which buyers and sellers can come together to do business. In developed markets, arange of specialized intermediaries provides the requisite information and contract enforcement needed to consummate transactions. Most developing markets fall short on this count.
Investors and companies quickly realize that these regions do not have the infrastructure, both physical and institutional, needed for the smooth functioning of markets. It is difficult for buyers and sellers to access information to find each other and to evaluate the quality of products and services.
When disputes arise, there are limited contractual or other means, such as arbitration mechanisms, to resolve these issues. Because of a tremendous backlog of cases, resolving disputes in Indian courts, for example, can take five to fifteen years.3 Some joke that if you litigate here, your sons and daughters will inherit your dispute.4 Anticipation of these transactional difficulties also hinders contracting.
We use the term institutional voids to refer to the lacunae created by the absence of such market intermediaries.5 To understand institutional voids in more concrete terms, consider the plight of an independent traveler from the United States visiting an emerging market on vacation.
Beyond the challenges of operating in an environment having a different language, culture, and currency, the traveler also must navigate a different way of doing business, even as a tourist. Accustomed to booking flights through Expedia, Orbitz, or Travelocity, choosing hotels based on easily accessible and reliable reviews, obtaining travelplanning assistance from the AAA, paying for goods and services with a credit card in virtually any location, purchasing goods that meet enforced regulatory standards and possess enforceable warranties, paying taxi drivers according to standardized rates, receiving flight status updates by mobile phone text message, and finding restaurant phone numbers by simply dialing 4-1-1, the traveler must adapt to a different environment in the emerging market.
Although they might come in different forms, most other developed markets, such as European countries or Japan, have a comparable tourism market infrastructure to that of the United States. The institutional arrangement of an emerging markets travel and hospitality marketplace, however, differs in fundamental ways.
Internet-based airline ticket vendors, published travel reviewers, telephone directory assistance providers, credit card payment systems, and other such intermediaries are businesses, but they are also part of the US market infrastructure.
They help bring together buyers and sellers of travel services. (Nonprofit organizations, such as AAA, can also serve as market intermediaries, and governments provide many intermediary functions through regulatory bodies and civic services.) In developed economies, companies can rely on a variety of similar outside institutions to minimize sources of market failure.
Emerging markets have developed some of these institutions, but missing intermediaries are a frequent source of market failures. Informal institutions have developed in many emerging markets to serve intermediary roles. To reach rural consumers in India, for example, many brands rely on traveling salespeople to promote products in villages that have limited television, radio, and newspaper penetration.
Salespeople stage live, infomercial-like performances out of the backs of trucks, explaining products while entertaining crowds with skits and banter.
One such salesman, profiled in the Wall Street Journal, traveled more than five thousand miles per month, moving from village to village pitching products as wide ranging as tooth powder and mobile phones.6 Although some informal institutions may look like functional substitutes for the intermediaries found in developed markets, they often exist on an uneven playing fieldaccessible only to certain local players.
A local loan provider might seem like a substitute for a venture capital industry, but only if the loan provider evaluates applicants on their merits or business plan. Seldom are informal market intermediaries truly open to all market participants.
Institutional voids come in many forms and play a defining role in shaping the capital, product, and labor markets in emerging economies. Absent or unreliable sources of market information, an uncertain regulatory environment, and inefficient judicial systems are three main sources of market failure, and they make foreign and domestic consumers, employers, and investors reluctant to do business in emerging markets.
When businesses do operate in emerging markets, they often must perform these basic functions themselves. Institutional voids, however, are not only roadblocks. They are also palpable opportunities for entrepreneurial foreign or domestic companies to build businesses based on filling these voids.
To return to the example of the travel industry, Ctrip.com has emerged as Chinas leading travel booking Web site, offering services similar to those of Expedia, Orbitz, and Travelocity.
Established in 1999, Ctrip.com fills voids by aggregating hotel reservation and airline ticket information, providing rates and schedules, and offering a platform for customers to complete transactionsa powerful proposition in a market without a well-developed network of alternative intermediaries, such as travel agents.7 Ctrip.com registered $210.9 million in revenue in the year ending September 30, 2008, with a profit margin of 31.8 percent.8 Listed on NASDAQ, the company had a market capitalization of $1.3 billion as of January 13, 2009.9 The significant value that can be created by intermediary-based businesses illustrates the importance of such market institutionsand the cost of their absence.
Transaction costs in markets, the role of market institutions in mitigating them, and the challenges of designing market institutions have been analyzed by several Nobel Prizewinning economists: Ronald Coase, Douglass North, George Akerlof, and Oliver Williamson.