Emerging cities are creating new consuming class (2)

In last week’s column I focused on the global wave of mass urbanization, with more than half of the world population now living, for the first time in history, in towns and cities, generating more than 80 percent of global gross domestic product (GDP). The 21st century is often referred to as the century of cities, highlighting their importance as economic growth poles.
Against that background I began to review the McKinsey Global Institute (MGI) report “Urban World: Cities and the Rise of the Consuming Class.” I summarized the report’s main projections of the global demographic and economic evolution of cities from 2010 to 2025.

The report’s major implication is that when we react to the global wave of mass urbanization our focus has to shift (1) from national economies in the aggregate to urban centers and regions in forensic detail and (2) from high-profile megacities, today’s economic heavyweights, to rising middleweights with current populations of less than 10 million — but with greater potential in terms of demographics, households and incomes — especially those in emerging market economies (EMEs). According to the UN’s “2011 Revision of World Urbanization Prospects,” the population of İstanbul, Turkey’s only megacity, is projected to increase 36 percent by 2025, but the population of middleweights such as Antalya, Gaziantep and Konya are projected to rise by more than 45 percent.

Urbanization, as it raises the demand for discretionary goods and services, puts severe stress on the supply side, particularly by requiring investment in the construction of buildings and infrastructure, including ports and municipal water supply. The report estimates that the required annual physical investment will soar from nearly $10 trillion to more than $20 trillion in the next 15 years. By 2025, cities will have to construct additional floor space equivalent to 85 percent of the current stock of residential and commercial buildings. The urban building boom will require cumulative investment, including replacement of old structures, of almost $80 trillion, most of it in EMEs. The capacity of ports to accommodate growing container traffic will have to increase to more than two-and-a-half times today’s level, and EMEs will account for 85 percent of the $200 billion investment required for the expansion of port capacity by 2025. The demand for municipal water will rise by almost 80 billion cubic meters, equivalent to more than 40 percent of today’s urban global level. Cumulative investment in water supply and waste water treatment will total more than $480 billion, close to half of it in EMEs, by 2025.

As the speed and composition of growth in demand for goods and services will vary across different industries and products, companies will have to identify the right micro-market opportunities at the city, not the national, level, to meet that demand. For this, the MGI has developed — based on McKinsey’s granularity of growth research — a three-step approach: (1) Understand specific market growth drivers; (2) predict the evolution of markets using forecasting formulas; and (3) conduct sensitivity analyses and assess local market conditions. The report illustrates this approach in terms of five businesses with different underlying demand drivers, and thus varying rankings of cities as potentially attractive markets: Medical devices for old people, baby food, laundry care products, commercial building construction and water-related infrastructure.

Companies that successfully reposition themselves in fast-growing urban markets will outperform their rivals. That requires companies to view the global economic geography at a granular disaggregation level since many of the rising middleweights are not yet household names. Combining market intelligence at such a level with company-specific data on the potential of different urban centers is costly. So the report suggests a strategy for many companies that are not yet truly global, as a replacement for their country-level strategy, based on clusters of cities — groups of target cities within a radius of 200 to 500 kilometers.

It is also critical for government policymakers at the city, state and national levels to understand how the global urban landscape is shifting. The outcome of the MGI’s projections of the global demographic and economic evolution of cities to 2025 will be affected by how those cities are managed. Those policymakers who anticipate and prepare to deal effectively with the evolving urban trends will enhance the growth prospects of their urban centers.

To realize the benefits of scale economies while minimizing the costs of rapid urban growth, the report offers policymakers the following advice, based on McKinsey’s cumulative research on urbanization: Plan effectively to coordinate investment decisions and operations, and have capable and accountable governance, as well as sustainable and responsible fiscal management. By using McKinsey’s Urban Performance Index (UPI), a proprietary quantitative tool, policymakers can rate themselves relative to peers and best-in-class performers across 100 actionable metrics in four key dimensions: economic performance, social conditions, sustainable resource use, finances and governance. Each dimension is the aggregate of several subcomponents. For example, economic performance is the aggregate of the capacity for wealth creation, the business environment and strength in research and development. The mayor and council members of the İstanbul Metropolitan Municipality might find the UPI helpful in assessing and improving their performance.