First break all the rules

GENERAL ELECTRIC'S health-care laboratory in Bangalore contains some of the company's most sophisticated products—from giant body scanners that can accommodate the bulkiest American football players to state-of-the-art intensive-care units that can nurse the tiniest premature babies. But the device that has captured the heart of the centre's boss, Ashish Shah, is much less fancy: a hand-held electrocardiogram (ECG) called the Mac 400.

The device is a masterpiece of simplification. The multiple buttons on conventional ECGs have been reduced to just four. The bulky printer has been replaced by one of those tiny gadgets used in portable ticket machines. The whole thing is small enough to fit into a small backpack and can run on batteries as well as on the mains. This miracle of compression sells for $800, instead of $2,000 for a conventional ECG, and has reduced the cost of an ECG test to just $1 per patient.

In Chennai, 200 miles (326km) farther east, Ananth Krishnan, chief technology officer of Tata Consultancy Services (TCS), is equally excited about an even lower-tech device: a water filter. It uses rice husks (which are among the country's most common waste products) to purify water. It is not only robust and portable but also relatively cheap, giving a large family an abundant supply of bacteria-free water for an initial investment of about $24 and a recurring expense of about $4 for a new filter every few months. Tata Chemicals, which is making the devices, is planning to produce 1m over the next year and hopes for an eventual market of 100m.

These innovations are aimed at two of India's most pressing health problems: heart disease and contaminated water. Some 5m Indians die of cardiovascular diseases every year, more than a quarter of them under 65. About 2m die from drinking contaminated water. The two companies are already at work on “new and improved”—by which they mean simpler and cheaper—versions of these two devices.

Budget-minded

There is nothing new about companies adapting their products to the pockets and preferences of emerging-market consumers. Unilever and Procter & Gamble started selling shampoo and washing powder in small sachets more than two decades ago to cater for customers with cramped living spaces and even more cramped budgets. Nike produces an all-enveloping athletic uniform to protect the modesty of Muslim women athletes. Mercedes puts air-conditioning controls in the back as well as the front of its cars because people who can afford a Mercedes can also afford a driver.

But GE and TCS are doing something more exciting than fiddling with existing products: they are taking the needs of poor consumers as a starting point and working backwards. Instead of adding ever more bells and whistles, they strip the products down to their bare essentials. Jeff Immelt, GE's boss, and Vijay Govindarajan, of the Tuck Business School, have dubbed this “reverse innovation”. Others call it “frugal” or “constraint-based” innovation.

There is more to this than simply cutting costs to the bone. Frugal products need to be tough and easy to use. Nokia's cheapest mobile handsets come equipped with flashlights (because of frequent power cuts), multiple phone books (because they often have several different users), rubberised key pads and menus in several different languages. Frugal does not mean second-rate. GE's Mac 400 ECG incorporates the latest technology. Many cheap mobile handsets allow users to play video games and surf the net. Frugal often also means being sparing in the use of raw materials and their impact on the environment.

The number of frugal products on the market is growing rapidly. Tata Motors has produced a $2,200 car, the Nano. Godrej & Boyce Manufacturing, one of India's oldest industrial groups, has developed a $70 fridge that runs on batteries, known as “the little cool”. First Energy, a start-up, has invented a wood-burning stove that consumes less energy and produces less smoke than regular stoves. Anurag Gupta, a telecoms entrepreneur, has reduced a bank branch to a smart-phone and a fingerprint scanner that allow ATM machines to be taken to rural customers.

Frugal innovation is not just about redesigning products; it involves rethinking entire production processes and business models. Companies need to squeeze costs so they can reach more customers, and accept thin profit margins to gain volume. Three ways of reducing costs are proving particularly successful.

The first is to contract out ever more work. Bharthi Airtel, an Indian mobile company that charges some of the lowest fees in the business but is worth $30 billion, has contracted out everything but its core business of selling phone calls, handing over network operations to Ericsson, business support to IBM and the management of its transmission towers to an independent company. To make this work, Bharthi had to persuade its business partners to rethink their business models too. For example, Ericsson had to agree to be paid by the minute rather than for selling and installing the equipment, and rival mobile companies to rent their towers rather than own them outright.

The second money-saver is to use existing technology in imaginative new ways. TCS is looking at using mobile phones to connect television sets to the internet. Personal computers are still relatively rare in India but televisions are ubiquitous. TCS has designed a box that connects the television to the internet via a mobile phone. It has also devised a remote control that allows people who have never used keyboards to surf the web. This idea is elegant as well as frugal: by reconfiguring existing technology it can potentially connect millions of people to the internet.

The third way to cut costs is to apply mass-production techniques in new and unexpected areas such as health care. Devi Shetty is India's most celebrated heart surgeon, having performed the country's first neonatal heart surgery on a nine-day-old baby, and numbered Mother Teresa among his patients. Yet his most important contribution to medicine is not his surgical skill but his determination to make this huge industry more efficient by applying Henry Ford's management principles. He believes that a combination of economies of scale and specialisation can radically reduce the cost of heart surgery. His flagship Narayana Hrudayalaya Hospital in the “Electronics City” district of Bangalore, not far from GE, Infosys and Wipro, has 1,000 beds (against an average of 160 beds in American heart hospitals), and Dr Shetty and his team of 40-odd cardiologists perform about 600 operations a week.

The sheer number of patients allows surgeons to acquire world-class expertise in particular operations, and the generous backup facilities allow them to concentrate on their speciality rather than wasting their time on administration. Dr Shetty has performed more than 15,000 heart operations and other members of his team more than 10,000. The hospital charges an average of $2,000 for open-heart surgery, compared with $20,000-100,000 in America, but its success rates are as good as in the best American hospitals.

Dr Shetty has devoted much of his energy to boosting his customer base, largely for humanitarian reasons but also because he believes that higher volumes lead to better quality. He has established video and internet links with hospitals in India, Africa and Malaysia so that his surgeons can give expert advice to less experienced colleagues. He also sends “clinics on wheels” to nearby rural hospitals to test for heart disease. He has created a health-insurance scheme, working with various local self-help groups, that covers 2.5m people for a premium of about 11 cents a month each. About a third of the hospital's patients are now enrolled in the scheme. A sliding scale of fees is used for operations so that richer customers subsidise poorer ones. The entire enterprise is surprisingly profitable given how many poor people it treats. Dr Shetty's family-owned hospital group reports a 7.7% profit after taxes, compared with an average of 6.9% in American private hospitals.

The group has recently built three other hospitals next to the heart clinic—a trauma centre, a 1,400-bed cancer hospital and a 300-bed eye hospital. They all share central facilities such as laboratories and a blood bank. Dr Shetty is also setting up “medical cities” in other parts of the country. Over the next five years his company plans to increase its number of beds to 30,000, making it the largest private-hospital group in India and giving it more bargaining power when it negotiates with suppliers, thus driving down costs further.

From jugaad to shanzhai

Indians often see frugal innovation as their distinctive contribution to management thinking. They point to the national tradition of jugaad—meaning, roughly, making do with what you have and never giving up—and cite many examples of ordinary Indians solving seemingly insoluble problems. But China is just as good as India at coming up with frugal new ideas. Mindray, for example, specialises in cheap medical products such as ECG devices, and BYD has radically reduced the price of expensive lithium-ion batteries by using less costly raw materials and learning how to make them at ambient temperatures rather than in expensively heated “dry rooms”. This has reduced their price from $40 to $12 apiece and made them competitive with less powerful nickel-cadmium batteries.

The Chinese have made two distinctive contributions to frugal innovation. The first is the use of flexible networks—powered by guanxi or personal connections—to reduce costs and increase flexibility. Li & Fung, a Hong Kong-based company, has long been a pioneer, working closely with a network of about 12,000 companies operating in more than 40 countries. It puts together customised supply chains from its vast network of associates and keeps an eye on quality and order fulfilment. Similarly, Dachangjiang, a motorcycle-maker in China's Guangdong province, works with hundreds of parts suppliers.

These post-modern guanxi have several powerful qualities. They can contract or expand with demand. Li & Fung and Dachangjiang seldom have problems with excess capacity when times are hard or with waiting lists when times are flush. And they can be turned into engines of innovation. Li & Fung relies on its partners to help solve problems, not just fulfil orders. Dachangjiang provides its suppliers with rough sketches rather than detailed blueprints and encourages them to innovate.

A second area where the Chinese excel is in “bandit” or “guerrilla” innovation, known as shanzhai. The original bandits lived in isolated villages and carried out raids on upright citizens. Today's bandits live at the margins of official society but are much in evidence: in Shanghai's People's Square you will be offered a cheap watch or phone at every step.

These bandits are parasites who profit from China's weak property rights, but they are also talented innovators, quickly producing copies of high-tech gadgets that are cheap enough for migrant workers to be able to afford them but also fashionable enough for young professionals to covet them. Some of the more exotic phones are designed to look like watches or packets of cigarettes (they even have room for a few real ones) and often have striking new features, such as solar chargers, superloud speakers, telephoto lenses or ultraviolet lights that make it easier to detect forged currency. In their own way the bandits deploy as much innovation and ingenuity as their legitimate counterparts.