Nowhere was the collapse of global trade following the financial crisis of 2008-09 more frightening than in Asia’s export-reliant economies. For the first time in recent history, the American consumer, the favorite customer of Asia’s factories, cut back on consumption, sending shock waves all the way up the supply chain to Guangzhou, Hsinchu, and Gurgaon. Workers were laid off, factories closed, and businesses went belly up. The largest market for Asian wares was no longer buying the way it used to. Today, even though exports to the U.S. are gradually resuming, it is becoming clear that Asia may have to look elsewhere to find consumers for its toys, electronics, and textiles.

A couple of trends are starting to take shape: domestic consumption is gathering steam, and intra-emerging market trade is set to boom. In other words, the Asian consumer will be buying more of the goods that Asia produces, and Asian exporters will be looking to other emerging markets to find new consumers. This raises important questions for multinationals operating in Asia. Their traditional business models, built on buying cheaply in Asia and selling at higher prices in the United States, won’t easily fit the new reality as trade patterns shift.

Boosted by a massive stimulus package, including lower taxes, rebates, trade-in programs and easier loans, Chinese consumers are starting to buy like never before. Real estate markets are booming, China is set to become both the world’s largest car market and its largest car maker, and the average size of a flat-screen TV sold in China is now larger than that in the United States. Exports too are being re-oriented. For the past ten years or so intra-regional trade was booming, though it mostly consisted of multinational supply chains transferring parts, components, and semi-finished products from factories in one country to factories in other countries in Asia. That business-to-business trade will continue to grow. But at the same time, a new business-to- consumer trade will develop and grow, as demand in most Asian economies takes off, lifted by growing standards of living, stronger currencies, and relatively easy credit. Already, Asia’s trade with the rest of the world is the fastest growing part of world trade, and intra-emerging market trade is the fastest growing part of Asia’s exports.

This year, China unseated the U.S. as Brazil’s largest trading partner, and trade between the two emerging countries is expected to continue to grow rapidly from about $40 billion in 2009 (as recently as 2005, Brazil-China trade was about one-third of the Brazil-U.S. trade). Trade between China and India has grown tenfold in the past seven years, to more than $50 billion. Within a few years, China will supplant the U.S. as India’s largest trading partner. Much of the current boom in exports to China from other emerging economies consists of raw materials or semi-finished goods. But already, consumer goods are flowing in the other direction, and within a few years both goods and services will also be part of the exports from other emerging markets to China. Trade between the emerging markets is the fastest growing type of international trade. Within five years, emerging-market-to-emerging market (EM2EM) trade will amount to over $1trillion.

What are the implications of these profound shifts in trade patterns for multinationals? For a long time, the most pressing global business question that top management teams grappled with was, “What is our emerging market strategy?” More often than not, it meant “What is our strategy for sourcing products from China and other low-cost manufacturing centers?” More recently, these companies have also begun honing their strategy for selling products to China, and for sourcing from and selling into other large emerging economies. But the model remains the same: find low-cost labor and manufacturing sources to make the products, brand them, and market them to consumers in developed markets willing to pay several-fold the production cost. But now, just as this model is being perfected, its relevance as an emerging market strategy is likely to begin fading.

The issue that should be on a company’s global agenda today is one of determining how it intends to participate in the rapidly growing trade between emerging markets, especially in Asia. The business models on which multinational companies have built their emerging-market strategies are not designed for this type of trade. Consider trade between India and China as an example. For over four decades, politics and trade between the two natural trading partners were frozen. Business in 2003 amounted to no more than $8 billion, about the level of trade that takes place between the U.S. and Canada in four days. But with the two largest populations in the world, two of the fastest growing economies in the world, and complementary industrial capabilities, the two countries have much to trade. In fact, India-China trade has been growing at a compound rate of over 45 percent per year.

Multinational companies around the world will need to define their strategic stance relative to this EM2EM awakening. Key questions from their standpoint will include what will be traded, and how this new EM2EM will affect the global trade system and the players in it. The questions are pressing because the newly forged trading partnerships between emerging markets will call into question the existing business models on which multinational companies have built their Asia and emerging-market strategies.

Over the past 20 years, the business model put in place by multinational companies has essentially been premised on capturing the value difference between the low-cost, emerging- market manufactured goods and services, and the significantly higher prices that consumers in their home markets have been willing to pay. Two-thirds of China’s current manufacturing exporters are multinational companies, which collectively account for half of all of China’s exports. A pair of branded athletic shoes manufactured in China retails for between 10 and twenty times its manufacturing cost in the markets of North America, Europe and Japan. Similar economics drive multinationals’ strategies in other emerging markets. The resulting high returns have customarily been ascribed to the multinationals’ R&D, design, management and branding capabilities. The returns have allowed these companies to carry heavy overheads in their home markets, and still provide a comfortable return to shareholders.

The rapidly emerging EM2EM trade will increasingly call this model into question for two reasons. First, while the business model of the multinationals has been devised to sell Chinese tools, toys, and trinkets to affluent consumers, the model breaks down when the buyers are consumers in other emerging markets. These consumers cannot afford the R&D, design, branding, and management overhead built into the business model. Emerging market companies, with their razor thin margins and low overhead costs, are better placed to cater to the emerging market opportunity. Chinese toy manufacturers have rapidly captured a 70 percent share of India’s market, prompting India’s government to attempt to stop the onslaught to allow local manufacturers adjust. Increasingly, Indian information technology companies such as Wipro, Infosys and TCS are developing direct access to the Chinese market. They have already shown that they can grab market share from Accenture, EDS and IBM in the smaller Asian markets. Like Chinese toy manufacturers, Indian software and services firms have the advantage of low overheads.

If local rivals do indeed seize the opportunity to drive the EM2EM trade, the multinationals’ business model will come under further pressure. The economies of scale that local players can build serving both their domestic market and the markets of other emerging market giants will give them a formidable cost advantage in global markets. It will not be long before these advantages are deployed to challenge the R&D, design, and branding-based advantages of multinationals in their traditional, developed-country markets.

In preparing for these long-term shifts, it is worthwhile to ask what multinational companies ought to do. As a first step, they must decide whether the EM2EM trade is an important enough opportunity for them to invest in developing a new business model. Clearly, participating in this trade boom is not going to be merely a matter of redirecting exports from China to the emerging markets, or of competing for Chinese contracts from an Indonesian supply base. Neither of those actions will increase multinationals’ competitiveness against local rivals, at least as long as the products and services are made with the developed-countries’ markets and customers in mind.

The solutions are likely to reside in three areas. First, painful as it may be, multinational companies will have to shed overhead costs to gain competitiveness. The exact methods of shedding those costs may vary. Some firms may choose to further localize management, localize raw material sourcing, partner with local firms, and acquire local companies with local cost structures. Others may decide on more controversial approaches, for example, choosing not to charge full global overheads on intra-region sales. In other words, multinationals will not be able to expect head office to receive the same plump profit for a product manufactured in China and sold in India, as for one sold in the United States. This is akin to treating the multinational’s local subsidiaries revenue as incremental business that is not subject to global overhead. This approach may be assailed for creating double-cost standards, which can be justified on the grounds that little of the EM2EM sales revenue would have been generated at full-overhead costing. The approach is one of basic market segmentation. Clearly, the average consumer in Bangladesh represents an opportunity for greater price elasticity than the consumer in Germany. It makes business sense to discount the shoes and computers in Bangladesh to capture market share, just as an airline would discount its student tickets to fill its flights.

A second related approach is for multinationals to shed costs by spinning off local companies in these markets. Localizing these companies and listing them on local markets makes them accountable to local shareholders who will demand a localization of the cost base. Local accountability has worked well for many multinational companies that have a long history of operating in India and Brazil. Locally listed multinationals such as Hindustan Lever, Unilever’s Indian arm, have, in fact, been a source of talent and ideas for companies catering to base-of-the-pyramid consumers in other markets around the world.

Finally, the multinationals will have to redefine high-value added activities with a renewed vigor, focusing on market-making, finance, and knowledge management activities. In this approach, multinationals play the role of allies with local companies, as they set out to conquer their neighboring markets, and eventually global markets. They supply the R&D, design, and branding skills that local companies need to play on the global stage. By playing mid-wife to tomorrow’s global corporations, today’s multinationals retain a piece of the future pie.

This three-pronged approach explicitly builds on the key advantage that multinationals still possess over their local rivals: they know marketing. Aside from the notable exceptions such as Haier and Lenovo, manufacturers in most of emerging Asia have not dabbled in downstream activities. Since much of the export business from Asia is from contract manufacturers working for multinational companies, the multinationals have continued to do the marketing. This division of labor has meant that local manufacturers often lack the downstream skills required to build brands, manage distribution networks and relationships, keep up with changing consumer preferences, and keep an eye on evolving competition. This presents multinationals with an opportunity to continue to fulfill the marketing functions, but with the emerging-market consumer as a target. The prerequisite for achieving this goal will be a need to rethink the business model, with the goal of creating a lower-overhead cost structure.

If multinational companies are not already pondering the trillion-dollar opportunity of EM2EM trade, they should be. There is a lot that they can contribute to this playing field, but also a lot that they need to do to adapt their business models before they can play.