TOOL KITCompanies routinely exaggerate the attractiveness of foreignmarkets, and that can lead to expensive mistakes. Here's amore rational approach to evaluating global...

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TOOL KIT Companies routinely exaggerate the attractiveness of foreign markets, and that can lead to expensive mistakes. Here's a more rational approach to evaluating global opportunities. Distance Stiii Matters The Hard Reality of Global Expansion by Pankaj Ghemawat WHEN IT WAS LAUNCHED IN 1991 ,Star TV looked like a surefire winner. The plan was straightforward: The company would deliver television programming to a media-starved Asian audience. It would target the top 5% of Asia's soeioeeonomie pyramid, a newly rich elite who could not only afford the services but who also represented an attractive advertising market. Since En- glish was the second language for most of the target consumers. Star would be able to use readily available and fairly cheap English-language programming rather than having to invest heavily in creating new local programs. And by using satellites to beam programs into people's homes, it would sidestep the constraints of geographic distance that had hitherto kept traditional broad- casters out of Asia. Media mogul Rupert Murdoch was so taken with this plan - especially with the appeal of leveraging his Twentieth Century Fox film library across the Asian market-that his com- pany. News Corporation, bought out Star's founders for $825 million between 1993 and 1995- The results have not been quite what Murdoch expected. In its fiscal year ending June 30,1999, Star reportedly lost $141 million, pretax, on revenues of SEPTEMBER 2001 137 TOOL KIT • Distance Stil l Matters $111 million. Losses in fiscal years 1996 through 1999 came to about $500 mil- lion all told, not including losses on joint ventures such as Phoenix TV in China. Star is not expected to turn in a positive operating profit until 2002. Star has been a high-profile disaster, but similar stories are played out all the time as companies pursue global ex- pansion. Why? Because, like Star, they routinely overestimate the attractive- ness of foreign markets. They become so dazzled by the sheer size of untapped markets that they lose sight ofthe vast difficulties of pioneering new, often very different territories. The problem is rooted in the very analytic tools that managers rely on in making judgments about international investments, tools that consistently underestimate the costs of doing business internationally. The most prominent of these is country portfolio analysis (CPA), the hoary but still widely used technique for deciding where a company should compete. By focusing on national GDP, levels of consumer wealth, and people's propen- sify to consimie, CPA places all the em- phasis on potential sales. It ignores the costs and risks of doing business in a new market. Most of those costs and risks result from barriers created by distance. By dis- tance, I don't mean only geographic sep- aration, though that is important. Dis- tance also has cultural, administrative or political, and economic dimensions that can make foreign markets consid- erably more or less attractive. Just how much difference does distance make? A recent study by economists Jeffrey Frankel and Andrew Rose estimates the Measuring the Impact of Distance Economists often rely on the so-caiied gravity theory of trade flows, which says there is a positive relationship between economic size and trade and a negative relationship between distance and trade. Models based on this theory explain up to two-thirds ofthe observed variations in trade flows between pairs of countries. Using such a model, economists Jeffrey Frankel and Andrew Rose' have predicted how much certain dis- tance variables will affect trade. Distance Attribute income level: GDP per capita (1% increase) economic size: GDP (1% increase) physical distance (1% increase) physical size (1% increase)* access to ocean* common border common language common regional trading bloc colony-colonizer relationship common colonizer common polity common currency Change in Internationai Trade (%) +0.7 +0.8 -1.1 -0.2 +50 +80 +200 +330 +900 +190 +300 +340 1.Jeffrey Frankel and Andrew Rose, "An Estimate ofthe Effects of Currency Unions on Growth," unpublished working paper. May 2000. ^Estimated effects exclude the lost four variables in the table. impact of various factors on a country's trade flows. Traditional economic fac- tors, such as the country's wealth and size (GDP), still matter; a 1% increase in either of those measures creates, on average, a .7% to .8% increase in trade. But other factors related to distance, it turns out, matter even more. The amount of trade that takes place between coun- tries 5,000 miles apart is only 20% ofthe amount that would be predicted to take place if the same countries were 1,000 miles apart. Cultural and administrative distance produces even larger effects. A company is likely to trade ten times as much with a country that is a former colony, for instance, than with a coimtry to which it has no such ties. A common currency increases trade by 340%. Com- mon membership in a regional trading bloc increases trade by 330%. And so on. (For a summary of Frankel and Rose's findings, see the exhibit"Mea- suring the Impact of Distance.") Much has been made ofthe death of distance in recent years. It's been argued that information technolo- gies and, in particular, global com- munications are shrinking the world, turning it into a small and relatively homogeneous place. But when it comes to business, that's not only an incorrect assumption, it's a dan- gerous one. Distance still matters, and companies must explicitly and thoroughly account for it when they make decisions about global expansion. Traditional country port- folio analysis needs to be tempered by a clear-eyed evaluation of the many dimensions of distance and their probable impact on opportu- nities in foreign markets. The Four Dimensions of Distance Distance between two countries can manifest itself along four basic di- mensions: cultural, administrative, geographic, and economic. The types of distance influence different busi- nesses in different ways. Geographic distance, for instance, affects the costs of transportation and commu- nications, so it is of particular im- 138 HARVARD BUSINESS REVIEW TOOL KIT • Distance Sti l l Matters The CAGE Distance Framework The cultural, administrative, geographic, and economic (CAGE) distance framework helps managers identify and assess the impact of distance on various industries. The upper portion ofthe table lists the key attributes underlying the four dimensions of distance. The lower portion shows how they affect different products and industries. d iffejejTtJajig u_ag es _ Cultural Distance different ethnicities; lack of connective ethnic or soc i a I networks different religions dijferent social norms products have high iinguistic content (TV) products affect cultural or national identity of consumers_(foods) product features vary in terms of: •size (cars) •standards (electrical appliances) • packaging ^ _ ^ products carry country- specific cjuality associations (vyines) Administrative Distance absence of colonial ties absence of shared monetary or political association .PPliti_ca.l_hostility government policies institutional weakness government involvement is high in industries that are: • producers of staple goods (electricity) • producers of other "entitlements" (drugs) • large employers (farming) • large suppliers to government (mass transportation) • national champions (aerospace) •vital to national security (telecommunications) •exploiters of natural resources (oil, mining) •subjectto high sunk costs (infrastructure) Geographic Distance physical remoteness lack of a common border lack of sea or river access size of country weak transportation or communication links differences in climates products have a low value-to-weight or bulk ratio (cement) products are fragile or perishable (glass,iruit)_ communications and connectivity are important (financial services) local supervision and operational requirements are high (many services) Economic Distance differences in consumer incomes differences in costs and quality of: • natural resources •financial resources • human resources • infrastructure • intermediate inputs • information or knowledge nature of demand varies with income level (cars) economies of standardi- zation or scale are important (mobile phones) labor and other factor cost differences are salient (garments) distribution or business systems are different (insurance) companies need to be responsive and agile (hpjne appliances) portance to companies that deal with heavy or bulky products, or whose op- erations require a high degree of coor- dination among highly dispersed peo- ple or activities. Cultural distance, by Pankaj Ghemawat is the Jaime and Josefina Chua Tiampo Professor of Busi- ness Administration at Harvard Business School in Boston. His article "The Dubious Logic of Global Megamergers," coau- thored by Fariborz Ghadar, was published in the July-August 2000 issue of HBR. contrast, affects consumers' product preferences. It is a crucial consideration for any consumer goods or media com- pany, but it is much less important for a cement or steel business. Each of these dimensions of distance encompasses many different factors, some of which are readily apparent; others are quite subtle. (See the exhibit "The CAGE Distance Framework" for an overview ofthe factors and the ways in which they affect particular industries.) In the following pages, I will review the four principal dimensions of distance, starting with the two overlooked the most - cultural distance and adminis- trative distance. Cultural Distance. A country's cul- tural attributes determine how people interact with one another and with com- panies and institutions. Differences in religious beliefs, race, social norms, and language are all capable of creating dis- tance between two countries. Indeed, they can have a huge impact on trade: All other things being equal, trade between 140 HARVARD BUSINESS REVIEW TOOL K I T • Distance Sti l l Matters countries that share a language, for ex- ample, will be three times greater than between countries without a common language. Some cultural attributes, like lan- guage, are easily perceived and imder- stood. Others are much more subtle. Social norms, the deeply rooted system of unspoken principles that guide indi- viduals in their everyday choices and interactions, are often nearly invisible, even to the people who abide by them. Take, for instance, the long-standing tolerance of the Chinese for copyright infringement. As William Alford points out in his book To Steal a Book Is an Elegant Offense (Stanford University Press, 1995), many people ascribe this social norm to China's recent commu- nist past. More likely, Alford argues, it flows from a precept of Confucius that encourages replication ofthe results of past intellectual endeavors: "I transmit rather than create; I believe in and love the Ancients." Indeed, copyright in- fringement was a problem for Western publishers well before communism. Back in the 1920s, for example, Merriam Webster, about to introduce a bilingual dictionary in China, found that the Commercial Press in Shanghai had al- ready begun to distribute its own ver- sion ofthe new dictionary. The U.S. pub- lisher took the press to a Chinese court, which imposed a small fine for using the Merriam Webster seal but did noth- ing to halt publication. As the film and music industries well know, little has changed. Yet this social norm still con- founds many Westerners. Most often, cultural attributes create distance by infiuencing the choices that consumers make between substitute products because of their preferences for specific features. Color tastes, for example, are closely linked to cultural prejudices. The word "red" in Russian also means beautiful. Consumer durable industries are particularly sensitive to differences in consumer taste at this level. The Japanese, for example, prefer automobiles and household appliances to be small, refiecting a social norm common in countries where space is highly valued. Sometimes products can touch a deeper nerve, triggering associations related to the consumer's identity as a member of a particular community. In these cases, cultural distance affects entire categories of products. The food industry is particularly sensitive to reli- gious attributes. Hindus, for example, do not eat beef because it is expressly forbidden by their religion. Products that elicit a strong response of this kind are usually quite easy to identify, though some countries will provide a few sur- prises. In Japan, rice, which Americans treat as a commodity, carries an enor- mous amount of cultural baggage. Ignoring cultural distance was one of Star TV's biggest mistakes. By supposing that Asian viewers would be happy with English-language programming, the com- pany assumed that the TV business was insensitive to culture. Managers either dismissed or were unaware of evidence from Europe that mass audiences in countries large enough to support the development of local content generally prefer local TV programming. If they had taken cultural distance into account, China and India could have been pre- dicted to require significant investments in localization. TV is hardly cement. Administrative or Political Dis- tance. Historical and political associa- tions shared by countries greatly affect trade between them. Colony-colonizer links between countries, for example, boost trade by 900%, which is perhaps not too surprising given Britain's con- tinuing ties with its former colonies in the commonwealth, France's with the franc zone of West Africa, and Spain's with Latin America. Preferential trad- ing arrangements, common currency, and political union can also increase trade by more than 300% each. The integration of the European Union is Industry Sensitivity to Distance The various types of distance affect different industries in different ways. To estimate industry sensitivity to distance, Rajiv Mallick, a research associate at Harvard Business School, and I regressed trade between every possi ble pa i r of cou ntries i n the world in each of 70 industries (ac- cording to their SIC designations) on each dimension of distance. The results confirm the impor- tance of distinguishing between the various components of distance in assessing foreign market opportu- nities. Electricity,for instance, is highly sensitive to administrative and geographic factors but not at all to cultural factors. The following table lists some ofthe industries that are more and less sensitive to distance. CULTURAL DISTANCE Linguistic Ties meat and meat preparations cereals and cereal preparations miscellaneous edible products arid preparations tobacco and tobacco products office machines and automatic data-processing equipment photographic apparatuses, optical goods
Answered Same DayMar 22, 2023

Answer To: TOOL KITCompanies routinely exaggerate the attractiveness of foreignmarkets, and that can lead...

Dipali answered on Mar 23 2023
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Discussion
In his article "Distance Still Matters," Pan
kaj Ghemawat argues that despite advances in technology and globalization, distance remains an important factor in shaping economic and business activity. He contends that companies often overlook the significance of geographic proximity when making decisions about sourcing, production, and distribution, leading to suboptimal outcomes.
Ghemawat starts by debunking the notion of a borderless world, pointing out that cross-border flows of goods, services, and capital account for only a small fraction of economic activity. Most economic transactions still take place within national borders, with only a small percentage of companies engaging in international trade or investment (Hutzschenreuter & Kleindienst, 2019). Even within countries, distance can play a significant role in shaping business activity, with companies often clustering in specific regions to take advantage of local expertise, infrastructure, and networks (Guo & Lu, 2019).
Ghemawat then explores three dimensions of distance that impact economic activity: cultural distance, administrative or political distance, and geographic distance. Cultural distance refers to differences in language, religion, values, and customs, which can create barriers to communication and collaboration between individuals and organizations (Disdier & Head,...
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