SAM MPLE 2.

Dif fferences an nd the CAG GE Distanc ce Framewo ork1 Pankaj Gh hemawat Afte er analyzing g the cases s in section n 1, the real lity of semi iglobalizati ion and the import tance of cr ross-country y difference es should be b clear. Th his sect tion introdu uces the CAGE C dista ance framew work, whic ch is used to iden ntify and pr rioritize the e differences s between countries c th hat compani ies mus st address when w develo oping cross-border strat tegies.2 Beg gin by cons sidering the e example summarized in exhibi it 2-1, whi ich plot ts Walmart ts operatin ng margin by countr ry in 2004 4 against t the distance betwe een each co ountrys cap pital and Walmarts W he eadquarters in Ben ntonville, Ar rkansas. Th he impact of f geographic c distance is s obvious, b but wha at other type es of differe ence or distance can yo ou identify that t separat ted the markets tha at were prof fitable for Walmart W from m those tha at werent? Exhibi it 2-1 Wal lmart Intern nationals Operating O M Margin by Co ountry (2004 estimates)

The e CAGE dis stance frame ework disag ggregates di istance or difference d in nto four r major categories: c Cultural, Administra ative, Geog graphic, a and Eco onomic. Diff fferences alo ong these di imensions generally g ha ave a negati ive effe ect on man ny cross-bo order inter ractions, although in some case es, diff ferences alo ong a limited subset of o CAGE dimensions d can actual lly 3 enco ourage rath her than disc courage suc ch interactio ons. Each of o these bro oad type es of differe ence or dista ance is illus strated by th he Walmart example. Cultura al distance: : Culture can be defin ned as the collection of beliefs, values, and d social nor rmsthe un nwritten, un nspoken rul les of the gameth hat shape the behavi ior of ind dividuals a and organiz zations. Cu ultural dista ance encom mpasses differences d in religiou us beliefs, race/ethnicit r ty, languag ge, and soci ial norms a and values. Societies even diffe er in their social attit tudes towa ard market power and d globaliza ation in wa ays that ha ave importa ant effects, both form mally via re egulation and a informa ally, on ho ow busines sses operate. 4 Interes stingly, Wa almarts fo our profitab ble markets s share ling guistic, religious and ethnic simi ilarities or, at least, tie es through large l diaspo ora. Adminis strative dis stance: Historical an nd political associatio ons between n countries scolonial links, free e trade agr reements, t the tenor of o current relationsh hipsprofou undly affe ect econom mic exchang ge between n themw which is th he same as s saying th hat differen nces along these dime ensions mat tter a great t deal. So, of course, do admin nistrative attributes a specific s to a particul lar country y such as au utarchic pol licies or we eak instituti ions and high levels of o corruption n. In the Wa almart exam mple, note th hat two of t the profitab ble countrie es, Canada and a Mexico o, partner wi ith the Unit ted States in i a region nal free trad de agreeme ent, the Nor rth Americ can Free Tr rade Agreem ment (NAFT TA). And a third profit table count try as clas ssified by Walmart, , Puerto Rico, R is officially an unincor rporated terr ritory of the e United Sta ates. Geogra aphic distan nce: The geographic g dimension n of distan nce involve es more tha an just how w far two countries c ar re from ea ach other: other o attrib butes to be e considere ed include contiguity, a country ys physica al size, wit thin-country y distances s to borde ers,

access to t the ocean n, topograph hy, and eve en time zon nes. Exhibit 21 make es it clear th hat the capital city of f each of Walmarts W fo our profitab ble countr ries is ge eographicall ly closer to t Walmar rts headqua arters than the capitals s of any of the unprofitable ones; in addition n, Canada and a Mexico o share a co ommon land d border wi ith the Uni ited States. Econom mic distance e: Consume er wealth an nd income and a the cost of labor are a the most m obviou us (and re elated) determinants of econom mic distance e between countries. Others includ de differenc ces in avail lability (or lack) of re esources, in nputs, infra astructure a and complements, and d organizat tional capa abilities. It seems a b bit harder for f Walmar rt to do wel ll in poorer countries although t the number r of data points p is very v limited. Note, however, h th hat econom mic distance e has not been b entire ely or even n primarily y a by liability y for Walm mart. The company saves mor re money b procurin ng merchandise fro om China exploitin ng econom mic distance e, particular rly in terms s of labor co oststhan it i makes fro om its enti ire internati ional store network. We W will re eturn to su uch strategies in section n 5, which discusses d ar rbitrage.

Wha at the Numb bers Tell Us s ernational economists e apted Newt tons law of univers sal Inte have ada grav vitation to o describe trade an nd other internationa al econom mic inte eractions. Thus, T the simplest gra avity mode el of intern national tra ade betw ween two co ountries pre edicts that trade t will be e directly re elated to the eir econ nomic sizes (a unilate eral attribu ute of each country) and a inverse ely rela ated to the physical p dist tance betwe een them (a a bilateral or r country-pa air attri ibute). Aug gmented gra avity mode els add mea asures of other o types of diff ferences as well w as unil lateral attrib butes. Exhib bit 2-2 show ws the resu ults of one o such an nalysis that evaluated cultural, c adm ministrative e, geograph hic, and economic effects e on tr rade.

Exh hibit 2-2 Effe ects of Simil larities Vers sus Differences on Bilat teral Trade

D Dimensions of o D Distance/Prox ximity

Cultural Administrative e

Determina ant
Common la anguage Common re egional trading g bloc Colony/colo onizer links Common cu urrency Differences s in corruption n Physical dis stance: 1% inc crease Physical siz ze: 1% increas se Landlocked dness Common la and border Economic size: s GDP (1% % increase) Income leve el: GDP per ca apita (1% incr rease)

Chan nge in Trade

+42% % +47% % +188% +114% 11% % 1.1% % 0.2% % 48% % +125% +0.8% % +0.7% %

Geographic

Economic

Sour rce: Pankaj Ghemawat and a Rajiv Mallick, Ma The Industry-Lev vel Structure of Inter rnational Trad de Networks: A Gravity-Based Approac ch, working paper, Harva ard Busi iness School Boston, B Februa ary 2003. The estimates cor rrect for unob bserved thresh holds for participation in tr rade and are all signi ificant at the 1% 1 level but are, a in a numb ber of cases, smaller s than those t reported d in many y other studie es, apparently due to the cor rrection

The e signs on most m of the e estimates in the table probably y accord wi ith you ur intuitions (although h they cannot be re econciled with w a ful lly glob balized fla at world). What are probably more m surpr rising are t the mag gnitudes of f some of the t effects for exam mple, that countries wi ith colo onial ties ar re apt to tr rade almost t three time es as much h as countri ies with hout them, or even mo ore if one al lso account ts for the ro ole of colon nial ties in generat ting cultura al similariti ies! The pe ersistence of o such lar rge ects decades s and, in some instan nces, more than a cent tury after t the effe orig ginal coloni ial relations ships were dissolved reinforce r th he conclusion that t complete globalizatio onas in the t disappe earance of the t effects of such h considerat tionsis ex xtremely un nlikely anyti ime soon. milarities ver rsus differe ences along many of th he same dim mensions al lso Sim help p explain fo oreign direc ct investme ent or comp panies fore eign presenc ce. Thu us, for U.S. companies s that opera ate in just one o foreign country, th hat coun ntry is Cana ada 60 perc cent of the time t (and 10 0 percent of f the time it t is the United Kin ngdom).5 Gr ravity mode els have also o been adap pted to expla ain

cros ss-border interactions as diverse as equit ty trading, e-commer rce tran nsactions, patent citatio ons, immig grant flows, air traffic, , phone cal lls, and even the in ncidence of wars! The basic b conclu usion from this literatu ure is th hat differen nces betwee en countries sand diff ferences in differences mat tter in signif ficant, predi ictable way ys. Iden ntifying and d Prioritizin ng Differenc ces Hav ving highlig ghted the pe ersistent imp pact of cros ss-country differences d or distances, the rest r of this section foc cuses on us sing the CA AGE distan nce fram mework to identify and a prioriti ize the dif fferences that t must be acco ounted for in developi ing global strategies. s Exhibit E 2-3 helps in th his rega ard by ident tifying bilat teral and un nilateral fac ctors to cons sider for ea ach of th he CAGE categories. c
Exh hibit 2-3 The e CAGE Fra amework at the Country Level

Cultural Distance Cou untry pairs (bila ateral)

Different languages Different ethnicities; lack of connective ethnic or social networks Different religions ust Lack of tru Different rms, values, nor and ns disposition Insularity lism Traditional

Admin nistrative Geographic c Distan nce Distance

Lack of o colonial ties o shared Lack of regional trading bloc o common Lack of currency Political hostility Physical distance Lack of land border Differences in n time zones Differences in n climates / disease environments s

Econom mic Distance

Rich/po oor differen nces Other nces in differen cost or q quality of natur ral resource es, financia al resource es, human es, resource infrastru ucture, and info ormation or know wledge

Cou untries (uni ilateral)

Nonma arket/closed econom my (home bias vs s. foreign bias) o Lack of membe ership in interna ational organiz zations Weak institutions, corruption

Landlockedne ess Econom mic size Lack of intern nal Low pe er capita navigability income Geographic si ize Geographic remoteness Weak n transportation or on communicatio links

The e most dis stinctive fe eature of the t CAGE E framewor rk is that it enco ompasses the t bilatera al attributes s of countr ry pairs as s well as t the unil lateral attr ributes of individual l countries s. Most of o the oth her fram meworks that have bee en proposed d for thinking about th he differenc ces acro oss countrie es (or locati ions) focus on just uni ilateral attributes; that is, they y assume th hat countries s can be ass sessed one by b one again nst a comm mon set of yardstic cks. Note that t this ch haracterizati ion applies s not only to card dinal indic ces such as the World W Econ nomic Foru ums Glob bal Com mpetitiveness Index or Transparency Int ternationals s Corruption Perc ceptions Ind dex but also to ordina al ranking schemes suc ch as Micha ael Port ters diamo ond framework for di iagnosing th he (relative) ) internation nal com mpetitivenes ss of diffe erent count tries as home bases s in specif fic indu ustries. But t indexicalit ty of this sort s is restri ictive since e it cant de eal with h ideas such h as The U.S. U is close er to Canada a than it is to t Indonesia a. Mor re general lly, indexic cality is incapable of captur ring bilater ral diff ferences of the t sort nec cessary to en nvision cou untries as ex xisting in (a and even n occupyin ng) space in n relation to o each othe er, that is, as a nodes in na 6 netw work instead d of as an array along a common yardstick. y Hav ving drawn that distinc ction betwee en unilatera al and bilate eral influenc ces, it is s useful to add a that the ey can be fitted f togeth her into the same over rall stru ucture. Spec cifically, un nilateral me easures of isolation i (o or integratio on) capt turing coun ntry-specific c attributes that t general lly decrease e (or increas se) a countrys in nvolvement in cross-b border econ nomic activ vities can be trea ated as a common c co omponent of that co ountrys dis stances along vari ious dimens sions from all a other cou untries. For r example, really r isolat ted coun ntries (ch haracterized d by uni ique, ingr rown cultu ures, clos sed adm ministrative policies, ph hysical rem moteness, or r extremely y high or lo ow inco omes) can be b thought of as being g relatively distant from m everywhe ere else e. That said d, one needs to add bi ilateral indicators to su uch unilater ral conceptions to o capture th he idea tha at a compa anys home e base affec cts whi ich countrie es are close and which ones o are far rther away. The e other poin nt worthy of f even more e emphasis is that diffe ferent types of distance matter r to differen nt extents in i different industries. For instanc ce, ce geograph hic distance e affects th he costs of f transporta ation, it is of sinc part ticular impo ortance to companies c d dealing in heavy h or bu ulky produc cts.

Cult tural distan nce, on th he other hand, h shapes consum mers produ uct pref ferences and d should be e a crucial consideratio c on for a con nsumer goo ods or media m comp panybut is much le ess importan nt for a cem ment or ste eel busi iness. Exhib bit 2-4 prov vides a sum mmary of th he character ristics that a are like ely to make e an industr ry particular rly sensitive to a parti icular kind of distance.
Exhibi it 2-4 The CAGE C Fram mework at th he Industry Level L

Cult tural Dist tance

Cultur ral differences matter r the most when: : Products have high h guistic content ling (TV V programs) Products matter to cult tural or national l iden ntity (foods) Product features y in terms of vary size e (cars) or stan ndards (ele ectrical equ uipment) Products carry untry-specific cou qua ality asso ociations (win nes)

Adminis strative Distance e

t Government involvement t is high in industries th hat are: Producers s of staple goods (ele ectricity) Producers s of other entitleme ents (drugs) Large emp ployers (farming) Large sup ppliers to governme ent (mass transporta ation) National champions c (aerospace e) Vital to na ational security (telecomm munications) Exploiters s of natural resources (oil, mining) o high sunk Subject to costs (infr rastructure)

Geographi ic Distance
Geography pla ays a more importan nt role when: Products hav ve a low value-to-wei ight or bulk ratio (ce ement) Products are e fragile or perishable e (glass, fruit) vision Local superv and operatio onal requirements s are high (service es)

Economic Distance
nomic differenc ces Econ mak ke the biggest impa act when: Na ature of demand d va aries with incom me (ca ars) Ec conomics of sta andardization o or scale are limited (ce ement) La abor and other fac ctor cost dif fferences are salient (garments s) istribution or Di bu usiness systems are e different (in nsurance) Co ompanies need to be e responsive and d ag gile (home ap ppliances)

plications of f the CAGE E Distance Framework F App The e CAGE fra amework, on nce it is tak ken down to o the industr ry level, len nds itsel lf to a very y broad arra ay of applic cations. Let ts focus he ere on four of the most impor rtant ones. Mak king Differe ences Visible

One e applicatio on of the CAGE distance fram mework is to t make k key diff ferences vis sible. While e this applic cation may seem too obvious o to be wor rth belabori ing, most notable n inte ernational business b deb bacles can be trac ced back to o a failure e to apprec ciate a key y type of cross-count try diff ference or distance. d Fu urthermore, in a very diverse d wor rld, manage ers cann not simply y fall back on person nal experien nce to ens sure adequa ate sens sitivity to differences. Checklists C o the sort embedded of e in n exhibits 2 2-3 and 2-4 can help even n experienced people e avoid er rrors due to forg getfulness an nd cognitiv ve overload in a comple ex environm ment. Und derstanding the Liabilit ty of Foreig gnness A second s app plication of f the CAG GE framew work is to pinpoint t the diff ferences ac cross coun ntries that t might handicap multination nal com mpanies rel lative to local comp petitorsthe e so-called d liability of fore eignnesso or more gen nerally affect their rela ative positio ons. This c can be a useful exe ercise for both b multina ationals and d their local l competitors. When there are e substantia al liabilities of foreignn ness, multin nationals oft ten look k to acquire or set up p joint vent tures with local l firms to overcom me thes se barriers. Ass sessing Natu ural Owners s and Comp paring Forei ign Competi itors Eve en if multin nationals ca an be confid dent that th hey are goi ing to prev vail over r local com mpetitors in a particular r market, th he CAGE fr ramework c can be used u at a fin ner level of resolution to t shed ligh ht on the rel lative position of multinationa m als from dif fferent coun ntries. For example, e CA AGE analys sis can help expla ain why Spa anish firms s do well in n many indu ustries acro oss Lati in Americ ca, but al lso why success in n Mexico has prov ved com mparatively easier for U.S. firm ms. 7 Again, such anal lysis is mo ost valu uable when n conducted d at the ind dustry level and is ind dicative rath her than n decisive. Thus, T partic cularly good d or bad glo obal strategi ies can matt ter mor re than nat tural owners ship advan ntages. mparing Ma arkets and Discounting D ce Com by Distanc The e CAGE fra amework ca an also be used to com mpare mark kets from t the pers spective of a particular r company. One method to conduc ct quantitati ive anal lysis of this s type is to discount (sp pecifically, divide) raw w measures of 8

mar rket size or r potential with meas sures of dis stance, broadly define ed. While such discounting d involves numerous n approximati a ions, making som me adjustme ents of mark ket potentia al for distan nce is a bette er idea, giv ven how w much distance d m matters, tha an refraining from making a any adju ustments at all. Some companies c d formally do y use methods of this so ort in deciding d to enter or exi it markets (as ( describe ed in the firs st case in th his sect tion, on Gro olsch). Con nclusion The e CAGE fra amework he elps identify fy the most important cross-count try diff ferences and d their impl lications fo or strategy. However, understandi u ng diff ferences is not a suffi icient basis for setting g global str rategy. Think back k to the AD DDING valu ue scorecard d from the previous se ection and a ask you urself how each e type of f difference or distance affects the six levers f for valu ue addition and subtrac ction. Is it a challenge e that must be account ted for and address sed? Or doe es it offer an a opportunity to impro ove econom mic prof fitability? The T next th hree section ns help add dress these questions by intro oducing thr ree types of f strategies for creatin ng and claim ming value in the presence of o cross-bor rder differen nces: adaptation, agg gregation, a and arbi itrage.

Pankaj j Ghemawat t And Jordan n I. Siegel, Cases on Re edefining Global Strategy , (Harv vard Business Review Pre ess, 2011):59 9-69 For a more extende ed treatment of this mate erial, see Pan nkaj Ghemaw wat, Dis stance Still Matters: M The Hard H Reality of Global Ex xpansion, Harvard Ha Business Revi iew, Septembe er 2001. This topic is also addressed at substantially s g greater length h in chap pter 2 of Pank kaj Ghemawat t, Redefining Global Strate egy (Harvard Business B Scho ool Press, 2007), and d chapter 3 of f Pankaj Ghem mawat, World d 3.0: Global l Prosperity a and How w to Achieve It I (Harvard Bu usiness Revie ew Press, 2011). For a col llection of ma aps that highlight dista ance effects, see s www.ghem mawat.com. For furt ther discussion n of the ways in which CAG GE difference es can encoura age rathe er than discou urage cross-bo order activity, see the discussion of arbitr rage in section n5 and the t references s cited therein. For an original disc cussion of cultural distance and how it t affects forei ign direc ct investmen nt, see Jord dan Siegel, Amir Lich ht, and Sha alom Schwar rtz,
4 3 2

Ega alitarianism, Cultural Dist tance, and FDI: A New Approach, working pap per, Harv vard Business School, Bosto on, October 2008. 2 Susan E. Feinberg g, The Expansion and Location Pa atterns of U U.S. Mul ltinationals, unpublished working paper, p Rutger rs University y, 2005. For a more m extended d discussion of o indexicality y in a broade er social scien nce context, see Andr rew Abbott, Chaos of Dis sciplines (Chi icago: Univer rsity of Chica ago Press, 2001). Subram manian Ranga an and Aldem mir Drummon nd, Explainin ng Outcomes in Com mpetition amo ong Foreign Multinationa als in a Foc cal Host Ma arket, Strateg gic Man nagement Jour rnal 25, no. 3: : 285293.
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