• Distance Still Matters
million. Losses in fiscal years 1996through 1999 came to about $500 mil-lion
on jointventures such as Phoenix TV in China.Star
not expected to turn in
positiveoperating profit until 2002.Star has been a high-profile disaster,but similar stories are played out
thetime as companies pursue global ex-pansion. Why? Because, like Star, theyroutinely overestimate the attractive-ness of foreign markets. They become
the sheer size of untappedmarkets that they lose sight ofthe vastdifficulties of pioneering new, oftenvery different territories. The problem
rooted in the very analytic tools thatmanagers rely on in making judgmentsabout international investments, toolsthat consistently underestimate the costsof doing business internationally. Themost prominent of these is countryportfolio analysis (CPA), the hoary butstill widely used technique for decidingwhere a company should compete. Byfocusing on national GDP, levels ofconsumer wealth, and people's propen-sify to consimie, CPA places all the em-phasis on potential sales. It ignores thecosts and risks of doing business in anew market.Most of those costs and risks resultfrom barriers created
don't mean only geographic sep-aration, though that is important. Dis-tance also has cultural, administrativeor political, and economic dimensionsthat can make foreign markets consid-erably more or less attractive. Just howmuch difference does distance make?A recent study by economists JeffreyFrankel and Andrew Rose estimates the
Measuring the Impact
Economists often rely on the so-caiied gravity theory of trade flows,which says there is a positive relationship between economic size andtrade and a negative relationship between distance and trade. Modelsbased on this theory explain up to two-thirds ofthe observed variationsin trade flows between pairs of countries. Using such a model, economistsJeffrey Frankel and Andrew Rose' have predicted how much certain dis-tance variables will affect trade.
income level: GDP per capita
increase)economic size: GDP
increase)*access to ocean*common bordercommon languagecommon regional trading bloccolony-colonizer relationshipcommon colonizercommon politycommon currency
Change inInternationai Trade (%)
Frankel and Andrew Rose,
Estimate ofthe Effects of Currency Unions on Growth,"unpublished working
^Estimated effects exclude the lost our variables in the table.
impact of various factors on a country'strade flows. Traditional economic fac-tors, such as the country's wealth andsize (GDP), still matter; a 1% increasein either of those measures creates, onaverage, a
increase in trade.But other factors related to distance, it
more. The amountof trade that takes place between coun-tries
oftheamount that would be predicted to takeplace if the same countries were 1,000miles apart. Cultural and administrativedistance produces even larger effects.
to trade ten times asmuch with a country that is a formercolony,for instance, than with
coimtryto which it has no suchties.
commoncurrency increases trade by340%.Com-mon membership in a regional tradingbloc increases trade by 330%. And soon. (For a summary of Frankel andRose's
the exhibit"Mea-suring the Impact of Distance.")Much has been made ofthe deathof distance in recent years. It's beenargued that information technolo-gies and, in particular, global com-munications
shrinking the world,turning it into a small and relativelyhomogeneous place. But when itcomes to business, that's not onlyan incorrect assumption, it's a dan-gerous one. Distance still matters,and companies must explicitly andthoroughly account for it whenthey make decisions about globalexpansion. Traditional country port-folio analysis needs to be temperedby a clear-eyed evaluation of themany dimensions of distance andtheir probable impact on opportu-nities in foreign markets.
The Four Dimensionsof Distance
countries canmanifest itself along four basic di-mensions: cultural, administrative,geographic, and economic.
typesof distance influence different busi-nesses in different ways. Geographicdistance, for instance, affects the
of transportation and commu-nications, so it is of particular im-138
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