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    Ghemawat, HBR 2001

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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 Still Matters The Hard Reality of Global Expansion by Pankaj Ghemawat HEN IT WAS LAUNCHED 1N 1991, Star TV looked like a surefire ‘winner. The plan was straightforward: ‘The company would deliver television programming to a mediastarved Asian audience. tt would target the top 5% of Asia's socioeconomic pyramid, a newly ‘ich elit who could not only afford the services but who also represented an attractive advertising market. Since En- lish was the second language for most ofthe 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 SEPTEMBER 2001 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 20, 1999, Star reportedly lost $141 million, pretax, on revenues of 137 TOOL KIT + Distance Still matters ‘sn1 million. Losses in fiscal years 1996 through 1959 came to about $500 mi lion all told, not including losses on joint ventures such as Phoenix TV in China. ‘Star isnot expected to turn in apositive ‘operating profit until 2002. Star has been @ 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 of the vast difficulties of pioneering nen, often very different territories. The problem is rooted inthe very analytic tools that ‘managers rly on in making jugments about interaational investments, tools ‘that consistently underestimatethe costs of doing business internationally. The Measuring the I most frominent of thes? is country portfolio analysis (CPA), the hoary but still widely used technique for deciding where 4 company should compete. By focusing on national GDP, levels of consumer wealth, and people's propen- sity to consume, 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, 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 of less attractive. Just how much difference does distance make? ‘A recent study by economists Jeffrey Frankel and Andrew Rose estimates the mpact of Distance Economists often rly on the so-called gravity theory of trade flows, wich says thete i a positive “lations ‘trade and a negative relationship between distance and trade. Models based on this theory explain up to two thirds ofthe observed variations in rade ows between pairs of countries. Using such a model, economists Jeffrey Frankel and Androw Rose’ have predicted how much certain di- tance var ables wil affect trade between economic size and ‘Change in _tnternational Trade («) __ income level: GOP per capita (ms increase) +7 economic size: GOP (ms increase) 408 physical distance ins increase) a4 physical size (1 increase)” <2 aceess to ocean” +50 common border 0 ~ common language #200 — commgn regional trading biog . +330 ~ colonycolonizer relationship +300 common colonizer +90 common polity +300 ‘common currency 10 “ie ae and ane ean Esti fh cs ed Caen Uso Gow Uinpishea warsing paper May 238 since fects ecu the st for varios inthe tobe 138 impact of various factors on a country’s trade flows. Traditional economic fac tors, such as the country’s wealth and size (GDP), still mater; a 1% increase in cither of those measures creates, on average, a .7% to -8% increase in trade. But other factors rested to distance, it ‘tums out, matter even more. The amount of trade that takes plece between coun- tries 5,000 miles apart is only 20% of the amount that would be predicted to take place ifthe same countries were 1,000 ‘miles part. Cultural end administrative distance produces even larger effects. Acompany is likely totrade ten times as ‘much with a country that is a former coony, for instance, tan with a country ‘towhich it has no such ties. A common currency increases trade by 340%. Com- ‘mon membership in a regional tra 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 beenmade ofthe death of distance in recent years. It been argued that information technolo- gies and, in particular, global com- ‘munications are shrinking the worid, ‘tumingitinto a small and relatively ‘homogeneous place. But when it comes to business, that’s not only an incorrect assumption, i's a dan- .gerous one. Distance still matters, and companies raust explicitly and thoroughly account for it when they make decisons about global ‘expansion. Traditional country port folio analysis needs to be tempered by a cleareyed 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 countriescan 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- ‘TOOL KIT = Distance Still Matters The CAGE Distance Framework [Cultural Distance __‘| Administrative “The cultural, administrative, geographic, and economic (CAGE) distance framework helps ‘managers identify and assess the impact of distance on various industries. The upper portion af the table lst the key attributes underlying the four dimensions of distance. The lower portion shows how they affect diferent products and industries. [Geographic Distance absence of colonial ties _ absence of shared monetary o politcal association different ethnicities; tack lof connective ethnic of networks cifferent religions political hostility different social norms ____| government policies. ‘attributes creating distance institutional weakness. _| ptnysical remotenes _| ize of country lack of sea or river access weak transportation or communication links ences in climates Economic Distance diferences in ‘consumer Incomes difterences in costs ‘and quality of natural resources financial resources human resources infrastructure termediate inputs + information or knowledge Jhigh in industries that are: “producers of staple oods | Getectriciyy + producers ofother products have high Ainguistic content (TV) ‘products afect cultural for natonal identity of FS Iconsumers (foods). ‘entitlements (drugs) eg |-large employes (arming) % | produ features large supplisto & Jeary in terms of ‘government mass PS | Sie cars) {ansporation) § |-sancaras national champions § | (elecrcal appliances) {Gerospace) 8 |-paclasing ital to national security 31 {telecommurications) 3 {products carry country. [exploiters of natural B specif quality resources (i, mining) = subject to high sunk jssocbtions (ines) costs (infrastructure) es eseeeeeeseseeeeectesreareee portance to companies that deal with products have alow | Value-to-weight or bul aio (cement). products are fragile jorperishable {lass rit). communications and connectivity are important (nancial services) oral supervision and operational requirements [ore high (many.serices) contrast, affects consumers’ product nature of demand varies with income level (cars) economies of standardi- zation or scale are important (mobile phones) |iavor and tne factor correc ae ent Garmens) distribution or business | systems are different (insurance) companiesneedtobe | responsive and agile ! | home appliances) ‘our principal dimensions of distance, 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 Faribore Ghadar, wax published inthe July-August 2000 issue of HBR. 140 preferences. Its a crucial consideration for any consumer goods or media com- ‘pany, but it is much less important for 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 of the factors and the ways in Which they affect particular industries.) In the following pages, Iwill review the starting with the wo 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 Ianguage are all capable of creating dis tance between two countries. Indeed, they can have a huge impact on trade: All ther things being equal, trade between HARVARD BUSINESS REVIEN TOOL KAT + Distance Still 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 easly perceived and under- 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 ivisible, 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 2 precept of Confucius that ‘encourages replication of the 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 9208, 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 of the new dictionary. The US. pub- lisher took tae press to a Chinese court, which impesed a small fine for using the Merriam Webster seal but cid noth- ing to halt eublication. As the film and industries well know, Litle has changed. Yet this social norm still con- founds many Westemers. ‘Most often, cultural attributes create distance by influencing the choices that ‘consumers make between substitute products because of their preferences for specific features. Color tastes, for example, are closely inked 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 agpliances ‘to be small, reflecting a social norm common in countries where space is highly valued. 142 Sometimes products can touch a deeper nerve, triggering associations related to the consumers identity as a member of a particular community. In these cases, cultural distance affects entire categories of products. The food industry is particularly sersitive torel- gious attributes. Hindus, ‘or example, do not eat beef because itis expressly forbidden by their religion. Products thatelicita strong respons: ofthis kind are usualy quite easy to identify though some countries will provide a few sur- prises In Japan, rie, which Americans treat asa commodity, caries an enor- mous amount of cultural baggage. Ignoring cultural distance was one of, star TVsbiggest mistakes. By supposing that Asian viewers would be happy with Englistvlanguage programming, the com- pany asumed that the TV business was insenshive 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 ontent generally prefer local TV programming. Ifthey had talen cultural distarce into account, China and India could have been pre- dited to require significant investments in ocalization. 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, bboost trade by 00%, 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 {ng 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 dierent ways. ‘To estimate industry sensitivity to distance, Rajiv Mallick, 2 research associate at Harvard Business School, and | regressed trade between every possible pair of countries in the ‘world in each of 70 industries (ac- cording to thelr SIC designations) ‘on exch dimension of distance. “The results confirm the impor- tance of distinguishing tetween the various components of distance in assessing foreign market opportu nities. Electricity, for instance, is highly sensitive to administrative and geographic factors tut not at alto cultural factors. The following table lists some of the industries thatare more and less sensitive to distance, CULTURAL DISTANCE Lingui meat and meat preparations _cereals ane cereal preparations miscellaneous edible products and preparations more sensitive tobacco and tobacco products office machines and automatic data-processing equipment | photograpric apparatuses, S!_ optical goods, watches 3! road vehices © cork and wood ‘metalworking machinery | eect urrene | more sensitwe <= HARVARD BUSINESS REVIEW probably the leading example of delib- erate efforts to diminish administrative and political distance among trading partners. (Neecless to say, ties must be friendly to have a positive influence on trade. Although India and Pakistan share colonial history-not tomention a bor-

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