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.
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 socioeconomic pyramid, a newly rich elite who could not only afford the services but who also represented an attractive advertising market. Since English 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 broadcasters 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 company, 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 $111 million. Losses in fiscal years 1996 through 1999 came to about $500 million 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 expansion. Why? Because, like Star, they routinely overestimate the attractiveness of foreign markets. They become so dazzled by the sheer size of untapped markets that they lose sight of the 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 propensity to consume, CPA places all the emphasis 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 distance, I don't mean only geographic separation, though that is important. Distance also has cultural, administrative or political, and economic dimensions that can make foreign markets considerably more or less attractive. Just how much difference does distance make? A recent study by economists Jeffrey Frankel and Andrew Rose estimates the impact of various factors on a country's trade flows. Traditional economic factors, 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 countries 5,000 miles apart is only 20% of the 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 country to which it has no such ties. A common currency increases trade by 340%. Common 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 "Measuring the Impact of Distance.")
The Four Dimensions of Distance
Distance between two countries can manifest itself along four basic dimensions: cultural, administrative, geographic, and economic. The types of distance influence different businesses in different ways. Geographic distance, for instance, affects the costs of transportation and communications, so it is of particular importance to companies that deal with heavy or bulky products, or whose operations require a high degree of coordination among highly dispersed people or activities. Cultural distance, by contrast, affects consumers' product preferences. It is a crucial consideration for any consumer goods or media company, 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 of the factors and the ways in which they affect particular industries.) In this article, I will review the four principal dimensions of distance, starting with the two overlooked the most—cultural distance and administrative distance.
Pankaj Ghemawat is the Anselmo Rubiralta Professor of Global Strategy at IESE Business School. Professor Ghemawat earned his A.B. degree in Applied Mathematics from Harvard College, where he was elected to Phi Beta Kappa, and his Ph.D in Business Economics from Harvard University. He then worked as a consultant at McKinsey & Company in London before joining the Harvard Business School (HBS) faculty in 1983. In 1991, he was appointed the youngest full professor in HBS’s history. He joined the IESE faculty in 2006. Professor Ghemawat’s current teaching and research focus on globalization and strategy. He has developed a 30-session MBA course on the topic, chairs focused programs at IESE and at HBS on Getting Global Strategy Right, and has written more than 50 articles and case studies on the topic. His “Regional Strategies for Global Leadership” received the McKinsey Award for the best article published in the Harvard Business Review (HBR) in 2005. Other recent globalization-related publications include “Managing Differences: The Central Challenge in Global Strategy,” the lead article in the March 2007 issue of HBR, “Why the World Isn’t Flat” in the March/April 2007 issue of Foreign Policy, and “Global Integration ≠ Global Concentration” (with Fariborz Ghadar), the lead article in the August 2006 issue of Industrial and Corporate Change. He has also begun a blog on global strategy, “What in the World” for Harvard Business Online. In August 2008, he won the Irwin Outstanding Educator Award from the Academy of Management (California). He has been the first European Business School Professor who receives this award. In October 2008 has been appointed Fellow of the Strategic Management Society (SMS).
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