study guide

www.hbrreprints.org

T

O O L

K

I T

Distance Still Matters

The Hard Reality of Global Expansion

by Pankaj Ghemawat

•

Included with this full-text

Harvard Business Review

article:

The Idea in Brief—the core idea

The Idea in Practice—putting the idea to work

1

Article Summary

2

Distance Still Matters: The Hard Reality of Global Expansion

A list of related materials, with annotations to guide further

exploration of the article’s ideas and applications

12

Further Reading

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.

Reprint R0108K

T

O O L

K

I T

Distance Still Matters

The Hard Reality of Global Expansion

page 1

The Idea in Brief The Idea in Practice

C O

P Y

R IG

H T

© 2

0 0 4 H

A R

V A

R D

B U

S IN

E S

S S

C H

O O

L P

U B

L IS

H IN

G C

O R

P O

R A

T IO

N . A

L L

R IG

H T

S R

E S

E R

V E

D .

Why did U.S. media giant Star TV lose $500 million trying to deliver TV program- ming to Asia? Like many companies, it was so dazzled by the foreign market’s immen- sity that it ignored the difficulties of pioneering new territories. For example, it assumed—wrongly—that Asian viewers wanted English-language programming.

How to avoid this fate—and select the right targets for your firm’s global expansion? Look beyond a country’s sales potential (as ex- pressed by national wealth or propensity to consume)—and analyze the probable im- pact of distance.

But don’t focus only on distance’s geographi- cal dimension. Consider three other dimen- sions as well: cultural factors (religion, race, social norms, language); administrative fac- tors (colony-colonizer links, currencies, trad- ing arrangements); and economic factors (in- come, distribution-channel quality).

The more two countries differ across these dimensions, the riskier the target foreign market. By contrast, similarities along these dimensions suggest great potential. Com- mon currency, for example, boosts trade more than 300%. Also, types of distance af- fect industries differently. Religious differ- ences, for instance, shape people’s food pref- erences but not their choices of cement or other industrial materials.

By analyzing the possible impact of dis- tance—in all its dimensions—you sweeten the odds of investing in profitable foreign markets.

How to decide whether to expand into a particular foreign country? Consider distance’s four di- mensions—and ask how they might affect your industry. The table provides examples.

By considering the potential impact of distance on your industry, you may identify highly promising global-investment opportunities.

Example:

Suffering limited cash flow and high debt- service obligations, Dallas-based Tricon Res- taurants International (TRI) had to select its global-expansion investments carefully. An analysis of per-capita income and fast-food consumption suggested Japan, Canada, and Germany as the most promising coun- tries in which to invest—with Mexico rank- ing 16th among 20 possibilities. But when TRI included the four dimensions of dis- tance in its analysis, Mexico leapt to 2nd place.

Why? Mexico’s geographic proximity to TRI’s headquarters, the common land border, and membership in a trade agreement with the U.S. reduced geographic and adminis- trative distance between the two countries. If TRI hadn’t considered these dimensions of distance, it might have neglected this core market.

Cultural Distance

Administrative and Political

Distance Geographic

Distance Economic Distance

Distance between two countries increases with. . .

• Different languages, ethnicities, religions, social norms

• Lack of connec- tive ethnic or social networks

• Absence of shared mon- etary or political association

• Political hostilities

• Weak legal and financial institu- tions

• Lack of com- mon border, waterway ac- cess, adequate transportation or communica- tion links

• Physical remoteness

• Different climates

• Different con- sumer incomes

• Different costs and quality of natural, financial, and human resources

• Different information or knowledge

Distance most affects in- dustries or products. . .

• With high lin- guistic content (TV)

• Related to national identity (foods)

• Carrying country-specific quality associa- tions (wines)

• That a foreign government views as staples (electricity), as building nation- al reputations (aerospace), or as vital to national security (telecommuni- cations)

• With low value- to-weight ratio (cement)

• That are fragile or perishable (glass, fruit)

• In which com- munications are vital (financial services)

• For which de- mand varies by income (cars)

• In which labor and other cost differences mat- ter (garments)

T

O O L

K

I T

Distance Still Matters

by Pankaj Ghemawat

harvard business review • september 2001 page 2

C O

P Y

R IG

H T

© 2

0 0 1 H

A R

V A

R D

B U

S IN

E S

S S

C H

O O

L P

U B

L IS

H IN

G C

O R

P O

R A

T IO

N . A

L L

R IG

H T

S R

E S

E R

V E

D .

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 straight- forward: The company would deliver televi- sion 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 lan- guage 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 creat- ing 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—espe- cially with the appeal of leveraging his Twenti- eth Century Fox film library across the Asian market—that his company, News Corpora- tion, bought out Star’s founders for $825 mil- lion between 1993 and 1995.

The results have not been quite what Mur- doch 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 oper- ating 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? Be- cause, like Star, they routinely overestimate the attractiveness of foreign markets. They be- come so dazzled by the sheer size of untapped markets that they lose sight of the vast difficul- ties of pioneering new, often very different ter- ritories. The problem is rooted in the very ana- lytic 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 analy- sis (CPA), the hoary but still widely used tech-

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 3

nique 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 bar- riers created by distance. By distance, I don’t mean only geographic separation, though that is important. Distance also has cultural, admin- istrative or political, and economic dimensions that can make foreign markets considerably more or less attractive. Just how much differ- ence 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 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% of the amount that would be predicted to take place if the same countries were 1,000 miles apart. Cul- tural 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 cur- rency increases trade by 340%. Common mem- bership 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.”)

Much has been made of the death of dis- tance in recent years. It’s been argued that in- formation technologies and, in particular, glo- bal communications are shrinking the world, turning it into a small and relatively homoge- neous place. But when it comes to business, that’s not only an incorrect assumption, it’s a dangerous one. Distance still matters, and companies must explicitly and thoroughly ac- count for it when they make decisions about global expansion. Traditional country portfo- lio analysis needs to be tempered by a clear- eyed evaluation of the many dimensions of distance and their probable impact on oppor- tunities in foreign markets.

The Four Dimensions of Distance

Distance between two countries can manifest

itself along four basic dimensions: cultural, ad- ministrative, geographic, and economic. The types of distance influence different busi- nesses in different ways. Geographic distance, for instance, affects the costs of transportation and communications, so it is of particular im- portance to companies that deal with heavy or bulky products, or whose operations require a high degree of coordination among highly dis- persed people or activities. Cultural distance, by contrast, affects consumers’ product prefer- ences. It is a crucial consideration for any con- sumer goods or media company, but it is much less important for a cement or steel business.

Each of these dimensions of distance en- compasses 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 indus- tries.) In the following pages, I will review the four principal dimensions of distance, starting with the two overlooked the most—cultural distance and administrative distance.

Cultural Distance. A country’s cultural at- tributes determine how people interact with one another and with companies and institu- tions. Differences in religious beliefs, race, so- cial norms, and language are all capable of cre- ating distance between two countries. Indeed, they can have a huge impact on trade: All other things being equal, trade between coun- tries that share a language, for example, will be three times greater than between countries without a common language.

Some cultural attributes, like language, are easily perceived and understood. Others are much more subtle. Social norms, the deeply rooted system of unspoken principles that guide individuals 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 Univer- sity Press, 1995), many people ascribe this so- cial norm to China’s recent communist past. More likely, Alford argues, it flows from a pre- cept 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 infringe- ment was a problem for Western publishers

Pankaj Ghemawat

is the Jaime and Josefina Chua Tiampo Professor of Busi- ness Administration at Harvard Busi- ness School in Boston. His article “The Dubious Logic of Global Megamergers,” coauthored by Fariborz Ghadar, was published in the July–August 2000 issue of HBR.

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 4

well before communism. Back in the 1920s, for example, Merriam Webster, about to in- troduce a bilingual dictionary in China, found that the Commercial Press in Shanghai had already begun to distribute its own version of the new dictionary. The U.S. publisher took the press to a Chinese court, which imposed a small fine for using the Merriam Webster seal but did nothing to halt publication. As the film and music industries well know, little has changed. Yet this social norm still confounds many Westerners.

Most often, cultural attributes create dis- tance by influencing the choices that consum- ers make between substitute products be- cause 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 in- dustries are particularly sensitive to differ-

ences in consumer taste at this level. The Jap- anese, for example, prefer automobiles and household appliances to be small, reflecting 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 particu- lar community. In these cases, cultural distance affects entire categories of products. The food industry is particularly sensitive to religious at- tributes. Hindus, for example, do not eat beef because it is expressly forbidden by their reli- gion. 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 enormous 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 company assumed that the TV business was insensitive to culture. Manag- ers either dismissed or were unaware of evi- dence from Europe that mass audiences in countries large enough to support the develop- ment of local content generally prefer local TV programming. If they had taken cultural dis- tance into account, China and India could have been predicted to require significant invest- ments in localization. TV is hardly cement.

Administrative or Political Distance. His- torical and political associations shared by countries greatly affect trade between them. Colony-colonizer links between countries, for example, boost trade by 900%, which is per- haps 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 Amer- ica. Preferential trading arrangements, com- mon currency, and political union can also in- crease trade by more than 300% each. The integration of the European Union is probably the leading example of deliberate efforts to di- minish administrative and political distance among trading partners. (Needless to say, ties must be friendly to have a positive influence on trade. Although India and Pakistan share a colonial history—not to mention a border and linguistic ties—their mutual hostility means that trade between them is virtually nil.)

Countries can also create administrative and

Measuring the Impact of Distance

Economists often rely on the so-called 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 of the observed variations in trade flows between pairs of countries. Using such a model, economists Jeffrey Frankel and Andrew Rose1 have predicted how much certain dis- tance variables will affect trade.

Change in Distance Attribute International Trade (%)

income level: GDP per capita (1% increase) +0.7

economic size: GDP (1% increase) +0.8

physical distance (1% increase) -1.1

physical size (1% increase)* -0.2

access to ocean* +50

common border +80

common language +200

common regional trading bloc +330

colony-colonizer relationship +900

common colonizer +190

common polity +300

common currency +340

1. Jeffrey Frankel and Andrew Rose, “An Estimate of the Effects of Currency Unions on Growth,” unpublished working paper, May 2000.

*Estimated effects exclude the last four variables in the table.

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 5

political distance through unilateral measures. Indeed, policies of individual governments pose the most common barriers to cross-border competition. In some cases, the difficulties arise in a company’s home country. For compa- nies from the United States, for instance, do- mestic prohibitions on bribery and the pre- scription of health, safety, and environmental policies have a dampening effect on their in- ternational businesses.

More commonly, though, it is the target country’s government that raises barriers to foreign competition: tariffs, trade quotas, re-

strictions on foreign direct investment, and preferences for domestic competitors in the form of subsidies and favoritism in regulation and procurement. Such measures are expressly intended to protect domestic industries, and they are most likely to be implemented if a do- mestic industry meets one or more of the fol- lowing criteria:

• It is a large employer. Industries that repre- sent large voting blocs often receive state sup- port in the form of subsidies and import protec- tion. Europe’s farmers are a case in point.

• It is seen as a national champion. Reflect-

The CAGE Dis tance 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 of the table lists the key attributes underlying the four dimensions of distance. The lower portion shows how they affect different products and industries.

a tt

ri b

u te

s cr

ea ti

n g

d is

ta n

ce in

d u

st ri

es o

r p

ro d

u ct

s a

ff ec

te d

b y

d is

ta n

ce

Cultural Distance

different languages

different ethnicities; lack of connective ethnic or social networks

different religions

different social norms

products have high linguistic 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 quality associations (wines)

Administrative Distance

absence of colonial ties

absence of shared monetary or political association

political 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)

• subject to 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, fruit)

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 (home appliances)

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 6

ing a kind of patriotism, some industries or companies serve as symbols of a country’s mo- dernity and competitiveness. Thus the show- down between Boeing and Airbus in captur- ing the large passenger-jet market has caused feelings on both sides of the Atlantic to run high and could even spark a broader trade war. Also, the more that a government has invested in the industry, the more protective it is likely to be, and the harder it will be for an outsider to gain a beachhead.

• It is vital to national security. Governments will intervene to protect industries that are deemed vital to national security—especially in high tech sectors such as telecommunications and aerospace. The FBI, for instance, delayed Deutsche Telekom’s acquisition of Voicestream for reasons of national security.

• It produces staples. Governments will also

take measures to prevent foreign companies from dominating markets for goods essential to their citizens’ everyday lives. Food staples, fuel, and electricity are obvious examples.

• It produces an “entitlement” good or service. Some industries, notably the health care sector, produce goods or services that people believe they are entitled to as a basic human right. In these industries, governments are prone to in- tervene to set quality standards and control pricing.

• It exploits natural resources. A country’s physical assets are often seen as part of a na- tional heritage. Foreign companies can easily be considered robbers. Nationalization, there- fore, is a constant threat to international oil and mining multinationals.

• It involves high sunk-cost commitments. In- dustries that require large, geography-specific sunk investments—in the shape, say, of oil re- fineries or aluminum smelting plants or railway lines—are highly vulnerable to interference from local governments. Irreversibility expands the scope for holdups once the investment has been made.

Finally, a target country’s weak institu- tional infrastructure can serve to dampen cross-border economic activity. Companies typically shy away from doing business in countries known for corruption or social con- flict. Indeed, some research suggests that these conditions depress trade and invest- ment far more than any explicit administra- tive policy or restriction. But when a coun- try’s institutional infrastructure is strong—for instance, if it has a well-functioning legal sys- tem—it is much more attractive to outsiders.

Ignoring administrative and political sen- sitivities was Star TV’s other big mistake. Foreign ownership of broadcasting busi- nesses—even in an open society like the United States—is always politically loaded be- cause of television’s power to influence peo- ple. Yet shortly after acquiring the company, Rupert Murdoch declared on record that sat- ellite television was “an unambiguous threat to totalitarian regimes everywhere” because it permitted people to bypass government-con- trolled news sources. Not surprisingly, the Chinese government enacted a ban on the re- ception of foreign satellite TV services soon thereafter. News Corporation has begun to mend fences with the Chinese authorities, but it has yet to score any major breakthroughs in

How Far Away Is China, Really?

As Star TV discovered, China is a partic- ularly tough nut to crack. In a recent sur- vey of nearly 100 multinationals, 54% ad- mitted that their total business performance in China had been “worse than planned,” compared with just 25% reporting “better than planned.” Why was the failure rate so high? The survey provides the predictable answer: 62% of respondents reported that they had overestimated market potential for their products or services.

A quick analysis of the country along the dimensions of distance might have spared those companies much disap- pointment. Culturally, China is a long way away from nearly everywhere. First, the many dialects of the Chinese lan- guage are notoriously difficult for for- eigners to learn, and the local popula- tion’s foreign-language skills are limited. Second, the well-developed Chinese business culture based on personal con- nections, often summarized in the term

guanxi,

creates barriers to economic in- terchange with Westerners who focus on transactions rather than relation- ships. It can even be argued that Chi- nese consumers are “home-biased”; mar- ket research indicates much less

preference for foreign brands over do- mestic ones than seems to be true in In- dia, for example. In fact, greater China plays a disproportionate role in China’s economic relations with the rest of the world.

Administrative barriers are probably even more important. A survey of mem- bers of the American Chamber of Com- merce in China flagged market-access restrictions, high taxes, and customs du- ties as the biggest barriers to profitabil- ity in China. The level of state involve- ment in the economy continues to be high, with severe economic strains im- posed by loss-making state-owned enter- prises and technically insolvent state- owned banks. Corruption, too, is a fairly significant problem. In 2000, Transpar- ency International ranked the country 63rd out of 90, with a rating of one indi- cating the least perceived corruption. Considerations such as these led Stan- dard & Poor’s to assign China a political- risk ranking of five in 2000, with six being the worst possible score.

So, yes, China is a big market, but that is far from the whole story. Distance mat- ters, too, and along many dimensions.

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 7

a country that accounts for nearly 60% of Star TV’s potential customers. Murdoch of all peo- ple should have foreseen this outcome, given his experience in the United States, where he was required to become a citizen in order buy the television companies that now form the core of the Fox network.

Geographic Distance. In general, the far- ther you are from a country, the harder it will be to conduct business in that country. But geographic distance is not simply a matter of how far away the country is in miles or kilome- ters. Other attributes that must be considered include the physical size of the country, aver- age within-country distances to borders, ac- cess to waterways and the ocean, and topogra- phy. Man-made geographic attributes also must be taken into account—most notably, a country’s transportation and communications infrastructures.

Obviously, geographic attributes influence the costs of transportation. Products with low

value-to-weight or bulk ratios, such as steel and cement, incur particularly high costs as geo- graphic distance increases. Likewise, costs for transporting fragile or perishable products be- come significant across large distances.

Beyond physical products, intangible goods and services are affected by geographic dis- tance as well. One recent study indicates that cross-border equity flows between two coun- tries fall off significantly as the geographic dis- tance between them rises. This phenomenon clearly cannot be explained by transportation costs—capital, after all, is not a physical good. Instead, the level of information infrastructure (crudely measured by telephone traffic and the number of branches of multinational banks) accounts for much of the effect of physical dis- tance on cross-border equity flows.

Interestingly, companies that find geogra- phy a barrier to trade are often expected to switch to direct investment in local plant and equipment as an alternative way to access tar-

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 possible pair of countries in 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 of the industries that are more and less sensitive to distance.

CULTURAL DISTANCE Linguistic Ties

meat and meat preparations

cereals and cereal preparations

miscellaneous edible products and preparations

tobacco and tobacco products

office machines and automatic data-processing equipment

M O

R E

S E

N S

IT IV

E L

E S

S S

E N

S IT

IV E photographic apparatuses,

optical goods, watches

road vehicles

cork and wood

metalworking machinery

electricity current

MORE SENSITIVE

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 8

get markets. But current research suggests that this approach may be flawed: Geographic dis- tance has a dampening effect, overall, on in- vestment flows as well as on trade flows. In short, it is important to keep both information networks and transportation infrastructures in mind when assessing the geographic influences on cross-border economic activity.

Economic Distance. The wealth or income of consumers is the most important economic attribute that creates distance between coun- tries, and it has a marked effect on the levels of trade and the types of partners a country trades with. Rich countries, research suggests, engage in relatively more cross-border eco- nomic activity relative to their economic size than do their poorer cousins. Most of this ac- tivity is with other rich countries, as the posi- tive correlation between per capita GDP and trade flows implies. But poor countries also trade more with rich countries than with other poor ones.

Of course, these patterns mask variations in the effects of economic disparities—in the cost and quality of financial, human, and other resources. Companies that rely on econ- omies of experience, scale, and standardiza- tion should focus more on countries that have similar economic profiles. That’s because they have to replicate their existing business model to exploit their competitive advantage, which is hard to pull off in a country where cus- tomer incomes—not to mention the cost and quality of resources—are very different. Wal- Mart in India, for instance, would be a very different business from Wal-Mart in the United States. But Wal-Mart in Canada is vir- tually a carbon copy.

In other industries, however, competitive advantage comes from economic arbitrage— the exploitation of cost and price differen- tials between markets. Companies in indus- tries whose major cost components vary widely across countries—like the garment

ADMINISTRATIVE DISTANCE Preferential Trading Agreements

gold, nonmonetary

electricity current

coffee, tea, cocoa, spices

textile fibers

sugar, sugar preparations, and honey

GEOGRAPHIC DISTANCE Physical Remoteness

electricity current

gas, natural and manufactured

paper, paperboard

live animals

sugar, sugar preparations, and honey

ECONOMIC DISTANCE Wealth Differences

(economic distance decreases trade)

nonferrous metals

manufactured fertilizers

meat and meat preparations

iron and steel

pulp and waste paper

gas, natural and manufactured

travel goods, handbags

footwear

sanitary, plumbing, heating, and lighting fixtures

furniture and furniture parts

pulp and waste paper

photographic apparatuses, optical goods, watches

telecommunications and sound-recording apparatuses

coffee, tea, cocoa, spices

gold, nonmonetary

(economic distance increases trade)

coffee, tea, cocoa, spices

animal oils and fats

office machines and automatic data-processing equipment

power-generating machinery and equipment

photographic apparatuses, optical goods, watches

LESS SENSITIVE

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 9

and footwear industries, where labor costs are important—are particularly likely to tar- get countries with different economic pro- files for investment or trade.

Whether they expand abroad for purposes of replication or arbitrage, all companies find that major disparities in supply chains and dis- tribution channels are a significant barrier to business. A recent study concluded that mar- gins on distribution within the United States— the costs of domestic transportation, wholesal- ing, and retailing—play a bigger role, on aver- age, in erecting barriers to imports into the United States than do international transporta- tion costs and tariffs combined.

More broadly, cross-country complexity and change place a premium on responsiveness and agility, making it hard for cross-border competitors, particularly replicators, to match the performance of locally focused ones be- cause of the added operational complexity. In the home appliance business, for instance, companies like Maytag that concentrate on a limited number of geographies produce far better returns for investors than companies like Electrolux and Whirlpool, whose geo- graphic spread has come at the expense of sim-

plicity and profitability.

A Case Study in Distance

Taking the four dimensions of distance into ac- count can dramatically change a company’s as- sessment of the relative attractiveness of for- eign markets. One company that has wrestled with global expansion is Tricon Restaurants In- ternational (TRI), the international operating arm of Tricon, which manages the Pizza Hut, Taco Bell, and KFC fast-food chains, and which was spun off from Pepsico in 1997.

When Tricon became an independent com- pany, TRI’s operations were far-flung, with res- taurants in 27 countries. But the profitability of its markets varied greatly: Two-thirds of reve- nues and an even higher proportion of profits came from just seven markets. Furthermore, TRI’s limited operating cash flow and Tricon’s debt service obligations left TRI with less than one-tenth as much money as archrival Mc- Donald’s International to invest outside the United States. As a result, in 1998, TRI’s presi- dent, Pete Bassi, decided to rationalize its glo- bal operations by focusing its equity invest- ments in a limited number of markets.

But which markets? The exhibit “Country

JAPAN

KEY: (applies to both charts) 1

KOREA2

TAIWAN3

PUERTO RICO4

MALAYSIA5

AUSTRALIA6

THAILAND7

NEW ZEALAND8

S. AFRICA9

SINGAPORE10

SAUDI ARABIA11

POLAND12

BELGIUM13

FRANCE14

GERMANY15

SPAIN16

UK17

CANADA18

MEXICO19

CHINA20

-5,000

100

0

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000

per capita income ($)

p er

c ap

it a

fa st

-fo od

c on

su m

p ti

on ( $)

200

300

400

Mexico

1

2 3

4

5

6

7

8

9

10

11

12 13

14

15

16

17

18

1920

Country Por t folio Analysis: A Flawed Approach

Here’s how country portfolio analysis (CPA) works. A company’s actual and potential markets are plotted on a simple grid, with a measure of per capita income on one axis and some measure of product performance, often penetration rates, on the other. The location of the market on the grid reflects the attractiveness of the mar- ket in terms of individual consumer wealth and propensity to consume. The size of the bubble represents the total size of the market in terms of GDP or the absolute consumption of the product or service in question. The bubbles provide a rough estimate of how large the relative revenue opportunities are.

This CPA map compares a number of non–U.S. markets for fast-food restaurants.

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 10

Portfolio Analysis: A Flawed Approach” pro- vides a portfolio analysis of international mar- kets for the fast-food restaurant business, based on data used by TRI for its strategy discussions. The analysis suggests that the company’s top markets in terms of size of opportunity would be the larger bubbles to the center and right of the chart.

Applying the effects of distance, however, changes the map dramatically. Consider the Mexican market. Using the CPA method, Mexico, with a total fast-food consumption of $700 million, is a relatively small market, ranking 16th of 20. When combined with esti- mates of individual consumer wealth and per capita consumption, this ranking would imply that TRI should dispose of its investments there. But the exhibit “Country Portfolio Analysis: Adjusted for Distance” tells a differ- ent story. When the fast-food consumption numbers for each country are adjusted for their geographic distance from Dallas, TRI’s home base, Mexico’s consumption decreases less than any other country’s, as you might ex- pect, given Mexico’s proximity to Dallas. Based on just this readjustment, Mexico leaps to sixth place in terms of market opportunity.

Further adjusting the numbers for a com- mon land border and for membership in a

trade agreement with the United States pushes Mexico’s ranking all the way up to second, after Canada. Not all the adjustments are posi- tive: adjusting for a common language—not a characteristic of Mexico—pushes Mexico into a tie for second place with the United King- dom. Additional adjustments could also be made, but the overall message is plain. Once distance is taken into account, the size of the market opportunity in Mexico looks very dif- ferent. If TRI had used the CPA approach and neglected distance, the company’s planners might well have ended up abandoning a core market. Instead, they concluded, in Bassi’s words, that “Mexico is one of TRI’s top two or three priorities.”

• • •

Factoring in the industry effects of distance is only a first step. A full analysis should consider how a company’s own characteristics operate to increase or reduce distance from foreign markets. Companies with a large cadre of cos- mopolitan managers, for instance, will be less affected by cultural differences than compa- nies whose managers are all from the home country. In TRI’s case, consideration of com- pany-specific features made Mexico even more attractive. The company already owned more than four-fifths of its Mexican outlets and had

Mexico

-5,000

100

0

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000

per capita income ($)

p er

c ap

it a

fa st

-fo od

c on

su m

p ti

on ( $)

200

300

400

1

2 3

4

5

6

7

8

9

10

12 13

14

15

16

17

18

1920 11

Country Por t folio Analysis: Adjusted for Distance

Taking distance into account dra- matically changes estimates of market opportunities. In the chart at right, each of the fast-food markets has been adjusted for a number of distance attributes, based on the estimates by Frankel and Rose. The relative sizes of the bubbles are now very different. For example, Mexico, which was less than one-tenth the size of the largest international markets, Japan and Germany, ends up as the second largest opportunity. Clearly, the CPA approach paints an incom- plete picture, unless it is adjusted for distance.

Distance Still Matters

•

•

•

T

OOL

K

IT

harvard business review • september 2001 page 11

a 38% share of the local market, well ahead of McDonald’s.

Consideration of the interaction of company- specific features and distance is beyond the scope of this article. But whether the analysis is at the industry or company level, the mes- sage is the same: Managers must always be conscious of distance—in all its dimensions. The CAGE distance framework is intended to help managers meet that challenge. While it is necessarily subjective, it represents an impor-

tant complement to the tools used by most companies seeking to build or rationalize their country market portfolios. Technology may in- deed be making the world a smaller place, but it is not eliminating the very real—and often very high—costs of distance.

Reprint R0108K

To order, see the next page or call 800-988-0886 or 617-783-7500 or go to www.hbrreprints.org

T

O O L

K

I T

Distance Still Matters

The Hard Reality of Global Expansion

To Order

For

Harvard Business Review

reprints and subscriptions, call 800-988-0886 or 617-783-7500. Go to www.hbrreprints.org

For customized and quantity orders of

Harvard Business Review

article reprints, call 617-783-7626, or e-mai [email protected]

page 12

Further Reading

A R T I C L E S

The Hidden Challenge of Cross-Border Negotiations

by James K. Sebenius

Harvard Business Review

March 2002 Product no. R0203F

Sebenius explores an additional cultural differ- ence that can create distance between two countries seeking to do business together: the varying ways in which people from different re- gions manage the negotiation process. Numer- ous promising deals have failed because the people involved ignored or underestimated these differences. How to avoid this fate? Pre- pare for a cross-border negotiation by map- ping out each party’s decision-making pro- cess—including who is involved, what formal and informal roles participants play, and how the agreement will be reached. Then design a negotiation strategy that anticipates obstacles before they arise. Your reward? A negotiation that leads to a meaningful “Yes.”

Clusters and the New Economics of Competition

by Michael E. Porter

Harvard Business Review

November–December 1998 Product no. 98609

Porter agrees that distance—in all its dimen- sions—can hamper business dealings be- tween companies from different regions. Geo- graphic, cultural, and institutional proximity provides companies with special access, closer relationships, better information, and other ad- vantages that are difficult to tap from a dis- tance. Such proximity gives rise to “clusters”— critical masses of linked industries and institu- tions (think Silicon Valley or Hollywood) that enjoy unusual competitive success in a particu- lar field.

Clusters affect competition by 1) increasing the productivity of companies based in the area, 2) driving the direction and pace of inno- vation, and 3) stimulating formation of new businesses within the cluster. Clearly, local assets—knowledge, relationships, and motivation—provide a competitive edge that distant rivals can’t replicate.