World 3.0

by Pankaj Ghemawat

  Some might question whether corporations today really need to worry that much about globalization. Since the financial crisis, there have been moves by many companies to retrench and refocus on home markets. Scanning the annual reports of the world's one hundred largest companies, you find that the percentage of firms in developed economies that emphasized international or global business in their letters to shareholders declined from 51 percent in 2006 to 31 percent in 2008.1 (In contrast, the percentage increased among the few companies in the group that were headquartered in emerging economies.) And use of the words global and globalization, while up significantly, mostly occurred in reference to the economic slowdown and its impact on company performance.

  Becoming homebodies, however, is usually a bad idea for firms based in the developed world, particularly since the biggest growth opportunities are now in developing countries. That leaves managers with the task of crafting a globalization strategy that accounts for the business implications of persistent semiglobalization and the law of distance. This chapter summarizes these implications in terms of five broad principles for developing a cross-border strategy. For a more extended treatment, please see my 2007 book, Redefining Global Strategy, which is devoted entirely to this topic.2

  Map Real Distances in Your Industry and Company

  Reviewing a range of possible postcrisis futures, cross-country differences seem unlikely to disappear. The crisis may serve to decrease a few kinds of differences, but many other kinds of differences should grow more salient. First of all, the crisis has accelerated the shift of the world's economic activity and dynamism toward major emerging markets, particularly ones in Asia. This increases the diversity confronting companies that want to tap rapidly growing markets. Second, governments around the world are participating more actively in national economies. Given the diversity of political systems and of policies being enacted, the administrative distance or barriers between countries is increasing. Third, protectionism remains a major wildcard. Companies need to prepare for the possibility of new restrictions on trade, investment, migration, and potentially even information flows, while working with governments to contain such protectionism. Getting a better handle on cross-country differences and distances should therefore be a priority for business leaders.

  The final section of chapter 12 articulated several principles for discerning differences and improving mental maps. For business it is particularly important to do such remapping at the industry level. Consider the two information technology (IT) services industry cartograms shown in figure 14-1 and again think about what kinds of CAGE distances are apparent.

  The map on the top of the figure shows countries proportional to their total spending on IT services: writing custom software, managing and maintaining computer systems, and the like. Unsurprisingly, IT spending is closely related to economic development, and there are clear scope or threshold effects: the use of IT services falls off sharply when you move out of the richest countries, and the poorest countries disappear from the map entirely. Maps for IT versus, say, agriculture should be as different as those that look at the world from Nigeria's versus Andorra's point of view.

  Now look at the map on the bottom of the figure. From Bangalore, it might seem like Indian IT is taking over the world, but here we can see the overwhelming impact of cultural distance, in particular language. Nearly 80 percent of India's IT exports go to the United States and United Kingdom, whereas Japan and continental markets are much smaller than in the map on the top. And if you thought the industry that inspired Thomas Friedman to believe that the world is flat had outwitted geography, you might be surprised to know that a significant fraction of the work delivered by Indian IT companies to their foreign clients is done on-site at client locations, so geographic distance matters as well, as does administrative distance in the form of visa requirements. Of course, the reason for going to all this trouble is to arbitrage across economic distance.

  Figure 14-1: IT services industry cartograms: Global spending versus Indian exports

  Note: On both maps, India is proportional to Indian domestic IT services market size.

  Source: Generated based on data from Gartner (top panel) and Nasscom (bottom panel) for 2007, with gaps filled by author's estimates.

  Think through how different kinds of distance and difference impact your own industry using similar visualization techniques and frameworks. Consult chapter 3 for background on the CAGE framework. And refer to table 14-1 for factors that make specific industries more sensitive to particular kinds of distance than others, a topic that is elaborated at greater length in chapter 2 of Redefining Global Strategy.

  While conducting your industry-level remapping exercise, try to incorporate some reflection of within-country diversity in parts of the world that are particularly important to your company. If you have a good mental map, you'll find that when you zoom in on key countries, their whole territory isn't painted one color. If your map of China doesn't extend past Beijing and Shanghai, you're missing the 88 percent of China's urban population that resides in cities with less than 5 million people, where much of the country's future growth is projected to take place.3 And China's second- and third-tier cities are very distant along multiple CAGE dimensions from Beijing or Shanghai, so adding them to your mental map will take some serious on-the-ground effort. It's also crucial to prioritize. McKinsey projects that in 2025 China will have 221 cities with more than 1 million inhabitants (including twenty-four with more than five million),4 and the Boston Consulting Group has identified 717 emerging market cities worldwide with populations of more than half a million that it describes as the “world's largest growth opportunity.”5 You certainly won't have time to develop a detailed understanding of every place that might be of interest to your company.

  Table 14-1: The distance sensitivity of industries: indicators

  Cultural distance

  Administrative distance

  Geographic distance

  Economic distance

  High linguistic content

  Government involved in funding, procurement, regulating standard-setting, before international bodies, etc.

  Low value-to-weight or bulk

  High intensity of labor, other factors prone to absolute cost differences

  Strong country of origin effects (vertical distance)

  Strategic industry status (votes, money, staples, state control, national champions)

  Hazards in transportation

  Potential for international scale/scope/experience economies

  Significant dif-ferences in prefer-ences/standards (horizontal distance)

  Specialized, durable sunk capital (and holdup potential)

  Perishability/time-sensitivity

  High income-related increases in willingness-to-pay

  Entrenched tastes/traditions

  Restraints on trade/FDI (e.g., agriculture)

  Need to perform key activities locally (favors FDI over trade)

  Differences in customers/channels/ business systems

  Another kind of difference I find merits special emphasis when conditioning executives to cross-country distance is the diversity of corporate forms and governance around the world. When you do business across borders, the company you're negotiating with may not resemble very closely the style of company you know best. The standalone, widely held American corporation, while the most studied capitalist organizational form in management education programs around the world, is the least typical. Most market economies' corporations are not widely owned by public shareholders but instead are parts of larger interconnected sets of companies principally owned and controlled by families, business groups, or states. These varied corporate forms and governance structures have significant implications for company goals and ways of operating—as well as ability to divert money. Think through the incentives that your business associates are operating under and respond accordingly. And recognize that it is often harder to work with companies with different go
vernance structures from your own. According to one study, the success rate for joint ventures between pyramidal groups in Brazil and standalone foreign firms was 7 percent, versus a 60 percent success rate when the Brazilian and foreign parents were both parts of pyramidal groups!6

  Similar visualization techniques and frameworks can also be applied to distances within a company. For example, map the breakup of sales revenues by country that you are targeting five years from now versus the composition of the nationalities of your executive team, or the geographic footprint of your R&D function. Then look at your reporting relationships. For most companies, organization and staffing are still stuck in World 1.0 even if their executives have their eyes firmly fixed on World 2.0. Thus, of all of the directors of U.S. S&P 500 companies in 2008 only 7 percent were foreign nationals, only 9 percent had degrees from non-U.S. institutions, and only 27 percent had any international work experience.7 Shifting to a global rather than U.S. dataset and looking at CEOs rather than directors, the picture isn't much better. Of the 2008 Fortune Global 500 companies, only 14 percent had a nonnative CEO.8 And these datasets are dominated by firms from advanced countries. The vast majority of firms, even very large ones, from emerging markets would seem to be significantly less internationalized in terms of such indicators.

  Customizing mental maps at the industry level, achieving within-country granularity in key countries, and carefully addressing internal distance all take a lot of effort, as I have emphasized. To maximize the efficiency of this learning process, it is usually best to start at the global level with a few industry-level visualization exercises and an assessment of what kinds of CAGE distance matter most for your business. This provides mental scaffolding that substantially increases the efficiency of firsthand learning on subsequent visits to key countries—for which there is ultimately no substitute. In other words, such analytical work complements on-the-ground experience.

  Avoid Market Imperialism

  Many companies in recent years have adopted what might be called an “imperialist” approach to globalizing their business. They've blindly oriented themselves toward expansion, seeking to extend their reach into every corner of the globe by gobbling up as many foreign assets as possible. According to one survey of Harvard Business Review readers before the financial crisis, 88 percent reported thinking of global strategy as an act of faith rather than as an alternative to be evaluated, and 64 percent believed that “the truly global company should aim to compete everywhere.”9 Such appetites were nourished by rising asset prices: many companies thought of globalization as one long asset accumulation play involving relatively little risk because they assumed that assets that proved surplus to requirements could be resold for more than they had cost.

  If you have developed a reasonable mental map that accounts for the real diversity within and across countries, you're unlikely to regard ubiquity—as in competing everywhere—as a sensible goal. And apart from a handful of global giants, the reality of multinational business would conform to your revised thinking. Thus, in 2004, less than one percent of all U.S. companies had foreign operations, and of these, the largest fraction operated in just one foreign country, the median number in two, and 95 percent in fewer than two dozen.10 Furthermore, none of these statistics had changed much in the past ten years!

  With the bursting of the asset bubble, executives have received a rude reminder about the need to actually evaluate the economic performance of specific country operations. Research confirms that for many firms, a considerable portion of their global operations actually subtract value over time. Data that Marakon Associates analyzed at my request revealed that “half of the [large] companies we have looked at [8 out of 16] have significant geographic units that earn negative economic returns … [We] know from our clients that their profitability by geography has stayed fairly stable over time unless they have specifically targeted action at specific countries/regions.”

  As companies become more mindful of national differences and depart from a misguided “get bigger at all costs” mind-set, they take a more considered view of international expansion. Such thinking leads companies to reevaluate their current country portfolios. Downturns (and their immediate aftermath) are more obvious occasions to restructure or exit weaker markets than upturns. Nokia, for example, announced in November 2008 that it was exiting the Japanese mobile handset market (except for its high-end Vertu brand) after years of investment yielded only a meager one percent market share (versus about 40 percent globally). Exiting the world's fourth-largest market must not have been easy for Nokia, but it's a realistic decision considering Japan's idiosyncratic, highly demanding consumers, different standards, and the dominance of local firms. Or to mention another example, Dr. Reddy's, the largest Indian-owned pharmaceutical firm, recently used the CAGE framework and the ADDING value scorecard to help scale back from 50 markets to fewer than 20. While the latter was deployed in this book mainly at the macro level, in chapter 4, I originally developed it to help companies with such assessments.11

  Eschewing market imperialism aligns with a number of other, more nuanced strategic shifts. In an increasingly fragmented world, with growth opportunities in Western markets drying up, Western companies competing in big emerging markets like China and India can't just hope to blast in there and dominate, nor can they prosper merely by continuing the practice of addressing themselves to local, urban elites. Rather, they will need to pay serious attention to local competitors and to think about extending their presence to secondary cities. And those local competitors may talk of inheriting the earth but again, instead of assuming that they hold all the cards, they have to reckon with the advantages of established multinationals.12

  Reining in “size-ism” in international expansion has benefits that go beyond improving financial profitability. It can also help curb protectionist tendencies and reinforce support for continued market integration. As companies acquire foreign assets with little rhyme or reason, they come across to the public as voracious and greedy, and capitalism itself seems inherently impersonal and destructive. Dispensing with market imperialism and treating foreign country markets in ways that respect their local sovereignty, uniqueness, and internal diversity can go a long way toward improving companies' reputations and, more broadly, the environment in which business as a whole has to operate.

  Revamp Market Strategies

  Strategies rooted in semiglobalization involve integrated consideration of both borders and distance—of the barriers and the bridges between countries. In chapters 4 to 7 of Redefining Global Strategy, I described three fundamental ways that companies can create value across borders in a world where differences still matter: the AAA strategies of adaptation, aggregation, and arbitrage. Adaptation strategies try to adjust to cross-country differences in order to be locally responsive. Aggregation strategies attempt to overcome cross-country differences to achieve scale/scope economies that extend across national borders. And arbitrage strategies seek to exploit differences—as in buying low in one country and selling high in another. My general prescription was for managers to select a combination of these strategies, tailored to their company's own industry, position, capabilities, and intent.

  Given their focus on differences, the AAA strategies remain the relevant strategy set for companies in World 3.0—and can even help countries with their decisions about how to compete, as we saw in the previous chapter. But given the crisis and its aftermath, it may make sense in the medium term for many companies to emphasize adaptation more than aggregation or arbitrage—although this should ultimately depend on each firm's industry, history, and strategy.13 It can take years for companies to execute meaningful shifts in this regard, so they need to consider longer-term plans and expectations for industry evolution in making such decisions. The rationale for strengthening adaptation is that becoming more responsive to local conditions increases robustness in case of protectionism, helps to address the growing role of governments, and is necessary in many cases
for participating in the growth that is available in emerging markets. In addition, becoming more respectful of differences can actually help lower the likelihood of protectionism.

  Adaptation encompasses a broad range of levers and sublevers that companies can use to respond to cross-country differences. Variation is the most obvious kind of adaptation: if local markets exhibit different preferences, offer them different products or services. It can also make sense to vary company policies, business positioning, and even metrics and targets across countries. However, variation is costly and also results in a great deal of complexity that can be hard to manage. Therefore, smart adaptation typically involves not only appropriate decisions about the amount of variation but adroit application of one or more complementary substrategies such as focus, externalization, design, and innovation, each of which can help reduce the costs of variation.

  Focus involves purposefully narrowing scope so as to reduce the extent of differences encountered and the amount of adaptation required. Typical bases for focus include regions, market segments or value added steps. Externalization involves splitting activities across organizational boundaries to reduce the internal burden of adaptation—for example, via the use of joint ventures or franchising, or even by relying on customers to customize their own products or services. Companies have long found partnerships to be particularly attractive when dealing with large cultural and administrative distances, as partners can provide access to local knowledge and relationships that would otherwise be hard to develop. Design can also deliberately reduce the cost of variation—for example, via the use of platforms or modularization. And finally, innovation sometimes yields whole new ways around the problem of adaptation.