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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...

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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.
Stiii Matters
The Hard Reality of Global Expansion
y Pankaj Ghemawat
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 soeioeeonomie pyramid, a newly
ich elite who could not only afford the
services but who also represented an
attractive advertising market. Since En-
glish was the second language for most
of the target consumers. Star would be
able to use readily available and fairly
cheap English-language programming
ather 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
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 li
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 yea
ending June 30,1999, Star reportedly
lost $141 million, pretax, on revenues of
TOOL KIT • Distance Stil l Matters
$111 million. Losses in fiscal years 1996
through 1999 came to about $500 mil-
lion 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,
ut similar stories are played out all the
time as companies pursue global ex-
pansion. Why? Because, like Star, they
outinely overestimate the attractive-
ness of foreign markets. They become
so dazzled by the sheer size of untapped
markets that they lose sight ofthe vast
difficulties of pioneering new, often
very different te
itories. 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 propen-
sify to consimie, 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 ba
iers created by distance. By dis-
tance, I 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 or less attractive. Just how
much difference does distance make?
A recent study by economists Jeffrey
Frankel and Andrew Rose estimates the
Measuring the Impact
of Distance
Economists often rely on the so-caiied 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
ased on this theory explain up to two-thirds ofthe observed variations
in trade flows between pairs of countries. Using such a model, economists
Jeffrey Frankel and Andrew Rose' have predicted how much certain dis-
tance variables will affect trade.
Distance Attribute
income level: GDP per capita (1% increase)
economic size: GDP (1% increase)
physical distance (1% increase)
physical size (1% increase)*
access to ocean*
common borde
common language
common regional trading bloc
colony-colonizer relationship
common colonize
common polity
common cu
Change in
Internationai Trade (%)
1.Jeffrey Frankel and Andrew Rose, "An Estimate ofthe Effects of Cu
ency Unions on Growth,"
unpublished working paper. May 2000.
^Estimated effects exclude the lost four variables in the table.
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% ofthe
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 forme
colony, for instance, than with a coimtry
to which it has no such ties. A common
ency increases trade by 340%. Com-
mon membership in a regional trading
loc 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 been made ofthe death
of distance in recent years. It's been
argued that information technolo-
gies and, in particular, global com-
munications are shrinking the world,
turning it into a small and relatively
homogeneous place. But when it
comes to business, that's not only
an inco
ect assumption, it's a dan-
gerous one. Distance still matters,
and companies must explicitly and
thoroughly account for it when
they make decisions about global
expansion. Traditional country port-
folio analysis needs to be tempered
y a clear-eyed 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 countries can
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-
nications, so it is of particular im-
TOOL KIT • Distance Sti l l Matters
Distance Framework
The cultural, administrative, geographic, and economic (CAGE) distance framework helps
managers identify and assess the impact of distance on various industries. The uppe
portion ofthe table lists the key attributes underlying the four dimensions of distance. The
lower portion shows how they affect different products and industries.
d iffejejTtJajig u_ag es _
Cultural Distance
different ethnicities; lack
of connective ethnic o
soc i a I networks
different religions
dijferent social norms
products have high
iinguistic content (TV)
products affect cultural
or national identity of
product features
vary in terms of:
•size (cars)
(electrical appliances)
• packaging ^ _ ^
products ca
y country-
specific cjuality
associations (vyines)
Administrative Distance
absence of colonial ties
absence of shared
monetary or political
government policies
institutional weakness
government involvement is
high in industries that are:
• producers of staple goods
• producers of othe
"entitlements" (drugs)
• large employers (farming)
• large suppliers to
government (mass
• national champions
•vital to national security
•exploiters of natural
esources (oil, mining)
•subjectto high sunk
costs (infrastructure)
Geographic Distance
physical remoteness
lack of a common borde
lack of sea or river access
size of country
weak transportation o
communication links
differences in climates
products have a low
value-to-weight or bulk
atio (cement)
products are fragile
or perishable
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 facto
cost differences are salient
distribution or business
systems are different
companies need to be
esponsive and agile
(hpjne appliances)
portance to companies that deal with
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 Fariborz Ghadar, was published
in the July-August 2000 issue of HBR.
contrast, affects consumers' product
preferences. It is a crucial consideration
for any consumer goods or media com-
pany, but it is much less important fo
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 ofthe factors and the ways in
which they affect particular industries.)
In the following pages, I will review the
four principal dimensions of distance,
starting with the two 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
eligious beliefs, race, social norms, and
language are all capable of creating dis-
tance between two countries. Indeed,
they can have a huge impact on trade: All
other things being equal, trade between
TOOL K I T • Distance Sti l l Matters
countries that share a language, for ex-
ample, will be three times greater than
etween countries without a common
Some cultural attributes, like lan-
guage, are easily perceived and imder-
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 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 University
Press, 1995), many people ascribe this
social norm to China's recent commu-
nist past. More likely, Alford argues, it
flows from a precept of Confucius that
encourages replication ofthe results of
past intellectual endeavors: "I transmit
ather 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 1920s, for example, Me
Webster, about to introduce a bilingual
dictionary in China, found that the
Commercial Press in Shanghai had al-
eady begun to distribute its own ver-
sion ofthe new dictionary. The U.S. pub-
lisher took the press to a Chinese court,
which imposed a small fine for using
the Me
iam Webster seal but did noth-
ing to halt publication. As the film and
music industries well know, little has
changed. Yet this social norm still con-
founds many Westerners.
Most often, cultural attributes create
distance by infiuencing the choices that
consumers make between substitute
products because of their preferences
for specific features. Color tastes, fo
example, are closely linked 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, prefe
automobiles and household appliances
to be small, refiecting a social norm
common in countries where space is
highly valued.
Sometimes products can touch a
deeper nerve, triggering associations
elated to the consumer's identity as a
member of a particular community. In
these cases, cultural distance affects
entire categories of products. The food
industry is particularly sensitive to reli-
gious attributes. Hindus, for example,
do not eat beef because it is expressly
idden by their religion. 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, ca
ies an enor-
mous 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 com-
pany assumed that the TV business was
insensitive to culture. Managers eithe
dismissed or were unaware of evidence
from Europe that mass audiences in
countries large enough to support the
development of local content generally
prefer local TV programming. If they had
taken cultural distance into account,
China and India could have been pre-
dicted to require significant investments
in localization. TV is hardly cement.
Administrative or Political Dis-
tance. Historical and political associa-
tions shared by countries greatly affect
trade between them. Colony-colonize
links between countries, for example,
oost trade by 900%, 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-
ing a
angements, common cu
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 different ways.
To estimate industry sensitivity to
distance, Rajiv Mallick, a research
associate at Harvard Business School,
and I regressed trade between every
possi ble pa i r of cou ntries i n 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 ofthe industries
that are more and less sensitive to
Linguistic Ties
meat and meat preparations
cereals and cereal preparations
miscellaneous edible products
arid preparations
tobacco and tobacco products
office machines and automatic
data-processing equipment
photographic apparatuses,
optical goods
Answered Same Day Mar 22, 2023


Dipali answered on Mar 23 2023
16 Votes
Table of contents
Discussion    3
References    5
In his article "Distance Still Matters," Pankaj Ghemawat argues that despite advances in technology and globalization, distance remains an important factor in shaping economic and business activity. He contends that companies often overlook the significance of geographic proximity when making decisions about sourcing, production, and distribution, leading to suboptimal outcomes.
Ghemawat starts by debunking the notion of a borderless world, pointing out that cross-border flows of goods, services, and capital account for only a small fraction of economic activity. Most economic transactions still take place within national borders, with only a small percentage of companies engaging in international trade or investment (Hutzschenreuter & Kleindienst, 2019). Even within countries, distance can play a significant role in shaping business activity, with companies often clustering in specific regions to take advantage of local expertise, infrastructure, and networks (Guo & Lu, 2019).
Ghemawat then explores three dimensions of distance that impact economic activity: cultural distance, administrative or political distance, and geographic distance. Cultural distance refers to differences in language, religion, values, and customs, which can create ba
iers to communication and collaboration between individuals and organizations (Disdier & Head,...

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