Last week, in this global strategy discussion, we tackled the question of why. This week, we tackle the question of where.
Where
When an organization decides to operate outside of its borders, the question of where depends on why. If the reason for crossing borders is to broaden revenue opportunities, then the essential questions revolve around the market opportunity and the likelihood of market success. If the reason is to improve the value chain, then the essential questions revolve around factors of production, logistical infrastructure, and local administrative and institutional conditions.
Economists normally consider two important factors when studying trade between countries—size of economies and distance between economies. Larger the economies mean increased opportunities for trade and shorter distances decrease logistical difficulties. However, geographic distance is not as critical for many industries, especially those in the business of intangibles, such as dissemination of online content. In fact, given advances in global logistics, even with tangible products, there are factors even more important than geographic distance.
When understanding the desirability of a location for purposes of increasing revenue opportunities, the basic viability questions used for any new business can be asked: Can the business become market viable? Can it operate efficiently and effectively at scale? And can the business earn enough to pay for its cost of capital? These three viabilities of market, operations, and financial or economic must be asked.
It is usually clear that operating in a different country requires being able to adjust to local law. But this is typically not the only difference a multinational must be aware of when deciding to enter a new country. The risks involved in expanding beyond the home marketplace involve much more than different laws or dealing with geographic distance, or even language. The reason for this is that the existing business model has been crafted within the home country situation. This means it takes into account domestic norms and references and even presumes certain things exist in the business environment. For example, delivering service with a smile can run into problems in Germany where it is considered impolite to smile to strangers. Spanish companies would lose critical shopping hours if they implemented siesta in other countries. Western e-commerce companies would have difficulty relying only on credit cards and Paypal when entering developing markets.
Distance and Differences
Hence, regardless of the reason for internationalization, one of the most important questions a company needs to ask concerning operating in another country is whether it needs to amend its strategy, activities, or organization. CAGE distance framework provides an approach to evaluating these differences between countries. He provides four categories of what he calls distance: Cultural distance includes differences emanating from differences in ethnicities, religions, or social norms. These differences affect customer preferences and behavior, and also affect employee and local partner behavior. For example, fast food chains must adapt their menu, kitchen lay-out and food procurement in order to provide Halal food offers in Islamic markets. Administrative distance captures differences in government policy, strength of local financial institutions and intermediaries as well as strength of institutions and intermediaries in the areas of labor, market, and logistics; and the effects of such things as bilateral or multinational trade agreements and colonial ties. Geographic distance involves an understanding of physical remoteness, physical access (transportation infrastructure), size, communication access, and climate. For example, certain remote locations become inaccessible during typhoon season. Finally, economic distance covers such things as differences in consumer income, costs and quality of local resources, including natural resources, talent, infrastructure, information, and intermediate inputs for production.
The larger the distance, the more adjustments companies must make when entering new markets, and, hence, potentially, the higher the risks. The results of CAGE distance analysis can affect the three key viabilties and should be taken into account regardless of the reason for internationalization.
To my students, I normally recommend supplementing adding a SGORR analysis to the core CAGE analysis when the reason for internationalizing is for globalizing markets. The first two letters refer to the evaluation of the size and potential growth of the market. It is important to look at both customer base and revenue opportunity. O refers to the available opportunity. For example, opening a store in California is potentially a doorway into the United States whereas opening in Guam is probably simply about the Guam market. Finally the final two R’s mean Resources and Risks. The company needs to ask whether the essential resources exist or can be developed in the new location. The company also needs to ask what risks are involved.
Next week, we address the question of when and how.
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References: (a) Gallegos, Herrera et al Asian Institute of Management Strategic Management Department Strategic Management Cycle, 2017, (b) Ghemawat, P. (2001). Distance still matters. Harvard business review, 79(8), 137-147.
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